class 12

1. Balance of payments

2. Meaning of BoP
 A balance of payment account is a systematic record of all economic
transactions between residents of a country and the rest of the world
carried out in a specific period of time
 BoP records a country’s inflows and outflows of foreign exchange in a
fiscal year
 In short BOP account is a summary statement of transactions in foreign
exchange in a year

3. Structure
 BoP account , like a typical business account, is based on double entry
system
 Contains two sides ---Credit side and Debit side
 Any transaction which brings in foreign exchange (currency) is recorded on
credit side and given a positive sign (+)
 Any transaction that cause a country to low foreign exchange is recorded
onb debit side and is given a negative (-) sign

4. Credit (inflow of foreign exchange) Debits ( outflow of foreign exchange)
Exports of goods (Visible items)
imports of goods
Exports of services (invisibles)
Unilateral transfer(gifts, remittances…)
Import of services
Unilateral ( Paid to foreigners …)
Capital receipts
capital payments

5. Account of a country’s Balance of
Payment
Credits Debits
Row 1 Exports of
goods
550 Row 5 Imports of
goods
800
Row 2 Exports of
services
150 Row 6 Imports of
services
50
Row 3 Unilateral
transfers
(gifts ,
received
from
foreigners)
100 Row 7 unilateral
transfer (
gifts paid to
foreigners)
80
Row 4 capital
receipts
200 Row 8 Capital
payments
70
Total Receipts 1,000 Total Payments 1,000

6. Features of BoP
 Systematic record of all economic transactions
 It includes all transactions
 It it constructed on double entry system
 BoP account is broadly divided into two sub-account Current account and
the Capital account
Current account ( first three items )
Capital account (fourth item )

7. Balance of Trade (BoT)
 Balance of trade is the net difference of Import and export of all visible
items between the normal residents of a country and rest of the world.

8. Surplus or Deficit BOT
 Balance of trade may be surplus or in deficit or in equilibrium
 If value of export of goods (visible items) is more than the value of imports
of goods, balance of trade is said to be positive or favorable or surplus
 In case the value of export of goods is less than the value of imports of
goods, the balance of trade is said to be negative or unfavorable or deficit

9. Difference between BOT and BOP
BOT BOP
1 It records transactions relating to goods
only
1 It records transactions relating to both
goods and services
2 It does not record transactions of capital
nature
2 It records transactions of capital nature
which cause flow of foreign exchange
3 It is a narrow concepts as it is only one
part of BOP account
3 It is wider concepts as it includes balance of
trade, balance of services, balance of
unilateral transfers and balance of capital
transactions
4 It may be favorable , unfavorable or in
equal
4 It always remains in balance
5 Deficit in BOT can be met by BOP 5 Deficit in BOP cannot be met through BOT
6 It is not true indicator of economic
relations or economic prosperity of a
country
6 It is true indicator of economic performance
of an economy

10. Current account and Capital account
 Current account records export and imports of goods, export and import
of services, and unilateral transfers during a year
 Capital account records
1. Borrowings and lending to an from abroad
2. Investments to and from abroad
3. Changes in foreign exchange reservews

11. Difference between/components current
account and capital account
Components of Current Account Components of Capital Account
1. Visible items (import and export of
goods).
1. Foreign Direct investment.
2. Invisible items (import and export of
services).
2. Loans.
3. Unilateral transfers. 3. Portfolio investment.
4.Income receipts and payments from
and to abroad.
4. Banking capital transactions.
5. These are the transactions which do
not affect the assets or liabilities
position of the country.
5. These are the transactions which
affect assets or liabilities
position of the country.
6. It is a flow concept. 6.It is a stock concept.

12. Official Reserve Account
 Official Reserve Account: The official reserve account is a part of the
capital account, are the foreign currency and securities held by the central
bank of a country and used to balance the payments from year-to-year.
The reserves increase in case of a trade surplus and decrease when there
is a trade deficit.

13. Balance of payment always balances
 This balance is expressed in accounting sense
 BOP accounts are prepared on the basis of system of double entry under
which receipts side are always equal to payment side
 The balance of current account need not be equal (surplus or Deficit )
 The point to be noted here is that a deficit or surplus in current account is
balanced by an equal amount of surplus or deficit in capital account

14. Autonomous and
Accommodating items in
BOP

15. Autonomous items in BOP
 These refer to international economic transactions that take place due to
some economic motives like earning income and profit maximization
 They have nothing to do with foreign exchange payments ,they are
irrespective of whether BOP is favorable or unfavorable , they are,
therefore called autonomous items
 It is autonomous transactions which make deficit or surplus in BOP
 These items are generally called ‘ above the line items’ in BOP

16. Accommodating items in BOP
 These refer to transactions that take place to cover deficit (or Surplus)
arising from autonomous transactions
 These items are also called ‘below the line items’
 Mind, accommodating items do not cause movement of goods and
services across the border.

