Development Economics International Trade

Balance of Payment, Causes of Deficit and Measures to remove Deficit


The balance of payment position of Pakistan remained unsatisfactory. Pakistan is a developing country. Which has to import industrial raw material, machinery, and modern technology. Due to the shortage of capital resources, Pakistan had to depend on foreign capital assistance which has increased debt burden and debt serving.

Meaning of Balance of Payments:

The balance of payments, (BOP) measures the payments that flow between any individual country and all other countries. It is used to summarize all international economic transactions for that country during a specific time period, usually a year. The BOP is determined by the country’s exports and imports of goods, services, and finance capital, as well as financial transfers. It reflects all payments and liabilities to foreign (debits) and all payments and obligations received from foreigners (credits). Balance payments is one of the major indicators of a country’s status in international trade with net capital outflow.

In simple words:

The balance of payments refers to the sum of both the balance of visible and invisible items. The balance of payment is a comprehensive record of a country with the rest of the world during a given period of time.

Causes of Adverse Balance of Payments:

Income Type of Disequilibrium

The deficit may arise because of changes in the income level of a country. If in a country the incomes are rising more than the rest of the world, it will have the effect of increasing the imports of the country, when import increase the demand for foreign exchange will go up. Hence the foreign payment will increase. Again, because of the rise in incomes, the consumption in the country will increase and the export surplus will decrease. In this way, the foreign receipts will come down..

Price Type of Disequilibrium

The changes in the price level are al responsible for the BOP deficit. If in a country due to demand-pull inflation or Cost-push inflation, the price level rises, the domestic products will become expensive. In this way, the exports of a country may fall. Moreover, the imports of a country may increase. In this way, receipts will come down and payments will increase. Hence the deficit in BOP will occur.

Structural Changes

The structural changes which occur in an economy are also responsible for deficit in the BOP. They are as:

If in a country, the population increases, the domestic use of goods will increase. In this way, the exports will decrease, and imports will increase.

If in a country, the natural resources are depleted the exports of iron, gas, and copper, etc. may come down.

If in the world, the substitutes are developed, as the case of polyester against cotton, acrylic against wool, etc., they may have the effect of reducing the exports of a country.

If in the world, foreign competition increases, exports may decrease. As the case of cut-throat competition in the field of electronics and automobiles etc. may have the impact of reducing a country’s exports.

If a country is engaged in the process of economic development, it has to import machinery, raw material and a variety of goods. In this way, the country has to spend foreign exchange on its importation.

Capital Movement

The capital movement is also responsible for deficit in BOP. Due to political instability, the domestic capital is flowing out of the country has to spend a lot on military hardware, or the country has to make the repayments of the foreign loans, etc. In such all cases the foreign payments of a country will increase. Again, if the foreign capital is not coming to the country, the receipts of a country may also go down. Thus, the changes in the capital movement at capital accounts of BOP are also responsible for deficit in the BOP.

Increase in Imports:

Pakistan is a developing country and has to import industrial raw material, machinery, instruments, and capital goods while exports could not increase. Besides above, it has to spend a lot of foreign exchange on the import of consumer goods, petrol, defense armaments etc.

Low Volume of Exports:

Pakistan’s exports consist of agricultural raw material and primary goods. Due to unfavorable weather conditions, crop production of rice and cotton remains low and due to political instability, industrial production is also affected which decreases the volume of export.

Increase in Import Prices:

Both the quantum and price of imports are increasing. Pakistan devalued its currency in 1955 and in 1972, therefore, import price increased, In 1982, Pakistan declined its currency from the U.S. dollar which resulted in an approximately 150% decrease in the external value of the currency. Presently due to the Gulf crisis, the 9/11 crisis, the Afghanistan crisis, and Iraq our prices increased. Therefore, terms of trade remained Unfavorable for Pakistan.

Increase in Domestic Demand:

Domestic demand for goods services has incredibly increased due to a higher population growth rate. The major portion of the goods and services produced in the country consumed, therefore, a smaller portion is left for exports.

Increase in Defense Needs:

Pakistan is surrounded by enemies. Pakistan has not good relations with India, the ex-Soviet Union, and its states.


The price level in Pakistan has increased rapidly. The cost of production has increased due to an increase in wages and prices of other factors of production. Due to the increase in export prices, Pakistan has to face tough competition with other countries whose products cheaper and more durable.

Increase in Invisible Imports:

Pakistan’s invisible export are less than the invisible imports which make the balance of payments position and the terms of trade Unfavorable.

A decrease in Amount of Foreign Aid:

Developed countries have decreased the amount of foreign aid to developing countries like Pakistan. Aid-to-Pakistan consortium, non-Consortium and Islamic countries have been the three main, sources of aid. Consortium and non-consortium countries have decreased the quantity of foreign aid based on our peaceful atomic program. After the nuclear explosion, the situation further worsened but for the last few years, the conditions have changed in favor of Pakistan.

