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What is Balance of Payments (BOP)?

The balance of payments (BOP) is a comprehensive record of all international trade and financial transactions made by a nation’s residents with the rest of the world over a specified period. The BOP serves as a measure of a country’s ability to finance its imports and reflects whether it generates enough economic output to support its growth. Typically reported on a quarterly or annual basis, the BOP provides valuable insights into a nation’s economic health.

In essence, a country that spends more on imports than it earns from exports must cover the difference by borrowing from or selling assets to foreign entities. Thus, a current account deficit must be financed by a capital account surplus, meaning net capital inflows from abroad:

Current Account+Capital Account=0\text{Current Account} + \text{Capital Account} = 0

What is a Balance of Payments Surplus?

A balance of payments surplus occurs when the total money coming into a country from exports, foreign investments, and other sources exceeds the money leaving the country over a specified timeframe. This indicates a net positive inflow of funds.

What is a Balance of Payments Deficit?

A balance of payments deficit means that a country imports more goods, services, and capital than it exports. To cover this gap, the nation may need to draw on its foreign exchange reserves or borrow funds from other countries. Here are key aspects of managing a BOP deficit:

  • Official Reserve Sales: The central bank may sell foreign reserves to balance a deficit, a process known as official reserve sale.
  • Impact on Reserves: Fluctuations in official reserves are measured as either a BOP surplus or deficit, depending on whether reserves increase or decrease.
  • Role of Monetary Authorities: In cases of a BOP deficit, the central bank serves as the final source of financing, covering shortfalls, while also accumulating funds in the case of a surplus.

While reserve transactions are more relevant under fixed exchange rate systems, they can still play a role in countries with floating exchange rates, providing stability during times of economic fluctuation.

Understanding the balance of payments is essential for analyzing a country’s financial stability and economic policy. For more information on this topic and other key concepts in international trade economics, stay tuned to our educational resources.

Q.1 EXPLAIN THE MEANING OF DEFICIT IN BALANCE OF PAYMENT. HOW IS IT CORRECTED?

OR

HOW IS BALANCE OF PAYMENT DEFICIT MEASURED?

ANSWER:
a) MEANING OF DEFICIT IN BOPBalance of Payment deficit is a situation when autonomous receipts are less than autonomous payments.

[Current A/c + Capital A/c Receipts] < [Current A/c + Capital A/c Payments]

 

Autonomous transactions are those transactions which are carried out with economic motive irrespective of the present position of the BOP.

 

This situation arises only on account of autonomous transactions.

 

b) CORRECTION OF BOP DEFICITTo correct the deficit i.e. Adverse BOP position government will:

i. Withdraw the required amount from its Foreign Exchange Reserves or

ii. If required, it can borrow from the IMF.

These are the accommodating transactions of the government made only to bring equilibrium in the Balance of Payment.

Q.2 EXPLAIN THE MEANING OF SURPLUS IN A BALANCE OF PAYMENT ACCOUNT. HOW IS IT

CORRECTED?

OR

HOW IS BALANCE OF PAYMENT SURPLUS MEASURED?

ANSWER:
a) MEANING OF SURPLUS IN BOPBalance of Payment Surplus is a situation when autonomous receipts are more than autonomous payments.

[Current A/c + Capital A/c Receipts] > [Current A/c + Capital A/c Payments]

 

Autonomous transactions are those transactions which are carried out with economic motive irrespective of the present position of the Balance of Payment.

 

This situation arises only on account of autonomous transactions.

b) CORRECTION OF BOP SURPLUSTo remove the surplus government will:

Deposit the excess foreign exchange in its Foreign Exchange Reserves.

This is an accommodating transaction of the government made only to bring equilibrium in the Balance of Payment.

 

Q.3 WHAT ARE THE CAUSES OF DEFICIT IN BOP?

OR

WHAT ARE THE CAUSES OF UNFAVOURABLE BOP?

ANSWER:
Following are the causes of Deficit in BOP or Unfavourable BOP.
a) ECONOMIC FACTORSi) Fast Economic Development

  • For fast development, developing countries import machines, technology, and other equipment.
  • This leads to a high level of outflows of foreign exchange that can result in a deficit in the BOP account.

ii) Inflation

  • Inflation i.e. continuous rise in prices in a country makes foreign goods relatively cheaper.
  • It increases imports which cause a deficit in the Balance of Payment.

 

b) POLITICAL FACTORSi) Political Instability

  • Due to uncertainty, there may be large capital outflows and lesser inflows of foreign funds. It can create an adverse position in the Balance of Payment.

 

ii) Political disturbances

  • Frequent changes in government, unstable tax structure, etc. result in loss of trust of foreign investors and discourage inflows of capital.
  • Domestic investors also prefer to invest outside the economy. As a result, an adverse position created in the balance of Payment.
c) SOCIAL FACTORSi) Changes in taste, preferences, fashion, and style, etc.

  • A favorable change for imported goods increases the demand for imported goods and lead to a deficit in the balance of payment.

ii) Demonstration effect

  • Most of the developing countries get influenced by developed nations and start adopting the foreign pattern of consumption.
  • This results in a sharp rise in imports leading to a deficit in the Balance of Payment.

iii) Population explosion

  • Population explosion in underdeveloped nations, also generally, results in large scale imports and causes a deficit in the Balance of Payment.

 

The above mentioned is the concept that is explained in detail about the Balance of Payments Surplus and Deficit for the class 12 students. To know more, stay tuned to Eduacademy.

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