Revision: Balance of Payments and Exchange Rate Economics ISC (Commerce) Class 12 CISCE

1. According to Kindleberger, "The balance of payments of a country is a systematic record of all economic transactions between its residents and residents of foreign countries."
2. According to Sodersten, "The Balance of Payments is merely a way of listing receipts and payments in international transactions for a country."
3. According to James O. Ingram, "The Balance of Payments is a summary record of all economic transactions between residents of one country and the rest of the world during a given period of time."
4. According to Walter Krause, “The balance of payments of a country is a systematic record of all economic transactions completed between its residents and the rest of the world during a given period of time usually a concept of year."
5. The government of every country keeps account of its economic transactions with other countries of the world. The record of economic transactions among different countries is known as balance of payments.

Current Account + Capital Account = 0

BoT = V_x - V_m

Where,

V_x = Value of goods exported
V_m = Value of goods imported

BoT Surplus:

\[V_x>V_m\]

BoT Deficit:

\[V_m>V_x\]

• BoP is a systematic record of all economic transactions between a country's residents and the rest of the world over one year.
• It covers visible items (goods), invisible items (services and transfers), and capital transactions.
• The two main accounts are the Current Account and the Capital Account.
• BoP follows the double-entry bookkeeping system, so Total Credits = Total Debits.
• A Current Account Deficit is generally financed through capital inflows or borrowing from abroad and may increase a country's external debt burden if it persists.

• An open economy is linked to the rest of the world; a closed economy is not.
• The three linkages of an open economy are: output market, financial market, and labour market.
• Exports act as injections, while imports act as leakages in aggregate demand.
• Foreign trade influences the overall level of aggregate demand.
• Different national currencies create the need for foreign exchange rates.
• A stable international monetary system is essential for smooth international transactions.

• Two sides:
  Credit (receipts) = money received from abroad,
  Debit (payments) = money paid to foreigners.
• Current Account:
  Includes exports & imports of goods (visible), services (invisible), income, and gifts/transfers.
• Capital Account:
  Includes foreign loans, investments, banking capital, gold, SDRs, and reserve changes.
• Meaning:
  BOP shows the flow of receipts and payments with other countries over a period, not assets and liabilities.

• The current account records transactions in goods, services, factor income, and unilateral transfers.
• Goods are the visible component; services, factor income, and transfers are invisible components.
• IMF's BPM6 classifies BOP into Current, Capital, and Financial Accounts. India has adopted this classification, but the RBI continues to publish data according to the old classification.
• Current Account Surplus → Country is a net lender; Current Account Deficit → Country is a net borrower.
• Balance of Trade covers only goods; Balance on Invisibles covers services, factor income, and transfers.
• Exports and receipts are Credits (+); Imports and payments are Debits (−).

• The Capital Account records international transactions involving assets (money, stocks, bonds, government debt).
• Purchases of assets are debits; sales of assets are credits in terms of foreign exchange flows.
• The account can show a surplus, deficit, or balance depending on the direction of capital flows.
• The main components are FDI, FII (Portfolio Investment), external borrowings, and external assistance.
• Capital inflows are recorded as Credit (+) entries; capital outflows are recorded as Debit (−) entries.

• Balance of Trade:
  Difference between exports and imports of visible goods only.
• Balance of Current Account:
  Includes goods, services (invisibles) and transfers; shows flow of income.
• Balance of Capital Account:
  Records capital inflows and outflows like loans, investments, gold, forex.
• Balance of Payments:
  Sum of current account + capital account; always balances in accounting sense.
• Key relation:
  Current account deficit is matched by capital account surplus, and vice versa.

• Basic Balance:
  Current account balance + long-term capital balance.
• Net Liquidity Balance:
  Basic balance + short-term illiquid capital + SDRs + errors and omissions.
• Official Settlement Balance:
  Net liquidity balance + short-term private liquid capital.
• These methods show how external deficits or surpluses are finally settled.

• BoP always balances: Current Account + Capital Account ≡ 0.
• Autonomous transactions are independent ("above the line"); accommodating transactions finance the BoP imbalance ("below the line").
• Accommodating items include IMF borrowings and changes in foreign exchange reserves.
• BoP surplus = Autonomous receipts > Autonomous payments; BoP deficit = Autonomous payments > Autonomous receipts.
• Errors and Omissions is a separate third element of the BoP.
• BoT covers goods only; BoP covers goods, services, transfers, and capital transactions.
• IMF's BPM6 classifies the BoP into Current, Financial, and Capital Accounts; the RBI continues to publish data according to the old classification as well.

• Disequilibrium occurs when receipts and payments are unequal, resulting in surplus or deficit.
• Fall in Exports / Rise in Imports:
  Due to fall in foreign demand, inflation at home, or appreciation of currency.
• Development & Cost Factors:
  High developmental imports, rising production costs, or supply shortages reduce export competitiveness.
• Other Causes:
  Debt burden, population growth, demonstration effect, and political instability worsen BOP position.

• Foreign exchange refers to foreign currency used for international payments.
• The foreign exchange market is the market (system) where foreign currencies are bought and sold.
• Exchange rate is the price of one currency in terms of another currency (e.g., 1 USD = ₹75).
• Demand for foreign exchange arises from imports, gifts and transfers abroad, loan repayments, investment abroad, purchase of foreign financial assets, and outbound tourism.
• Supply of foreign exchange arises from exports, FDI and portfolio investment, remittances, loans from abroad, gifts and transfers received, and inbound tourism.
• A rise in the exchange rate generally reduces demand for foreign exchange and may increase its supply by encouraging exports.
• The exchange rate is determined by the demand for and supply of foreign exchange in the foreign exchange market.