ECONOMICS

• The balance of payments of a country is a systematic record of all economic transactions between the residents of one country and residents of foreign countries during a given period of time, usually one year.
• Payments made by a country's residents to foreigners are called debits and those received from foreigners are called credits.
• The current account records all international economic transactions relating to the import and export of goods, services, unilateral transfers and international incomes.
• The balance on current account is the value of exports minus the value of imports, adjusted for international incomes and net transfers.
• Current account transactions are of flow nature.
• The capital account records all international economic transactions relating to change in assets - both physical and financial. It is a record of short-term and long-term capital transactions, both private and official. These transactions change the capital stock of the country.
• Capital account transactions are mostly of stock nature.
• Visible trade comprises goods which are tangible, have physical form and we can see these when they cross the boundaries of a country.
• Services include a large variety of non-factor services sold abroad and non-factor services purchased by the residents of a country from the rest of the world. Exports comprise shipping services, banking and insurance services etc.
• Unilateral transfers are those receipts and payments which take place without any service in return in the current period. There is no quid pro quo in return.
• Incomes calculated in the balance of payments comprise two types: investment income (profits, dividends, interest etc) and compensation of employees (wages, salaries etc.).
• Direct foreign investment refers to the investment undertaken in the firms belonging to other countries by acquiring control over them.
• Portfolio investment is the form of investment under which companies and residents of a country purchase shares of foreign companies or buy bonds issued by foreign governments.
• Balance of trade shows the balance of exports and imports of visible goods in a given year.
• balance of trade = export of goods - import of goods
• balances of current account is made up of visibles, invisible, and transfers. It includes the balance of trade, the balance of invisibles or services, and balance of transfers.
• Balance of capital account refers to the balance of capital transfers - borrowing and lending from abroad and sales and purchase of assets, (export and import of capital), gold and foreign exchange from other countries.
• Autonomous capital flows take place due to normal economic considerations or motives of earning profit, dividends, interest etc. from international investment and lending.
• Accommodating capital flows are made specifically to bring the balance of payments of a country into equilibrium.
• Inflationary Pressures in the Economy as a Cause of Adverse BoP.

  A high rate of inflation at home encourages imports by making imports relatively cheaper. This also leads to a decrease in the country's competitiveness in the world markets and, therefore, reduces its exports. Thus balance of payments becomes unfavourable due to both increase in imports and decrease in exports due to increase in domestic prices.
• Fall in Foreign Demand as a Cause of Adverse BoP.

  Deficit may arise because of the shift in the foreign demand away from the country's goods to products of other countries due to change in taste or fashion or lower prices. Demand for goods may decrease in the foreign market due to fall in foreign income due to recession. A fall in foreign demand leads to a fall in exports.
• Developmental Expenditures as a Cause of Adverse BoP.

  In developing countries, BoP generally becomes unfavourable due to their developmental efforts. These countries have to depend on developed countries for supply of raw materials, machinery, technical know-how, etc. This pushes up their import bill, and they are not in a position to step up their exports to finance the increased imports. This leads to deficit in BoP called structural deficit.
• Increase in Cost Structure of Export Industries as a Cause of Adverse BoP.

  Increase in cost structure of export industries reduces the volume of exports by reducing the competitiveness of these industries in the world market. Cost structure may increase due to higher wages, higher prices of raw materials or higher rate of inflation.
• Decrease is Supply Increase as a Cause of Adverse BoP.

  A fall in supply at home leads to a situation of deficit. Agricultural production may fall due to the failure of crops, industrial production may fall due to labour strikes, shortages, etc. As a consequence, exports fall and imports may increase due to increase to overcome the scarcity of goods.
• Appreciation in the Exchange Rate as a Cause of Adverse BoP.

  BoP becomes unfavourable because of appreciation in the exchange rate of the country. Appreciation of a country's currency increases the external value of the currency. This makes imports cheaper and exports expensive. Consequently, imports increase and exports fall.
• Increased Debt Burden as a Cause of Adverse BoP.

  Developing countries need to import capital largely in the form of portfolio investment to promote their development. This creates a large debt burden on account of debt services like interest. There countries are therefore required to make large interest payments to developed countries hence creating the problem of payment in foreign currency.
• Demonstration Effect as a Cause of Adverse BoP.

  People of underdeveloped countries try to imitate the consumption pattern, particularly with regard to luxuries like cars, air-conditioners etc., of the people of developed countries. This has led to a large increase in the imports of consumer durable goods, leading to deficit in BoP.
• Population Pressure as a Cause of Adverse BoP.

  A rapid increase in population in underdeveloped countries has led to increase in demand for consumer goods. As a result, export surplus has fallen.
• Political Factors as a Cause of Adverse BoP.

  Political turmoil and instability in a number of countries have adverse effects on their BoP. Economic sanctions imposed by UNO and developed countries are also responsible for adverse BoP.
• Foreign currencies and claims on them in the form of bank deposits, cheques, etc. payable in those currencies are known as foreign exchange.
• The foreign exchange market is the market where foreign exchange is traded.
• Exchange rate refers to the rate at which the currencies of different countries are traded or exchanged.
• In a fixed exchange rate system, the rate of exchange is officially fixed by the Central Bank of the country by official action.
• In a flexible exchange rate system, exchange rate is left free to be determined in the foreign exchange market by forces of demand and supply.
• In a system of clean floating, central bank stands aside completely and allows exchange rate to freely be determined in the foreign exchange market.
• Under managed or dirty floating, central bank intervenes to buy and sell foreign currencies in an attempt to influence the exchange rate.
• Depreciation refers to the fall in the free-market value of a domestic currency relative to the currencies of other countries in the foreign exchange market.
• Appreciation means a rise in the free-market value of a domestic currency relative to currencies of other countries in the foreign exchange market.
• Devaluation refers to a deliberate action taken by the central bank to decrease the value of domestic currency relative to the currencies of other countries under a system of fixed exchange rates.
• Revaluation refers to the deliberate action undertaken by the central bank to raise the value of domestic currency relative to other currencies under a system of fixed exchange rates.