Sujata

Chapter 11 of Unit 5: Balance of Payments

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 THIS CHAPTER WILL Sujata

TEACH US -

Meaning of Foreign
Exchange Rate

Currency Depreciation vs,

Currency Appreciation

Types of Foreign
Exchange Rate
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Explain the meaning of Foreign Exchange & Foreign Exchange Rate.
Sujata
Foreign exchange refers to all currencies other than the domestic currency of a given
country.
For example, in India, the domestic currency is India Rupee; and all other currencies like
UAE Dirham, Egyptian Pound, Thai Baht and Malaysian Ringgit are foreign exchange.
Foreign Exchange Rate measures the number of units of one currency required to exchange with one unit
of another currency. For example, if 1 exchange rate for Chinese Yuan and Japanese Yen is 1 Yuan = 16
Yen, then it will mean that 16 Yen are required to buy 1 Yuan.

Differentiate between Currency Depreciation and Currency Appreciation.

Currency Depreciation Currency Appreciation

• Refers to decrease in the value of domestic currency in
terms of foreign currency
• Makes domestic goods cheaper in foreign country as
more of such goods cn be purchased with same
amount of foreign currency. It therefore leads to
increase in exports
• Example: If a change from $1 = ₹72 to $1 = ₹75 occurs,
it means Indian Rupee has depreciated
SUJATA.ECONOMICS
• Refers to increase in the value of domestic currency in
terms of foreign currency
• Makes foreign goods cheaper in domestic country as
more of such goods can be purchased with same amount
of foreign currency. It therefore leads to increase in
imports
• Example: If a change from $1 = ₹75 to $1 = ₹72
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occurs, it
means Indian Rupee has appreciated
 Define and explain any three major types of Foreign Exchange Rate Systems currently in
Sujata
practice.

The three main types of foreign exchange rate systems are:

• Fixed Exchange Rate System (also known as “Pegged Exchange Rate System”)
Refers to a system in which exchange rate for a currency is fixed by the government
Adopted to ensure stability in foreign trade, a country keeps value of its currency fixed in terms of some external
standard like gold or any precious metal or some internationally agreed unit of account. If the value of this
standard is currency of another country’s currency or gold, the currency is known as “Parity Value” of currency.
• Flexible Exchange Rate System (also known as “Floatable Exchange Rate System”)
Refers to a system in which exchange rate is determined by forces of demand and supply of different currencies in
the foreign exchange market
Adopted to ensure equilibrium level in foreign trade, a country lets value of its currency fluctuate freely based
upon interactions of numerous banks and other institutions buying oe selling currencies for purposes of transactions
in the foreign exchange market.
• Managed Floating Exchange Rate System (also known as “Dirty Floating System”)
Refers to a system in which exchange rate is determined by market forces and Central Bank influences the
exchange rate through interventions in the foreign exchange market
A hybrid of fixed and flexible exchange rate systems, the domestic currency is influenced by the Central Bank’s
interventions to control unfavourable trends or impacts in the foreign exchange market, usually through acquiring
or running down its holdings of foreign exchange reserves.

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 Differentiate between the 3 types of foreign exchange rate systems. Sujata

Officially fixed in Determined by Determined by

exchange rate system

system

system
Fixed exchange rate

Flexible exchange rate

Managed floating
terms of gold or forces of demand forces of demand
any other currency and supply of and supply of
by the government foreign exchange foreign exchange
Complete in the market in the market
government No government Intervention by
control intervention Central Bank to
Exchange rate Exchange rates monitor value
generally remains keep changing Exchange rates
stable keep changing,
but close to the
target values

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 BALANCE OF Sujata

PAYMENTS

CHAPTER 12 OF UNIT 5

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 Sujata

SUJATA.ECONOMICS
 THIS CHAPTER WILL Sujata

TEACH US -
Meaning of Balance of
Payments

Components of Balance of
Payments

Meaning of Balance of Trade

Deficit (Disequilibrium) in the

Balance of Payments
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 Sujata
What is meant by Balance of Payments? Explain its structure in brief.

