Quick answer: Balance of payments disequilibrium is corrected through automatic adjustment (exchange rates and prices) and deliberate measures. Monetary measures include tight money, higher interest rates, depreciation, devaluation and exchange control. Fiscal and trade measures include cutting government spending, import duties, quotas, export promotion and higher saving. Capital account measures include attracting foreign investment, foreign loans, tourism and remittances and capital controls. Structural reforms provide the lasting fix, as India’s 1991 crisis showed.
| Type | Measures |
|---|---|
| Monetary | Deflation, interest rates, depreciation, devaluation, exchange control |
| Fiscal and trade | Spending cuts, import duties, quotas, export promotion |
| Capital account | FDI, foreign loans, tourism, remittances, capital controls |
| Long term | Structural reforms |
A country’s balance of payments (BoP) is in disequilibrium when what it pays the rest of the world keeps running ahead of what it earns, or the other way round. A small deficit for a year or two is normal. A large, persistent one drains foreign exchange reserves and can end in a crisis.
India learned this the hard way. In mid-1991, reserves fell to about US$1.2 billion, enough for roughly three weeks of imports. The government devalued the rupee by about 18-19% in two steps in July 1991, pledged gold with the Bank of England, borrowed from the IMF and launched the liberalisation reforms that reshaped the economy. Almost every measure in this list was used in that one year.
Measures to correct disequilibrium fall into two groups: automatic adjustments that happen through market forces, and deliberate measures that the government and central bank choose. New to the topic? Read our guide to the types of disequilibrium in balance of payments first.
Automatic Measures
1. Automatic Adjustment Through Prices and Exchange Rates
Under a freely floating exchange rate, a deficit means more demand for foreign currency, so the home currency weakens. That makes exports cheaper and imports dearer, which narrows the deficit on its own. Under the old gold standard, the same thing happened through gold outflows and falling prices. In practice, automatic adjustment is slow and painful, so governments rarely rely on it alone.
Monetary Measures
2. Monetary Tightening (Deflation)
The central bank reduces money supply and credit. Lower spending cuts demand for imports and brings domestic prices down, which makes exports more competitive. The cost is slower growth and higher unemployment, so it is usually a short-term tool.
3. Higher Interest Rates
Raising interest rates attracts foreign capital looking for better returns, which strengthens the capital account. It also cools domestic demand. The Reserve Bank of India has used rate hikes during rupee pressure, for example in 2013 during the “taper tantrum”.
4. Exchange Rate Depreciation
In a floating system, the central bank lets the currency weaken. Exporters earn more rupees per dollar and imports become expensive, which helps the trade balance over time.
5. Devaluation
In a fixed or managed system, the government officially lowers the value of its currency. India devalued in 1966 and again in 1991. Devaluation works best when export and import demand respond strongly to prices (the Marshall-Lerner condition). If they do not, the deficit can get worse before it gets better, a pattern economists call the J-curve.
6. Exchange Control
The government or central bank controls who can buy foreign currency and for what. India ran strict exchange controls under FERA until 1999, when the more liberal FEMA replaced it. Controls protect reserves but encourage black markets and discourage investment.
Fiscal and Trade Measures
7. Cutting Government Spending
Lower public spending reduces overall demand, including demand for imports. It also lowers the fiscal deficit, which is often linked to the current account deficit through the “twin deficits” idea.
8. Import Duties
Higher customs duties make imports more expensive and protect domestic producers. India raised duties on gold several times to curb gold imports, one of its biggest import items. Too much protection, though, can make domestic industry lazy.
9. Import Quotas
A quota fixes the maximum quantity of a product that can be imported. It works faster and more predictably than a tariff, but it can create shortages and invite smuggling. World Trade Organization rules limit how freely members can use quotas.
10. Export Promotion
Governments help exporters with tax refunds, cheaper credit, export processing zones and trade fairs. India’s Remission of Duties and Taxes on Export Products (RoDTEP) scheme, launched in 2021, refunds embedded taxes to keep exports competitive.
11. Higher Domestic Saving
When households and firms save more, the country depends less on foreign borrowing to fund investment. Policies that encourage saving help reduce the current account deficit over the long run.
Capital Account Measures
12. Attracting Foreign Investment
Opening sectors to foreign direct investment (FDI) and portfolio investment brings in foreign currency without creating debt. FDI is preferred because it is long-term and usually brings technology.
13. Foreign Loans and International Assistance
Borrowing from the IMF, World Bank or other countries buys time to fix the deficit. In 1991 India borrowed from the IMF under a structural adjustment programme. Loans must be repaid with interest, so they are a bridge, not a cure.
14. Promoting Tourism and Remittances
Foreign tourists and remittances from citizens working abroad bring in foreign exchange. India has been the world’s largest recipient of remittances for years, and these inflows cover a large part of its trade deficit.
15. Capital Controls
In a crisis, governments may limit how much money residents and foreign investors can take out of the country. Controls stop sudden outflows but can scare away future investment if used too long.
Long-Term Measures
16. Structural Reforms
Lasting fixes come from making the economy more productive: better infrastructure, easier rules for business, stronger manufacturing and energy self-reliance. India’s 1991 reforms, which cut licensing, lowered tariffs and opened the economy, did more for the balance of payments over the following decades than any short-term measure.
Summary Table
| Type | Measures | Speed | Main cost |
|---|---|---|---|
| Monetary | Tight money, higher interest rates | Fast | Slower growth |
| Exchange rate | Depreciation, devaluation, exchange control | Medium | Costlier imports, inflation |
| Fiscal and trade | Spending cuts, duties, quotas, export promotion | Medium | Higher prices, retaliation |
| Capital account | FDI, loans, tourism, remittances, capital controls | Fast to medium | Debt or investor caution |
| Structural | Reforms to productivity and competitiveness | Slow | Political resistance |
In exams, a strong answer separates automatic from deliberate measures and gives at least one Indian example, usually the 1991 crisis. For background, see how the balance of trade differs from the balance of payments.