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How balance of payments affects the stock Market?

 

200282932-001Balance of payment is an indicator that enables an economy to detect the net inflows and outflows of money from a country. These both flows should be in equilibrium in order to result a balancing situation. It has direct impact over all sectors of the economy. For proving the economic theory of balance of payments, the net effect should be equal to zero. But in real scenario, the perfect situation may seldom be seen. In less developed countries, it is crucial to carry the critical limit of outflows of currency. Illegal means of outflows/ inflows of currency result in severe economic downturn. These illegal means are usually known as money laundering. It has adverse effects on stock market as observed in several money laundering scandals in past. Few impacts are as follows:

  • Concentration of Funds: disequilibrium in balance of payment increases the inflation and lessens the availability of funds to the investors as the government usually announces a tight monetary policy to liberalize the excess supply of money and same is the situation in case of more outflows. It is also described as a financial account deficit. The stock market suffers from vulnerability due to less mobilization, more speculation, and an environment of overall discontentment.
  • Current Account Deficit: This term is explained as more spending on imports as the local industries seem to be unable to fulfill the domestic requirements. This is a web that encircles the financial system as well as the economic coordination of a country. Stock market is affected in dual dimensions. At first, due to failure of local industries, the stock of these companies automatically go in downturn and secondarily, the foreign investors immediately uplift their investment and the stock market crashes and loss occurs to the domestic investors. After this loss, the economy is surrounded in a web of vulnerability and government has to intervene on intense grounds to recover the susceptibility.
  • Stock Market Efficiency: Market consequently becomes irresponsive as it does not react according to the situational happenings. Being most concise, the market reacts in an inverse manner to what actually is expected. In this way, it makes easy for speculators to manipulate the scenario and earn abnormal returns. The news and events does not affect the daily trading volumes and investors returns. The market loses its prime purpose i.e., wealth maximization of the investors. An environment of monopoly becomes feasible to be exercised and exploit the market.

The above discussed cycle is applicable on short run speculation to get abnormal returns. However, this situation is definitely a cause of economic slander for the fiscal and monetary authorities. Emergency plans are launched in terms of tight and contractionary monetary policy so that the depression may be recovered. The situation is undoubtedly handled but it leaves several impacts. The abnormal earners get a lot while many medium and small investors lose their investments.

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About Emaad Qureshi