Introduction
Fiscal deficit and Balance of Payments (BOP) are
the major twin effects of a country’s macroeconomic
planning and budgeting. At the same time a government
is required to deal with critical aspects of budget
like trade growth, savings, investment climate,
employment and interest rates as a control measure
for acceptable fiscal deficit and healthy BOP
levels. Obviously it is not a simple jugglery
with figures but a careful exercise taking into
account both internal and external fiscal factors.
The objective is both correct and infuse such
factors in the budgetary exercise that lead to
desired results. It is therefore imperative that
a thorough discussion and debate take place as
an integral part of budgeting and planning in
conjunction with existing and projected levels
of Gross Domestic Product (GDP).
Macroeconomics and the twin deficits
Balance of payments and fiscal deficit are directly
correlated issues of a budgetary exercise. To
correct the imbalance of BOP, fiscal deficit is
resorted to A country’s foreign exchange
reserves and gold reserves dictate the fiscal
deficit.
The US balance of payments deficit stood at a
staggering $144.9 billion in the first quarter
of this year, a quantum jump from the deficit
of $127 billion in the last quarter of 2003. As
a percentage of gross domestic product, the deficit
increased to 5.1 from 4.6.It is estimated that
to cover such huge deficit, the US needs to attract
more than $1.5 billion per day in foreign investment.
BOP is not to be understood merely in fixed currency
terms but in terms of the exchange rates with
other international currency as well. Thus there
is always a serious exogenous impact on BOP and
fiscal deficit. The main reasons cited for these
twin deficits are
Excessive consumption pattern of consumers meaning
low savings rate caused by low interest rates,
thus no incentive to save
A significant change over by sellers of goods
and services to offshore manufacturing platforms
to take advantage of low labor costs in countries
like India and China.
A palpable decrease in competition by domestic
manufacturers with foreign producers in a way
opening the floodgates for structural trade deficit
To compound the problem, exchange rates have not
responded to persistent trade deficits
Schools of thought
US Federal Reserve Board chairman Alan Greenspan
in the year 2000,recommended a fiscal deficit
of 20% to correct BOP based on eroded gold reserves
and bonds. But he handed out a positive forecast
of the US economy in 2004, discounting concerns
of inept consumer spending and manufacturing output.
He argued that economic development had indeed
been favorable in 2004.On the interest rates front,
he predicted a’ measured pace’ of
increase of 0.25% from the all time low of 1%,
which would help restore monetary policy neutrality.
At present, monetary policy is expansionary, as
interest rates are less than the rate of inflation.
However one should remember that the series of
bandied about booms have burst as a bubble. The
fundamentals of the economy have to rally and
revive to help ease the pressure on the deficits.
When we talk of external factors and their seriousness,
we should consider WTO collaboration and WTO Committee
on Balance of Payments Restrictions with common
members. A WTO member applying restrictions on
trade in goods and/or services to safeguard its
balance of payments must consult with the WTO
Committee,
IMF and World Bank have tried to evolve a coherent
global policy on deficit corrections. The WTO's
charter calls for cooperation in global economic
policy making. The Fund, given its responsibilities
in the macroeconomic policy area, including with
respect to exchange rates, can contribute to assessing
issues of coherence between macroeconomic and
trade policies.
Thus it is not merely a national exercise of corrective
measures but external policies and cooperation
do affect the deficits. Intrinsic interplay of
other currency exchange rates based on world trade
in products and services impact valuation of USD
too.
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