Balance of Payments , Components of BOP, Current account; Causes of disequilibrium in Balance of Payments, Foreign Exchange rate,Devaluation, Appreciation , Revaluation and Depreciation,

1. Balance of
Payments
Balance of Payment - Meaning and components;
Causes of disequilibrium and how the
disequilibrium can be corrected; Foreign
Exchange Rate – meaning, the meaning of fixed and
flexible exchange rate, determination of exchange
rate in a free market. Concepts of depreciation,
appreciation, devaluation and revaluation

2. Balance of
Payments
 Meaning and components
 The balance of payments accounts are the record of a country’s
international transactions.
Components of Balance of Payments :
The Current Account
The current account measures a country’s trade in currently
produced goods and services, along with unilateral transfers
between countries.

3. Three
Components
ofCurrent
Account :
1) Net Exports of Goods and Services
 The concept of net exports, NX, or exports minus imports, is part
of the expenditure approach to measuring GDP. Net exports are
broken into two categories: goods and services.
 Examples of internationally traded goods include U.S. Soybeans,
French perfume, Brazilian coffee, and Japanese cars.When a U.S.
consumer buys a Japanese car, for example, the transaction is
recorded as an import of goods for the United States ( a debit item
for the United States, because funds flow out of the United States
to pay for the car) and an export of goods for Japan ( a credit item
for Japan because funds flow into Japan to pay for the car).

4.  2) Net Income from Abroad
 Net income from abroad equals income receipts from abroad
minus income payments to residents of other countries. It is
almost equal to net factor payments from abroad.
 3) Net UnilateralTransfers :
 Unilateral transfers are payments from one country to another
that do not correspond to the purchase of any good, service or
asset.
 Examples are official foreign aid or a gift of money from a resident
of one country to family members living in another country.

5.  Capital Account Definition
 The capital account records all the international undertakings of
assets. An asset is any one of the types in which wealth can be
held. For instance, stocks, bonds, government debt, money, etc.
The purchase of assets is a debit on the capital account. If an
Indian purchases a UK car company, it enters the capital account
undertakings as a debit (as foreign exchange is going out of India).
 On the other hand, the sale of assets, like the sale of the share of
an Indian company to a Japanese customer, is a credit on the
capital account.These items are foreign direct investments (FDIs),
foreign institutional investments (FIIs), assistance, and external
borrowings.

6. Causes of
disequilibrium
in the Balance
of Payment
 Such causes for disequilibrium in BOP are listed below:
 (i) Economic Factors:
 (a) Imbalance between exports and imports. (It is the main cause
of disequilibrium in BOR),
 (b) Large-scale development expenditure which causes large
imports,
 (c) High domestic prices which lead to imports,
 (d) Cyclical fluctuations (like recession or depression) in general
business activity,
 (e) New sources of supply and new substitutes.

7. Causes of
disequilibrium
in the Balance
of Payment
 (ii) Political Factors:
 Experience shows that political instability and disturbances cause
large capital outflows and hinder Inflows of foreign capital.
 (iii) Social Factors:
 (a) Changes in fashions, tastes and preferences of the people bring
disequilibrium in BOP by influencing imports and exports; (b) High
population growth in poor countries adversely affects their BOP
because it increases the needs of the countries for imports and
decreases their capacity to export.

8. Measures to correct disequilibrium in BOP
 Sustained or prolonged deficit has to be settled by short-term loans or
depletion of capital reserve of foreign exchange and gold.
 Following remedial measures are recommended:
 (i) Export promotion:
 Exports should be encouraged by granting various bounties to
manufacturers and exporters. At the same time, imports should be
discouraged by undertaking import substitution and imposing reasonable
tariffs.
 (ii) Import:
 Restrictions and Import Substitution are other measures of correcting
disequilibrium.
 (iii) Reducing inflation:
 Inflation (continuous rise in prices) discourages exports and encourages
imports.Therefore, the government should check inflation and lower the
prices in the country.
Measures to
correct
disequilibrium in
BOP

9. Devaluation of domestic currency:
It means a fall in the external (exchange) value of the domestic currency
in terms of a unit of foreign exchange which makes domestic goods
cheaper for foreigners. Devaluation is done by a government order when
a country has adopted a fixed exchange rate system. Care should be
taken that devaluation should not cause a rise in the internal price level.
Government should control foreign exchange by ordering all exporters to
surrender their foreign exchange to the central bank and then ration it
out among licensed importers.

