- Current Account records trade in goods, services, and transfer payments.
- Includes exports & imports, factor/non-factor services, and transfers (gifts, remittances).
- Surplus: receipts > payments; Deficit: receipts < payments.
- Two parts: Balance of Trade (goods) and Net Invisibles (services & transfers).
- Exports increase and imports reduce domestic demand.
Definitions [1]
Definitions: Balance of Payments
- 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."
- According to Sodersten, "The Balance of Payments is merely a way of listing receipts and payments in international transactions for a country."
- 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."
Formulae [1]
Balance of Trade (BoT)
BoT = Vx - Vm
Where Vx = Value of goods exported
Vm = Value of goods imported.
Key Points
Key Points: Open Economy and Its Linkages
- An open economy interacts with other countries.
- Linkages occur through trade (goods & services) and financial markets.
- Imports reduce and exports increase aggregate demand.
- International trade requires currency exchange.
- Exchange rate = price of one currency in terms of another.
Key Points: Current Account
Key Points: Capital Account
- Capital Account records international asset transactions.
- Purchase of foreign assets = debit; sale to foreigners = credit.
- Includes FDI, FII, external borrowings, assistance.
- Surplus: capital inflows > outflows.
- Deficit: capital inflows < outflows.
Key Points: Foreign Exchange Rate
- Foreign exchange rate = price of one currency in terms of another.
- Demand for forex arises due to imports, gifts, and foreign investments.
- Higher forex price → imports fall → demand for forex falls.
- Supply of forex comes from exports, transfers, and foreign investment.
- Higher forex price → exports rise → supply of forex increases.
Key Points: Determination of the Exchange Rate
- Exchange rate systems: Flexible, Fixed, and Managed Floating.
- Flexible (floating) rate is determined by demand and supply of foreign exchange.
- Increase in forex demand → depreciation; increase in forex supply → appreciation.
- Speculation, interest rates, and income levels affect exchange rates.
- In fixed exchange rate, government intervenes; devaluation (rate ↑) and revaluation (rate ↓).
Key Points: Merits and Demerits of Flexible and Fixed Exchange Rate Systems
- Fixed exchange rate: Requires large foreign exchange reserves and is prone to speculative attacks.
- Fixed system demerit: BoP deficits force government intervention and possible devaluation.
- Flexible exchange rate: Adjusts automatically to BoP surpluses and deficits.
- Flexible system merit: No need for large reserves and greater monetary policy independence.
Key Points: Managed Floating Exchange Rate System
- It is a mix of fixed and flexible exchange rate systems.
- Exchange rate is mainly decided by market forces, but the central bank intervenes when needed.
- Also called dirty floating.
- Central bank uses foreign exchange reserves to limit excessive fluctuations.
Important Questions [12]
- Giving valid reason, state whether the following statement is true or false: Dividend received from investment abroad is recorded on the credit side of the capital account.
- As per the Reserve Bank of India (RBI) press report, dated 22nd June, 2022:"Net Foreign Portfolio Investment (FPI) recorded an outflow of US $15.2 billion mainly from the equity market." The
- State on Which Side of Capital Account/Current Account Will the Following Transactions Be Recorded and Why: (I) Interest on Loan Received from Nepal (Ii) Import of Mobile Phones from China
- Suppose, Country X, has more inflation than Country Y. Which of the following is most likely situation to happen in such a case, assuming other factors being constant?
- Assertion (A): The Balance of payments is in surplus, if autonomous receipts are greater than autonomous payments. Reason (R): Autonomous transactions are determined by
- 'Deficit' in Balance of payment (BOP) refers to the excess of ______.
- Distinguish between Autonomous transactions and Accommodating transactions.
- Answer the Following Question. Define "Trade Surplus". How is It Different from "Current Account Surplus"?
- "Under the flexible exchange rate system, the Central Bank does not intervene in the foreign exchange market."Justify the statement, giving valid arguments.
- Explain the impact of home currency depreciation on the exports of a nation.
- Giving valid reason, state whether the following statement is true or false: Depreciation of the Indian Currency will lead to promotion of Indian exports.
- Suppose, the price of one UK Pound (£) has increased from ₹ 70 to ₹ 80, owing to market forces. This means that value of Indian Currency (₹) has ______.
Concepts [10]
- Open Economy and Its Linkages
- Concept of Balance of Payments
- Current Account
- Capital Account
- Balance of Payments Surplus and Deficit
- Foreign Exchange Market
- Foreign Exchange Rate
- Determination of the Exchange Rate
- Merits and Demerits of Flexible and Fixed Exchange Rate Systems
- Managed Floating Exchange Rate System
