Balance of Payments

A statement recording the imports and exports done in goods by / from the country with the other
countries, during a particular period is known as the Balance of Trade. The Balance of Payment
captures all the monetary transaction performed internationally by the country during a course of
time.
BOP is always is Balance – Explain

In the accounting sense, the balance of payments of a country is always in equilibrium. The
statement of balance of payments is prepared in terms of credits and debits based on the system of
double-entry book-keeping. In the double-entry system, each transaction gives rise to two equal
entries: a credit entry (i.e., a receipt) and a debit entry (i.e., payment). Thus the sum of all credits
equals the sum of all debits. Similarly, an international transaction generates two equal entries: a
credit (+) for an export of a good or service, or for a foreign borrowing, or for the receipt of a
unilateral transfer (gifts, donations, grants, etc.); and a debit (-) for an import of a good or service,
or for a foreign lending, or for the making of a unilateral transfer. In other words, a country must
pay for its imports of goods and services, or foreign borrowings, or receipts of unilateral transfers
by the equal-valued export of goods and services or foreign lending, or making unilateral transfers.
Thus, the sum of all international receipts (credit items) always equals the sum all international
payments (debit items). While receipts and payments in the international transactions always must
be equal or must balance in the accounting sense, they may not be equal or in equilibrium in
operational sense. The accounting balance of a balance of payments account, which is merely a
truism, should not be confused with the 'economic balance which recognised the possibility of a
deficit or a surplus in the balance of payments. When the current account of the balance of
payments shows a deficit or a surplus, the balance is restored through changes in the capital
account. In fact, the capital account is specially prepared to neutralise the imbalance in the current
account. The deficit in the current account is neutralised by the equal amount of surplus in the
capital account; and the surplus in the current account is neturalised by the equal amount of deficit
in the capital account. Thus, the current and capital accounts together balance each other and
restore equilibrium in the balance of payments. Suppose, a country experiences a deficit in the
current account of its balance of payments statement due to excess of imports over exports. Such a
deficit can be met by resorting to the following changes in the capital account:

(i) By raising loans and getting grants from other countries:

(ii) By drawing on past accumulated balances of the country which it may be keeping in the foreign
countries;
(iii) By exporting gold;
(iv) By drawings from International Monetary Fund.

What is Foreign exchange?

Ans:- Foreign exchange is the exchange of one currency for another or the conversion of one
currency into another currency. Foreign exchange also refers to the global market where
currencies are traded virtually around the clock. The largest trading centers are London, New
York, Singapore and Tokyo. The term foreign exchange is usually abbreviated as "forex" and
occasionally as "FX."
Distinguish between Fixed Exchange rate & Flexible Exchange rate?
Ans:- The following points are noteworthy so far as the difference between fixed and flexible
exchange rates is concerned:-
 Fixed exchange rate is the rate which is officially fixed in terms of gold or any other
currency by the government. It does not change with change in demand and supply of
foreign currency. As against it, flexible exchange rate is the rate which, like price of a
commodity, is determined by forces of demand and supply in the foreign exchange
market. It changes according to change in demand and supply of foreign currency. There
is no government intervention.
 The exchange rate which the government sets and maintains at the same level is called
fixed exchange rate. The exchange rate that variates with the variation in market forces
is called flexible exchange rate.
 The fixed exchange rate is determined by government or the central bank of the
country. On the other hand, the flexible exchange rate is fixed by demand and supply
forces.
 In fixed exchange rate regime, a reduction in the par value of the currency is termed as
devaluation and a rise as the revaluation. On the other hand, in the flexible exchange
rate system, the decrease in currency price is regarded as depreciation and increase, as
appreciation.
 Speculation is common in the flexible exchange rate. Conversely, in the case of fixed
exchange rate speculation takes place when there is a rumour about change in
government policy.
 In fixed exchange rate, the self-adjusting mechanism operates through variation in the
supply of money, domestic interest rate and price. As opposed to the flexible exchange
rate that operates to remove external instability by the change in forex rate.