External Balance

A situation in which the money a country brings in from exports is roughly equ
al to the money it spendson imports. That is, external balance occurs when the
current
account is neither excessively positive norexcessively negative. An external bal
ance implies capital movement. That is, a country needs to haveboth imports an
d exports to maintain an external balance; it is not sufficient simple to note no b
alance bynot buying and selling goods. An external balance is considered sustai
nable

The External Balance And The Real Exchange Rate

The external balance and the real exchange rate along with the internal balance
are the terms that are consistent with each other. The term external balance is
also referred as the currentaccount and is defined as the equilibrium position
attained in the current and capital accounts.
Real exchange rate and external balance are co-related terms as, the external
balance represents the combination of domestic demand the exchange rate at
which the current account equates with the equilibrium level. To specify the
external balance is not easy. The external balance tells us about the international
flow of capital corresponding to the investment and he national saving over
the medium term.
In the absence of governmental institutions or the institutional authorities, with
the help of expected net flow of commodities and assets the external balance is
approached. Zero current accounts along with the net claim which is unchanged
over the other countries is another approach for identifying the external balance.
Balance of Payments Approach to the exchange rates is similar to those which
focus on the relationship between a long-term equilibrium value for the real
exchange rate and the external balance. In this, the long-term equilibrium
exchange rate defines itself if it generates both the external i.e. current account
and the internal balance is where internal balance is referred to as full
employment. The main focus these days is not on full employment but to
achieve a sustainable balance in current account that is not necessarily zero and
it will achieve economic and exchange rate equilibrium. According to the
Balance of Payments Approach the current account is just one of the

mechanisms of transmission for the exchange rate under all the types of
exchange rates i.e. may be fixed exchange rates or the floating exchange rates.
The depreciation in the real exchange rates is required to restore the equilibrium
when the external balance is curtailed of its previous proportion of deficit levels
in the history. Conversely, if it is shows a high external balance surplus, this
willmake a real exchange rate appreciation for restoring equilibrium. Within the
emerging markets, another good example of current account and the real
exchange rates is that of Russia. Before August 1998 crisis in Russia, it
continued to record significant external balance deficits.
The current account approach suggested real exchange depreciation was
required from time to time to restore the equilibrium. However, the Russian
rouble and US dollar were pegged due to which the interest rates were highly
raised for maintaining the peg. The costs of defending the Russian rouble peg in
order to attain monetary independence, high capital mobility and a fixed
exchange rate regime proved too much and due to this the rates of rouble were
de-pegged and devalued, and for good value Russia defaulted on its domestic
debt.