Q.1. Elaborate the disequilibrium of Balance of payment.

The balance of payments of a country is the record of all economic

transactions between the residents of the country and the rest of the
world in a particular period of the htc hd (e.g., a quarter of a year).
These transactions are made by individuals, firms and government
bodies. Thus the balance of payments includes all external visible and
non-visible transactions of a country. It is an important issue to be
studied, especially in international financial management field, for a
few reasons
The balance of payment provides detailed information concerning the
demand and supply of a country's currency. Second, a country's
balance of payments data may signal its potential as a business partner
for the rest of the world. If a country is grappling with a major
balance of payments difficulty, it may not be able to expand imports
from the outside world. Instead, the country may be tempted to
impose measures to restrict imports and discourage capital outflows in
order to improve the balance of payments situation. On the other
hand, a country with a significant balance of payments surplus would
be more likely to expand imports, offering marketing opportunities
for foreign enterprises, and less likely to impose foreign exchange
restrictions.
Balance of payments data can be used to evaluate the performance of
the country in international economic competition. Suppose a country
is experiencing trade deficits year after year. This trade data may then
signal that the country's domestic industries lack international
competitiveness.
To interpret balance of payments data properly, it is necessary to
understand how the balance of payments account is constructed.
These transactions include payments for the
country's exports and imports of goods, services, financial capital,
and financial transfers. It is prepared in a single currency, typically
the domestic currency for the country concerned. The balance of
payments accounts keep systematic records of all the economic
transactions (visible and non-visible) of a country with all other
countries in the given time period. In the BoP accounts, all the
receipts from abroad are recorded as credit and all the payments to
abroad are debits. Since the accounts are maintained by double entry
bookkeeping, they show the balance of payments accounts are always
balanced. Sources of funds for a nation, such as exports or the receipts
of loans and investments, are recorded as positive or surplus items.
Uses of funds, such as for imports or to invest in foreign countries, are
recorded as negative or deficit items.

Reasons for Disequilibrium

There are a number of reasons for market disequilibrium.

1. Population Growth

Most countries experience an increase in the population and in some

like India and China the population is not only large but increases at a
faster rate. To meet their needs, imports become essential and the
quantity of imports may increase as population increases.

2. Development Programmes

Developing countries which have embarked upon planned

development programmes require to import capital goods, some raw
materials which are not available at home and highly skilled and
specialized manpower. Since development is a continuous process,
imports of these items continue for the long time landing these
countries in a balance of payment deficit.

3. Demonstration Effect

When the people in the less developed countries imitate the

consumption pattern of the people in the developed countries, their
import will increase. Their export may remain constant or decline
causing disequilibrium in the balance of payments.

4. Natural Factors

Natural calamities such as the failure of rains or the coming floods

may easily cause disequilibrium in the balance of payments by
adversely affecting agriculture and industrial production in the
country. The exports may decline while the imports may go up
causing a discrepancy in the country's balance of payments.

5. Inflation

An increase in income and price level owing to rapid economic

development in developing countries, will increase imports and
reduce exports causing a deficit in balance of payments.

6. Poor Marketing Strategies

The superior marketing of the developed countries have increased

their surplus. The poor marketing facilities of the developing
countries have pushed them into huge deficits.

7. Globalisation

Due to globalisation there has been more liberal and open atmosphere
for international movement of goods, services and capital.
Competition has beer increased due to the globalisation of
international economic relations. The emerging new global economic
order has brought in certain problems for some countries which have
resulted in the balance of payments disequilibrium.
Q.2.What is managed float and floating exchange rate.

An exchange rate is the price of a country’s currency in terms of

another currency. In other words, it represents how many units of a
foreign currency a consumer can buy with one unit of their home
currency.
Exchange rates are ratios that are used across all international
markets, including finance, trading, and investment. Businesses and
investors use these rates to compare their currency’s purchasing
power with another country’s. They also use this to determine the
comparative strength of their domestic currency against foreign
currencies.