The difference in Import and Export Prices:

Pakistan mainly exports agricultural raw material and primary goods and imports industrial raw material and industrial machinery. Export prices of agricultural raw material and primary goods are fluctuating while import prices are either stable or increasing. The relative increase in import prices is greater than relative increase export prices which makes terms of trade Unfavorable.

Ambitious Development Programs:

Necessitating the large-scale import of machinery, plants and encampment, raw material and technical know-how.

Food Imports:

A number of food products e.g, wheat, sugar, edible oil, onion, potatoes, etc., are imported to meet the shortages.


Another cause is the protectionism of the other countries which give rise to low exports and the soft-commercial policy of this country gives rise to more imports.

Cost of Production:

If the cost of production is low prices are low and there are more exports and vice-versa. The cost of production may be low due to improved technology.


The balance of payments (on current A/C) is said to be balanced when the total of credit items is exactly equal to the total of debit items. But it is seldom so. Hence, there is either a deficit or surplus in the current A/C. The deficit or surplus is met by transfers from the capital A/C. In other words, the balance of payments is made to balance through the capital A/C. If for instance, there is a deficit in the current A/C. of the balance of payments. The deficit will be covered by (i) drawing upon the country’s foreign exchange reserves, (ii) by borrowing from abroad, (iii) by exporting gold.

Measures to Correct Balance of Payments:

Stimulating Exports and Checking Imports:

If total export earnings have fallen short then steps should be taken to increase and for this purpose, the cost of production may have to be brought down and giving subsidies to exporters, providing them information through trade delegations. The imports of luxuries and other unnecessary imports either be prohibited or curtailed.

Industrial Development:

Pakistan’s Balance of payments is unfavorable because Pakistan exports primary goods and agricultural raw material and imports industrial goods and industrial raw material whose prices are increasing rapidly. To avoid further increasing of balance of payments there must be industrial development.

Control on Inflation:

The general price level in Pakistan is increasing which is raisings the export prices and increased export prices are decreasing the quantity of exports, but a higher price level is attracting imports. People demand foreign-made goods due to the small difference in price. An increase in inflation rate is depreciating the currency.

Terms of Trade:

Terms of trade of Pakistan are unfavorable which is an increasing deficit in our balance of trade and balance of payments so there is a need to improve terms for trade by exporting finished goods instead of raw material and primary goods.

Balanced Growth:

Balanced growth means the development of various sectors of the economy simultaneously. In Pakistan the agricultural sector dominated in the earlier periods. The result was that other sectors of the economy remained neglected and we have to import the necessary goods to meet the shortage.

Protection of Local Industry:

The government should protect local industries and package of incentives must be and there should be trade restrictions on the import of goods competing with local goods.

Import Substitution:

Instead of import of consumer goods and capital goods, we must import machinery for import substitution which will save foreign exchange on imports and make the balance of payments unfavorable.


Pakistan’s balance of payments is now worsening due to repayment of debt and debt servicing. To avoid further deficit, we must follow the self-reliance policy.

Diversification of Economy:

In the beginning, Pakistan was exporting only raw material and now attention has been given to export finished products instead of raw material.

Decrease in Invisible Imports:

Although the invisible imports play an important role yet local services should be utilized to save foreign exchange.

Exploring Export Markets:

More emphasis should be laid on export survey and export market entry. It is paramount importance that our exporters should know more about operating in a foreign market. It must also be our export policy to make preparations for organizing our efforts to secure more export orders from abroad. There is a need to survey foreign markets, opening of display centers and information offices abroad and exploring the foreign markets by our manufactures for sale of Pakistani goods.

Fiscal and Financial Incentives:

Fiscal and financial incentives are must to increase the quantum of exports.

Export income should be exempted from income tax as is being done in India and other countries. The procedure for receiving the export duty-drawback should be made simple and expeditious. The rate of interest on export refinance should also be minimized and the loans granted liberally.

To Give Subsidies to Exporters

Any country which faces a deficit in BOP should give subsidies to the exporters. These subsidies may consist of rebates and giving of foreign exchange to the exporters and selling of domestic products in the world markets at cheaper prices etc. They may also consist of granting loans at reduced rates to the exporters as well as providing insurance facilities and concessions in cargo and shipment services etc. But the policy of giving subsidies to the exporters is not justified from the economic point of view. As giving of subsidies on exports means that a country is selling the products at the price far less than its cost. This is the reason that the giving of subsidies is like following the practice of dumping and because of this reason, so many countries are imposing the anti-dumping laws which may check the country’s exports. subsidizing the other countries may also follow it. In this way, the benefits of subsidies will not be availed.

Restrictions on Imports

Any country which faces a deficit in BOP may also impose restrictions on imports. Such restrictions may be consisting of an increase in import duties, the imposition of exchange control, etc. In this way, the prices of imports in e country will increase. Accordingly, the imports will decrease. By following this practice, the process of import substitution in a country will start, In this way the dependence on imports will fall and demand for foreign exchange will come down.

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