FACTORS AFFECTING BALANCE

OF

PAYMENTS
o!e"tic C#rrenc$% A lower value of the

Export of Goods And Services The Prevailing Exchange Rate 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--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. f 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. !or example, suppose ndia exports "## $uintals of wheat to the %& at a price of 's.(## per $uintal. !urther, assume that due to domestic inflation, the price increases to 's.()# per $uintal and there is a resultant fall in the $uantity demanded to *+ $uintals. The exports would increase from 's.(#,### to 's.(,,-## instead of falling. &orl' Price" of a Co!!o'it$. f 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 /e 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. Inco!e" of Foreigner"% There is a positive correlation /etween 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 0and hence, an increase in the incomes of the residents1 of such an economy will result in an increase in the exports of the domestic economy 2nce again, this would increase the demand for the local currency. Tra'e Barrier"% Higher the trade /arriers erected /y other economies against the exports from a country, lower will /e the demand for its exports a hence, for its currency.

Imports of Goods and Services mports of goods and services are affected /y the same factors that affect the exports. 3hile some factors have the same effect on imports as on exports, so of them have an exactly opposite effect. (al#e of the o!e"tic C#rrenc$% 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 o!e"tic Inco!e. 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 Price"% The. nternational demand and supply positions deter the international price of a commodity. A higher international price would translate into a higher domestic price. f 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. n 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 /ee relatively cheaper than domestically produced goods and services would increase the demand for the former, and hence, the supply domestic currency. Tra'e Barrier"% Trade /arriers have the same effect on imports exports - higher the /arriers, lower the imports, and hence, lower the supply of the domestic currency. Income on Investments 4oth 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 /e earned in an economy. !or payments, it is the level of past foreign investments and the current domestic rates of return5 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 /roadly affected /y two factors. 2ne is the num/er 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 /y granting aids to other countries along with the economic capa/ility to do so, or its need to take aids and grants from other countries to tide over difficulties.

Capital Account Transactions !our ma6or factors affect international capital transactions. The foremost is the rate of return which can /e earned on the investments as compared to the returns that can /e earned on domestic investments. The higher the differential returns offered /y a country, the higher will /e the capital inflows. Another factor is the additional risk that accompanies these returns. 7ore the risk, lower the capital inflows. 8iversification across countries may offer some extra /enefit in addition to the returns offered /y a particular investment. This /enefit arises from the fact that different economies may /e at different stages of economic cycle at a given time, thus making their performance unrelated. Higher the diversification /enefits, higher the inflows. 2ne more factor, which has a very significant affect on these transactions, is the expected movement in the exchange rates. f the exchange rates are $uite sta/le, or the movement is expected to /e in the investors9 favor, the capital inflows will /e higher.