10. Foreign
Exchange Rate
 Foreign Exchange Rate is defined as the price of the domestic
currency with respect to another currency.The purpose of foreign
exchange is to compare one currency with another for showing
their relative values.
 Foreign exchange rate can also be said to be the rate at which one
currency is exchanged with another or it can be said as the price of
one currency that is stated in terms of another currency.
 Exchange rates of a currency can be either fixed or floating. Fixed
exchange rate is determined by the central bank of the country
while the floating rate is determined by the dynamics of market
demand and supply.

11. Fixed
Exchange Rate
 Fixed exchange rate System or Pegged exchange rate system:The
pegged exchange rate or the fixed exchange rate system is
referred to as the system where the weaker currency of the two
currencies in question is pegged or tied to the stronger currency.
 Fixed exchange rate is determined by the government of the
country or central bank and is not dependent on market forces.
 To maintain the stability in the currency rate, there is purchasing
of foreign exchange by the central bank or government when the
rate of foreign currency increases and selling foreign currency
when the rates fall.
 This process is known as pegging and that’s why the fixed
exchange rate system is also referred to as the pegged exchange
rate system.

12. Flexible
Exchange Rate
 Flexible Exchange Rate System: Flexible exchange rate system is also known
as the floating exchange rate system as it is dependent on the market forces
of supply and demand.There is no intervention of the central banks or the
government in the floating exchange rate system.
 Advantages of Floating Exchange Rate System
 Following are the advantages of the floating exchange rate system
 1.There is no need to maintain foreign reserves in this exchange system.
 2. Any deficiencies or surplus in the Balance of Payment is automatically
corrected in this system.

13. Determination
of Exchange in
a free market
 Determination of Exchange rate in a free market
 •A free exchange market is one in which there is no
 restriction on foreign exchange transactions.
 •Foreign exchange market does not refer to a particular
 place, instead, refers to the facilities provided by the
 participants which deal in foreign exchange.
 The exchange rate is the price of one currency in terms
 of another or the rate of exchange is the rate at which
 one currency is exchanged for another

14. Depreciation
 Currency depreciation is the decline of a currency’s value relative to another currency. It
 specifically refers to currencies in a floating exchange rate – a system
 in which a currency’s value is set by the forex market, based on supply and demand.
Appreciation
A currency is said to appreciate when the base currency becomes more expensive in the currency
pair w.r.t. quote currency. So for the USD/INR pair where $1 = Rs. 75 previously
and now is $1 = Rs. 76, the Dollar is said to have appreciated w.r.t. Indian rupees.Thus a
person who wishes to buy $1 will now have to spend more rupees for the same $1 amount
and vice versa.

15. Devaluation
Devaluation is a downward adjustment to a country’s
value of money relative to a
foreign currency or standard. Many countries operate
using a fixed exchange
The rate tends to use devaluation as a monetary
policy tool to control supply and
demand.

16. Revaluation
 Revaluation is an upward adjustment to the value of assets, goods
or especially the currency from a chosen baseline. It is opposite of
devaluation, which means downward adjustment.
 A revaluation of currency can occur on a regular basis, due to the
significant fluctuations in the foreign currency market and other
associated exchange rates.The currency revaluation can also
affect the values of the assets held by the companies in a country.
The book values of the assets might have to be adjusted to reflect
the impact of the revalued currency rate.