Causes of BoP Deficit (BoP Disequilibrium)
The BoP deficit or Balance of Payment Disequilibrium occurs due to various factors, which may be economic or non-economic. In some cases, the economic factor may be dominant, while in other non-economic factors are creating a BoP deficit. The major factors which are responsible for the BoP deficit in Nepal are as follows:-
1) Domestic Price level of Inflation:
If the domestic price level is higher than other countries, it makes the domestic products less competitive in the market. It reduces the export and increase the import and there may be BoP deficit dies to the falling net export.
2) Domestic Interest Rate:
If the interest rate is falling continuously, it may encourage the capital flight or net capital outflow which may result in BoP deficit.
3) Exchange Rate:
If the domestic currency appreciates, it makes import more cheaper and export expensive which can cause BoP deficit.
4) Economic Condition of Regional and Global Economy:
If there is recession or depression in the regional and global economy, it reduces the export demand of the country which may cause BoP deficit.
Recession – slowdown in economic activity across the economy, usually visible in GDP, employment, income, and production.
Depression – much more severe and prolonged downturn than a recession. No strict formula, but generally a recession lasting several years. GDP declines by 10% or more.
5) Policy:
If the export destination country increases tariff and non- tariff barriers, it makes export expensive and reduces the export. This results in BoP deficit.
6) Status (structure) of the economy:
If the country is developing by making huge investment in infrastructure and industrialization through import of the machinery and equipment, there may be BoP deficit in such early phase of development.
7) Natural Disaster:
The frequent occurrence of natural disaster such as flood, landslide, earthquake may create huge economic loss resulting in BoP deficit.
8) Political Factor:
Political instability is another cause of BoP deficit as it disturbs the smooth functioning of the business which may create BoP deficit.
9) Policy of the Government:
If the government is more liberal for import in order to generate more revenue, it encourages the import and may cause the BoP deficit.
10) Nature and Pattern of Foreign trade:
If the country exports raw materials, agricultural and low value added products and imports high value added products and technology, it may create BoP Deficit.
How to Correct BoP Deficit
If the BoP deficit is more serous and threatening to overall macro-economic stability, then it should be corrected through policy intervention. The major policies for correcting BoP deficit are:
- Devaluation of domestic currency
- Control of domestic price level of inflation
- Export promotion through fiscal and monetary incentives
- Import restriction through fiscal and monetary measures
- Encourage foreign investment by providing fiscal and monetary incentives
- Provide incentives to attract foreign tourists
- Exchange control policy
- Priority and incentives for the use of local products
- Postpone the capital intensive mega-infrastructure developed through import of machinery and equipment.
- Minimize the government expenditure in forex by reducing the number of abroad visits and no of participants.
- Promote public awareness for the use of domestic products and reduce the import of goods and services.
- Control of illegal and informal cross boarder transaction such as Hundi, Crypto, online gambling etc.
- Provide incentives to channelize foreign remittance into the formal system.
Causes of BoP Deficit
- High Inflation: Makes domestic goods less competitive → exports fall, imports rise.
- Low Interest Rate: Causes capital flight and outflow.
- Exchange Rate Appreciation: Imports cheaper, exports costly.
- Global Recession/Depression: Reduces demand for exports.
- Trade Barriers Abroad: Tariffs/non-tariff barriers reduce exports.
- Developing Economy Structure: Heavy imports of machinery/equipment during industrialization.
- Natural Disasters: Floods, earthquakes, etc. cause economic loss.
- Political Instability: Disturbs trade and investment flow.
- Import-Liberal Policies: Boost imports for revenue generation.
- Trade Pattern: Export of low-value goods, import of high-value technology/products.
Measures to Correct BoP Deficit
- Devalue currency to make exports cheaper.
- Control inflation to keep goods competitive.
- Promote exports with fiscal/monetary incentives.
- Restrict imports through policies.
- Encourage FDI & remittances via incentives and formal channels.
- Boost tourism and local product consumption.
- Control foreign exchange outflow (govt. spending, informal channels).
- Postpone capital-intensive projects that require heavy imports.
Other Notes