Economics is the social science that analyzes the production, distribution, and consumption of goods and services.

Monday, 5 December 2011

Policy to reduce BOP deficit

Policy to reduce BOP deficit

1.         Monetary policy
Government increase the rates of interest rate, it become costly to borrow, people borrow less, spend less, so consumption decrease. (When money supply decrease the aggregate for the total import will reduced)

2.         Fiscal policy
Increase taxes for import goods (tariff) will causes increasing in the prices of imported good. So, demand for import goods will fall. The demand for imported goods decrease causes the falling in outflow income. So, deficit in BOP will controlled.

3.         Direct control
Discourage imports, imposed trade barriers for example: tariff, it will lead to an increase in the price of import goods, so the value of imports goods will reduces. (Or encourage people to buy local goods instead of import goods)

Encourage export, by giving subsidies to exporters where can reduces the cost of production and total export will increase. (by giving allowances to export duties)

4.         Devaluation
Decrease value of domestic currency compare with foreign currency.

Before devaluation $1USD = RM3.50
After devaluation $1USD = RM3.80

So, high cost to buy import goods. The domestic goods will cheaper then foreign goods. So, inflow incomes will more than outflow income. So, problems of deficit BOP will controller.


A.                 Methods used to finance a balance of payments deficits
                                             i.                        Borrowing
-          Another country
-          The International Monetary Fund (IMF)
-          The International Finance Corporation (IFC)
-          The International Development Association (IDA)

                                           ii.                        Imports on credit
-          Purchase now, pay later

                                         iii.                        Exporting Gold
-          The reserves of gold held by Malaysia can be exported to cover the deficit.

                                         iv.                        Receiving Foreign aid
-          An outright gift in money or materials
-          An interest free loan
-          An outright cancellation of debt owed.

B.                 Methods used to correct a recurrent deficit

                                             i.                        Restrict imports.
There are many ways of trying to reduce imports. The first is by imposing tariff on imported goods. This will raise the prices of imported goods and thus tend to reduce the demand for them.

It will only reduce expenditure on imported goods if the demand for imported goods is elastic. This means when the price of import rises a little, the local people will reduce the quantity purchased by a large amount. As a result of this the expenditure on imported goods will decrease.

                                           ii.                        Increase exports.

There are many methods that can be used to increase export revenue. For example by increasing the quality of the export goods, it can be done by carrying out research and development. The exported goods can more quality with using the modern technology in production processing.

Besides that’s, government can encourage of export by reducing the cost of production. It can decrease the cost to produce something goods. So, the exporter can increase the efficiency in production and more goods can be export out of country.

The government also can give subsidies to exporters. This ways causes the exporter to export more quantities of the exported goods.

                                         iii.                        Devaluation.

Devaluation occurs when a country announces to reducing the value of local currency in term of others currency in the world. By this method, the exported goods become cheaper to the foreigners and imported goods become expensive to the local people.

            Before devaluation   RM3.50 = USD$1
            After devaluation      RM3.80 = USD$1

If a book in Malaysia is RM30, how much the foreigners need to pay if devaluation was occurred?