 BALANCE OF PAYMENT is an accounting statement that provides a systematic record of all economic
transactions between residents of a country and the rest of the world, in a given period of time.
 Residents include individuals, firms and government agencies, but does not include Diplomatic staff, foreign
individuals and firms even if they may be working or operating within the domestic country.
 Economic transactions refer to those transactions which involve transfer of the title or ownership of goods,
services, money and assets.
 Balance of Payment (BOP) includes transactions related to all items transacted between residents of a
country and the rest of the world. It is a flow concept since it is related to a given period of time.
 The structure of BOP is prepared with both inflows as Credit and outflows as Debit Entries. The trial
balance is prepared to arrive at the final status of the BOP as
a. Balanced: when receipts of foreign exchange are equal to payments of foreign exchange
b. Surplus: when receipts of foreign exchange are more than payments of foreign exchange
c. Deficit: when receipts of foreign exchange are less than payments of foreign exchange

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 Sujata
Write a short note on Balance of Trade?.

 BALANCE OF TRADE refers to the difference between the amounts of exports and imports of
visible items (goods).
 The Balance of Trade (BOT) is actually a part of BOP which includes only those
transactions that are exported or imported. Other items such as shipping charges,
insurance, gifts, personal remittances, etc. which are part of BOP is not included in BOT.
 BOT, calculated as per formula below could be surplus (positive) or deficit (negative) as
a. Surplus: When a country’s exports are more than its imports, then the BOT is said to be
favourable and is surplus
b. Deficit: When a country’s exports are less than its imports, then the BOT is said to be
unfavourable and is deficit

Formula: Balance of Trade = Exports of goods – Imports of goods

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 What are the major components of Balance of Payments? Explain in brief the influence of
these components on a country’s economy. Sujata
Two major components of BOP are:
CURRENT ACCOUNT refers to an account which records all
the transactions relating to export and import of goods and CAPITAL ACCOUNT records all those transactions
services and unilateral transfers during a given period of time. between the resident of a country and the rest of the
Its further sub-divisions are :
world which causes a change in the assets or loabilities
Credit items Debit Items Net Credit of the residents of the country.
(Credit – Debit) Its further sub-divisions are:

1. Visible Trade Net export of Credit items Debit Items Net Credit
Exports of goods Imports of goods goods (BOT) (Credit – Debit)

2. Invisible Trade 1. Borrowings

Exports of Services Import of Services Net Exports of and Lendings
Services Borrowings from Lendings to Net borrowings
Abroad abroad from abroad
3. Unilateral
2. Investments Net Investments
Transfers Net transfer
From Abroad To abroad from Abroad
Transfer Receipts Transfer Payments Receipts
3. Foreign
4. Income
Exchange Net change in
Receipts and
Reserves foreign exchange
Payments Net Income
Decreases Increases reserves
Income Receipts Income Payments Receipts
Capital Receipts Capital Payments Capital Account
Current Receipts Current Payments Current Account (1+2+3+4) Balance
(1+2+3+4) Balance
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 Differentiate between Autonomous Transactions and Accommodating Transactions in the
context of Balance of Payments Sujata
Autonomous vs Accommodating Transactions

Autonomous Transactions Accommodating Transactions

Refers to those economic transactions which take
place due to some economic motive such as profit
maximisation
Are independent of the state of BOP account
Transactions take place on both current and capital
accounts
Also known as “Above the line items”
Refers to the transactions that are undertaken to
cover deficit or surplus in autonomous transactions
Undertaken to maintain the balance in the BOP
account
Transactions take place only on capital account
Also known as “Below the line items”

Define: Deficit in the Balance of Payments

DEFICIT (or Disequilibrium) in balance of payments account arises when total outflows on account of
autonomous transactions are less than total inflows of such transactions. (if the reverse is true, then there is
SURPLUS in the BOP)
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