Correction of Balance of Payment is a long term objective. Economies need strong and consistent steps to handle deficit Balance of Payment. BOP comprises of current account, capital account, unilateral transfer account, official reserve transaction account. These individual factors can be corrected by their consisting elements, as current account consists of transactions of tangible goods. This is also called balance of trade and to bring it at equilibrium level productivity has to be improved.
Apart of these micro aspects there are three vital monetary tools or methods to control these imbalances and correction of balance of payment. There are three mechanism used with some degree of mixture in most situations. Exchange rate of currency, adjustment of prices within the country with its demand level and rules based adjustment.
Exchange Rate Adjustment
Exchange rate of local currency against other international currencies is very important and sensitive issue. When it comes to across border dealing the significance is increased many fold. The imports will be cheaper if the value of currency increases and the export prices of local product will be increased, which makes local products expensive in global market, this mechanism will corrects the surplus balance of payment. Contrary the devaluation of currency has adverse affect and imports decreases while export will increase as the products prices become more competitive.
[linkunit]Exchange rate determined by the government by considering different influential forces.This system works as when the country makes more imports, the demand of currency of seller’s country increases as importer needs the currency to make payments. Increasing demand of exporter’s countries will increase the value of currency of exporter country. Countries use their currency exchange rate to correct balance of payment and to be competitive in global market. Competitive devaluation of currency makes the export flourish. US has passed a bill to push China for increase the value of its currency, it is because the us balance of payment is in deficit with china and with the increase in Chinese currency value make the products of china expensive in US and demand will decrease and exports will go down.
Correcting the balance, by adjusting prices and demand is applicable when the exchange rates are fixed by gold standards and difficult to change. This system has an automatic adjustment mechanism. A surplus balance of payment means more money inflow which leads to higher inflation rate. Inflation makes the value of money decrease, resulting an upward trend in prices and export products become expensive and lead to an automatic adjustment.
Rule Based Mechanisms
Deficit of balance of payment can be controlled by negotiating the Exchange rate with each other. Countries can enter mutually agreed contracts for the balancing the payments. Some economists are of the view that Traditional balancing mechanisms should be supplemented by the threat of confiscation of a portion of excess revenue if the imports did not increased by the surplus country.