FACTORS AFFECTING BALANCE OF PAYMENTS

Export of Goods And Services

The Prevailing Exchange Rate of the Domestic Currency: A lower value of the domestic currency results in the

domestic price getting translated into a lower international price. This increases the demand for domestic goods and

services and hence their export. This is likely to result in a higher demand for the domestic currency. A higher exchange

rate would have an exactly opposite effect.

Inflation Rate: The inflation rate in an economy vis-à-vis other economies affects the international competitiveness of

the domestic goods and hence their demand. Higher the inflation, lower the competitiveness and lower the demand for

domestic goods. Yet, a lower demand for domestic goods and services need not necessarily mean a lower demand for

the domestic currency. If the demand for domestic goods is relatively inelastic, then the fall in demand may not offset the

rise in price completely, resulting in an increase in the value of exports. This would end up increasing the demand for

the local currency. For example, suppose India exports 100 quintals of wheat to the US at a price of Rs.500 per quintal.

Further, assume that due to domestic inflation, the price increases to Rs.530 per quintal and there is a resultant fall in

the quantity demanded to 96 quintals. The exports would increase from Rs.50,000 to Rs.52,800 instead of falling.

World Prices of a Commodity: If the price of a commodity increases in the world market, the value of exports for that

particular product shows a corresponding increase. This would result in an increase in the demand for the domestic

currency. A fall in the demand for domestic currency would be experienced in case of a reduction in the international

price of a commodity. This impact is different from the previous one. The previous example considered an increase in

the domestic prices of all goods produced in an economy simultaneously, while this one considers a change in the

international price of a single commodity due to some exogenous reasons.

Incomes of Foreigners: There is a positive correlation between the incomes of the residents of an economy to which

the domestic goods are exported, and exports. Hence, other things remaining the same, an increase in the standard of

living (and hence, an increase in the incomes of the residents) of such an economy will result in an increase in the

exports of the domestic economy Once again, this would increase the demand for the local currency.

Trade Barriers: Higher the trade barriers erected by other economies against the exports from a country, lower will be

the demand for its exports a hence, for its currency.

Imports of Goods and Services

Imports of goods and services are affected by the same factors that affect the exports. While some factors have the

same effect on imports as on exports, so of them have an exactly opposite effect.

Value of the Domestic Currency: An appreciation of the domestic currency results in making imported goods and

services cheaper in terms of domestic currency, hence increasing their demand. The increased demand imports results

in an increased supply of the domestic currency depreciation of the domestic currency have an opposite effect.

Level of Domestic Income: An increase in the level of domestic income increases the demand for all goods and

services, including imports and it results in an increased supply of the domestic currency.

International Prices: The. International demand and supply positions deter the international price of a commodity. A

higher international price would translate into a higher domestic price. If the demand for imported goods is inelastic, this

would result in a higher domestic currency value of in increasing the supply of the domestic currency.

In case of the demand elastic, the effect on the supply of the domestic currency would depend the effect on the

domestic currency value of imports.

Inflation Rate: A domestic inflation rate that is higher than the inflation of other economies, would result in imported

goods and services bee relatively cheaper than domestically produced goods and services would increase the demand

for the former, and hence, the supply domestic currency.

Trade Barriers: Trade barriers have the same effect on imports exports - higher the barriers, lower the imports, and

hence, lower the supply of the domestic currency.

Income on Investments

Both payments and receipts on account of interest, dividends, profits etc., depend on the level of past investments and

the current rates of return that can be earned in an economy. For payments, it is the level of past foreign investments

and the current domestic rates of return; while for the receipts it is the past domestic investments in foreign economies

and the current foreign rates of return, which are relevant.

Transfer Payments

Transfer payments are broadly affected by two factors. One is the number of migrants to or from a country, who may

receive money from or send money to relatives. The second is the desire of a country to generate goodwill by granting

aids to other countries along with the economic capability to do so, or its need to take aids and grants from other

countries to tide over difficulties.

Capital Account Transactions

Four major factors affect international capital transactions. The foremost is the rate of return which can be earned on the

investments as compared to the returns that can be earned on domestic investments. The higher the differential returns

offered by a country, the higher will be the capital inflows. Another factor is the additional risk that accompanies these

returns. More the risk, lower the capital inflows. Diversification across countries may offer some extra benefit in addition

to the returns offered by a particular investment. This benefit arises from the fact that different economies may be at

different stages of economic cycle at a given time, thus making their performance unrelated. Higher the diversification

benefits, higher the inflows. One more factor, which has a very significant affect on these transactions, is the expected

movement in the exchange rates. If the exchange rates are quite stable, or the movement is expected to be in the

investors' favor, the capital inflows will be higher.