Managed Float Rate:-

A managed float is a floating exchange rate where a country's central

bank occasionally intervenes to change the direction or the pace of
change of a country's currency value. In most instances, the central
bank in a managed float system acts as a buffer against an external
economic shock before its effects become disruptive to the domestic
economy.
A managed float rate occurs when government's monetary rules or
laws affect the pricing of its currency.
With a managed float, the exchange rate is allowed to fluctuate on the
open market, but the central bank can intervene to keep it within a
certain range, or prevent it from trending in an unfavorable direction.
Managed floats are used when a country establishes a currency band
or currency board. The goal of a managed float is to keep currency
volatility low and promote economic stability.

Following can be a diagrammatic representation of it:-

D S1

1$ = Rs 70 UPPER LIMIT

1$ = Rs 60
--------------------------------
1$ = Rs 50 LOWER LIMIT

D
S
Current Rate of Exchange
 MANAGED FLOAT RATE

Floating Exchange Rate:-

A floating exchange rate system determines a currency’s value in

relation to other currencies. Unlike fixed exchange rates, these
currencies float freely, that is, unrestrained by government controls or
trade limits.
As the name suggests this is a flexible rate which is determined by the
market supply and demand .So this exchange rate reflects the true
picture of the economy.
Following can be the diagrammatic representation of the same:-

D2
D S1
New exchange rate

------------------------
-----------------------------
S D1 D3

Old exchange rate

FLOATING EXCHANGE RATE

In case of floating exchange rate it can have positive or negative

impact when exchange rates increase or decrease due to demand and
supply.
If currency depreciates more goods and services will be sold abroad
and vice versa.
It means devaluation makes import expensive and exports cheaper
and exactly reverse effect in appreciation.
The advantages of the floating exchange rate are as follows:
1. Government will not interfere
2. Government doesn’t have to maintain reserves for correcting
exchange rate
3. Balance of payment will adjust automatically with demand and
supply but at the same time floating exchange rate can create
speculation in the market& uncertainty for investors.

Q.3.Explain with examples how the Foreign exchange reserve can

be increased with help of international trade?

Following is the way how foreign exchange reserves are used by

central banks to increase them:-
1. Countries use their foreign exchange reserves to keep the value
of their currencies at a fixed rate. A good example is China,
which pegs the value of its currency, the yuan, to the dollar.
When China stockpiles dollars, it raises the dollar value
compared to that of the yuan. That makes Chinese exports
cheaper than American-made goods, increasing sales.
2. Those with a floating exchange rate system use reserves to keep
the value of their currency lower than the dollar. They do this
for the same reasons as those with fixed-rate systems. Even
though Japan's currency, the yen, is a floating system, the
Central Bank of Japan buys U.S. Treasurys to keep its value
lower than the dollar. Like China, this keeps Japan's exports
relatively cheaper, boosting trade and economic growth. Such
currency trading takes place in the foreign exchange market.

3. A third and critical function is to maintain liquidity in case of an

economic crisis. For example, a flood or volcano might
temporarily suspend local exporters' ability to produce goods.
That cuts off their supply of foreign currency to pay for imports.
 In that case, the central bank can exchange its foreign currency
for their local currency, allowing them to pay for and receive the
imports. Similarly, foreign investors will get spooked if a
country has a war, military coup, or other blow to confidence.
They withdraw their deposits from the country's banks, creating
a severe shortage in foreign currency. This pushes down the
value of the local currency since fewer people want it. That
makes imports more expensive, creating inflation. The central
bank supplies foreign currency to keep markets steady. It also
buys the local currency to support its value and prevent
inflation. This reassures foreign investors, who return to the
economy. 

4. The central bank assures foreign investors that it's ready to take
action to protect their investments. It will also prevent a sudden
flight to safety and loss of capital for the country. In that way, a
strong position in foreign currency reserves can prevent
economic crises caused when an event triggers a flight to safety.

5. Reserves are always needed to make sure a country will meet its
external obligations. These include international payment
obligations, including sovereign and commercial debts. They
also include financing of imports and the ability to absorb any
unexpected capital movements.

6. Some countries use their reserves to fund sectors, such as

infrastructure. China, for instance, has used part of its forex
reserves for recapitalizing some of its state-owned banks

7. Most central banks want to boost returns without compromising

safety. They know the best way to do that is to diversify their
portfolios. They'll often hold gold and other safe, interest-
bearing investments.