17. Significance of Distinction
 The significance of this distinction is that deficit /surplus in BOP occurs due
to deficit/surplus in autonomous transactions only
 Accommodating truncations are made to cover up deficit/surplus in
autonomous transactions

18. Causes of disequilibrium in BOP
 Economic factors
 Political factors
 Social factors

19. Measures of correcting disequilibrium
in BOP
 Export promotion
 Devaluation of domestic currency
 Exchange control
 Depreciation
 Reducing inflation
 Impost restriction and import substitution

20. Foreign exchange rate

21. Meaning
 Foreign exchange means foreign currency
 All currencies other than domestic currency of a given country

22. Foreign exchange rate
 The rate at which currency of one country can be exchanged for currency
of another country is called the rate of foreign exchange
 It is the price of a country’s currency in terms of other country’s currency
 It is also called as external value of currency
Nominal vs real exchange rate
Nominal exchange rate is the price of foreign currency in terms of
domestic currency
Real exchange rate is the relative price of foreign goods in terms of
domestic goods

23. Foreign exchange market
 The market in which national currencies of various countries are converted,
exchanged or traded for one another is called foreign exchange market .
 It is not any physical place
 It includes banks, specialized foreign exchange dealers, brokers and official
government agencies
 Spot market and forward market

24. Spot market
 A market that handles only spot transactions or current transaction in
foreign exchange is called spot market
 If operation is daily nature, it is called spot market or current market
 The exchange rate that prevails in the spot market for foreign exchange is
called Spot rate
 Spot rate of exchange refers to the rate at which foreign currency is
available on the spot

25. Forward market
 A market in which foreign exchange is bought and sold for future delivery
is known as forward market
 Which are contracted today but implemented sometimes in future
 Exchange rate that prevails in a forward contract for purchase or sale of
foreign exchange is called forward rate
 A forward contract is entered into for two reasons ;
1. To minimize risk of loss due to adverse change in exchange rate i.e.,
hedging
2. To make a profit i.e. speculation

26. Sources of demand for foreign
exchange
1. To purchase goods and services by domestic residents from foreign
countries
2. To purchase financial assets by domestic residents in a foreign country
3. To invest directly in shops , factories, buildings in foreign countries
4. To send gifts and grants abroad
5. To undertake foreign tours
6. To speculate on the value of foreign currencies
7. To make payments of international trade

27. Relationship between rate and
demand
 There is inverse relationship between price of foreign exchange and
demand for foreign exchange
 When exchange rate rises, demand for foreign exchange falls and when
exchange rate of foreign currency falls its demand rises

28. Reasons for rise in demand for foreign
currency when its price falls
1. When price of foreign currency falls, imports from the country become
cheaper
2. When foreign currency become cheaper in terms of domestic currency , it
promotes tourism
3. When price of foreign currency falls , it has negative effect on export of
home country

29. Reason for fall in demand
1. When price of foreign exchange rises, imports form that country become
costly, as a result , imports fall leading to fall in demand for foreign
currency
2. When foreign currency becomes costlier in terms of domestic currency , it
discourages tourism to foreign country

30. Sources of supply of foreign exchange
(say US dollars)
1. When foreigners purchase home country’s (India) goods and services
through exports
2. When foreigners invest in bonds ad equity shares of the home country
3. When currency dealers and speculators cause flow of foreign currency in
the domestic economy
4. When Indian workers working abroad send their savings to families in
India (remittances )

31. Relationship between rate of foreign
exchange and supply
 There is direct relationship between price of foreign exchange and supply
of foreign exchange

32. Reasons for increase in supply when rate of
foreign exchange rises
 A rise in foreign exchange rate makes home country’s goods cheaper to
foreigners ,
as a result, foreign demand for goods increases leading to increase in India's
exports
 Again a rise in foreign exchange rate renders home country’s currency
cheaper which attracts foreigners and promote tourism

33. How is rate of foreign exchange
determined ?

34. Fixed vs Flexible exchange rate

35. Fixed exchange rate
 Fixed exchange rate is the rate which is officially fixed in terms of other
currency by the government / Central bank
 The rate is not influenced by market forces

36. Flexible (floating ) exchange rate
 Flexible exchange rate is the rate which is determined by market forces of
demand and supply in the foreign exchange market
 There is no official intervention .

37. Managed floating exchange rate
 Managed floating exchange rate in essence is flexible exchange rate which
is determined by market forces but called managed floating exchange rate
because
 The central bank influences the rate through intervention to reduce
fluctuations in the rate
 When foreign exchange rate is too high, central bank starts selling foreign
currency from its reserve of foreign exchange
 On the other hand when exchange rate is too low, central bank start
buying foreign currency in the market.

38. Appreciation vs Revaluation of currency
˃

39. Appreciation of a currency
 Appreciation is the increase in value of domestic currency in terms of
foreign currency when exchange rate is freely determined by forces of
demand and supply
 Thus , it makes domestic currency more valuable indicating less of
domestic currency is required to buy the foreign currency .

40. Revaluation of currency
 When a country raises the value of its currency in terms of foreign
currency under a fixed rate regime
 The effect of revaluation is the same as that of appreciation

41. Depreciation vs Devaluation
˂

42. Depreciation of a currency
 Depreciation of the currency is the fall in value of domestic currency in
terms of foreign currency under a system of market determined rate of
exchange
 Depreciation of domestic currency means higher price of foreign currency
in terms of domestic currency

43. Devaluation of a currency
 Devaluation is fall in value of domestic currency in terms of foreign
currency under a fixed exchange rate system
 When government of a country officially lowers the value of its currency in
terms of foreign currency , it is called devaluation

44. Any questions ?

45. Thank you