How does inflation lead to a balance of payments deficit?

Most people avoid studying inflation because they think it is a technically complex phenomenon. There are hardly any forums where you can learn it quickly. Everyone should know about inflation and its link with the balance of payment deficit goals. When expatriates make international money transfers, like the Pakistani overseas workers who send money to Pakistan frequently, it profoundly impacts inflation and the balance of payment deficit.

ACE Money Transfer, however, takes it as a challenge to simplify the complex ideas for you. This tradition continues into this topic too.

International money transfers directly affect inflation and a country’s balance of payment positively. You will study both in the context of remittances and the best international money transfer services in the world. Let’s begin here!

What are imports and exports, and how do they impact an economy?

Imports and exports are some of the essential components of an economy. Be it an agricultural economy or one based on science and technology, without imports and exports, survival is impossible. Both imports and exports are directly connected to the balance of payment deficit one way or the other.

Defining Imports and Exports 

What are Imports?

Imports are the goods and services purchased from the outside world by a country’s residents. When the government cannot produce the required goods and services, it results in the outbound flow of funds to the manufacturers.

What are Exports?

Exports are the goods and services produced within a country and sent to the outside world. It happens when a country meets all the demands of its people and then sells out the goods and services produced domestically to other countries. It results in the inbound flow of funds as the buyers from outside pay for the same goods and services.

Understanding Imports and Exports Simply

Imagine two countries A and B are in imports and exports. Now, A’s imports from B are the exports of B to A and vice versa.

The impact of Imports and Exports on an Economy

There are many effects of imports and exports on an economy. A few critical, however, are discussed here.

  • Impacts on GDP

GDP or the Gross Domestic Product measures a country’s overall economic activity. If the imports exceed the exports, it will pull capital out of the country. It will put stress on the country’s currency and push inflation which will weaken the purchasing power of people.

  • Impacts on Exchange Rates

A weak currency will make imports more expensive. And if an item costs higher, it will be sold in the market even costlier. Therefore, low exchange rates of a currency are the primary reason for expensive imports and cheap exports concerning the value of the currency in which these are purchased.

  • Impacts on Inflation

As explained above, exceeding imports can push inflation as goods and services purchased from the outside world at a higher cost will be sold even more costlier. And this will weaken the purchasing power of the people. And the problem is complicated when the value of the currency is also low.

However, increasing exports, on the other hand, will control and decrease inflation since more capital and revenue will be brought into the country through exports. Exports will also help reduce inflation by improving countries’ exchange rates while strengthening GDP and economic power.

Now, let’s understand the balance of payment deficit and how it occurs.

  • Understanding Balance of Payment

The balance of payment is the savings by a country’s residents and whether these savings are enough to pay for a country’s imports. It also indicates if a country is viable enough economically to pay for its growth and afford it.

What is the Balance of Payment Deficit?

A deficit in the balance of payment occurs when a country imports more than it exports. And in such a scenario, a government necessarily borrows from international lenders to pay for its imports’ bills.

How does the balance of payment deficit occur?

There are several reasons for the balance of payment deficit. But, the following are the main reasons.

  • Rapid Developments

The outflow of capital from a country to pay for the technology, machines, and equipment can lead to a balance of payment deficit.

  • Persistent Inflation

The persistence of inflation in an economy can also lead to a high balance of payment deficit.

  • Political Instability

When a country suffers political instability and rough law and order situations more often, it is bound to undergo the balance of payment deficit.

Now, let’s see the link between the balance of payment deficit and imports & exports.

The link between the balance of payment deficit and imports/ exports.

There is a direct link between the deficit in the balance of payment and the imports and exports. As you have already studied above thoroughly, the deficit in the balance of payment occurs in the first place due to imports exceeding exports. Of course, when a country cannot meet the demands of its population for certain goods and services, it will have to import those from abroad through domestic production. For that, the said country will have to make payments. And since there is a shortage of domestic productivity, there are high chances that the government will borrow money from international money lenders.

It ultimately pushes inflation and results in a drop in the purchasing power of people.

The possible measures to control the balance of payment deficit

These are a few measures by which you can correct the balance of payment deficit.

Flexible Exchange Rates

The forces of demand and supply will automatically adjust the disequilibrium in the balance of payment deficit if the exchange rates are flexible.

 

Direct Government Intervention

Governments adopt measures to control the flow of imports and exports directly. These measures can aim to adjust the deficit in the balance of payment.

The Capital Movement also Helps Adjust the Deficit.

A massive capital can be moved in or out of the country to adjust the deficit in the balance of payment. The practice is in vogue in the modern world.

Increasing Exports

An increase in exports can also help adjust the deficit. Governments can devise export encouraging policies to accommodate the deficit.

Slashing Expenditures

Governments are supposed to take measures to ensure expenditures are cut. These measures can include austerity by the government officials, a ban on luxury cars for the officials etc.

The Role of Remittances in this Scenario

Remittances are the funds sent in by the expatriates. Such money can be seen as an earning through exporting human resources. Therefore, if a country invests heavily in their people to enhance skills and education, they can be of immense help to it after they go to other countries to earn remittances with the skills they have developed back home. For example, the number of Pakistani expatriates worldwide that send money to Pakistan online helps lift the living standards of their families along with aiding to achieve the balance of payment deficit goals.

The best method for International Money Transfer

Many methods are available for international remittances, such as wire transfers. But not all methods can offer all the same features. For example, a wire transfer through banks takes slightly longer than expected but is safe, with high fees and low exchange rates.

But, if you look for a low fee, best rates, and speedy transfer with security and convenience etc., all at once, you will have to search for the best online money transfer companies, which are a few in numbers across the world, including ACE Money Transfer. The company has millions of customers worldwide, especially Pakistani overseas workers who need to make online money transfers to Pakistan rely on ACE’s remittance services.