Balance of Payments

Chapter-12
+2(Arts)
 One marks questions:

Question 1.When does surplus BoP occurs?

Answer: receipts>payments

Question 2.What does invisible balance refers to?

Answer: balance of non factor services + balance of income + balance of transfers

Question 3. What records imports and exports of goods only?

Answer: Balance of trade.

Question 4. What kind of account transactions do not give rise to future claims?

Answer: current account.

Question 5. It true that services are not visible when they cross the borders?

Answer: Yes
Question 6. What items refers to such BoP transactions which are undertaken with a view to making profits?

Answer: autonomous items.

Question 7. What is the state of BoP when there is no movement of official reserves of the central bank?

Answer: Equilibrium BoP.

Question 8. External borrowing is a component of?

Answer: capital account.

Question 9. What does foreign direct investment relates to?

Answer: ownership of enterprises in the domestic economy by the rest of the world.

Question 10. What is official reserves account?

Answer: it is the account indicating reserves of forex with the RBI.

 Three Marks questions:

Question 1. Classification of Economic Transactions in BoP

Answer:(i) Visible items (physical goods)

(ii) Invisible items (services)

(iii) Capital transfers (capital receipts and payments)

(iv) Uni-lateral transactions

Question 2. Components of Current Account

(i) Export and import of visible items

(ii) Exports and imports of invisible items

(iii) Unilateral transfer to and from rest of the world.

Question 3. When is BoP Deficit?

Answer:BoP Deficit When the payments of a country on account of autonomous transactions exceed the receipts of
a country on account of autonomous transactions, this difference is termed as BoP deficit.

BoP Deficit = Receipts on account of autonomous transactions < Payments on account of autonomous transactions or

Bop Deficit = R<P

Where, R = Receipts

P = Payments

Question 4. What is Disequlibrium in BoP?

Answer: BoP is said to be in state of disequilibrium when there is either surplus or deficit in BoP.

Causes of Disequilibrium in BoP

(i) Economic factors

(ii) Social factors

(iii) Political factors

Question 5.State the components of capital account of Balance of Payments.

Answer. Components of capital account of Balance of Payments:

(i) Investments It includes investments to and from abroad in the form of FDI and Fll. Investment from abroad is a
‘credit’ item, whereas investment to abroad is a ‘debit’ item.

(ii) Borrowing and lending It includes the borrowings by residents from the residents of abroad (credit item), and
sending to the resident of foreign country (debit item).

(iii) Foreign exchange It includes the reserve of foreign currency gold and Special Drawing Rights (SDRs) with the
domestic country.

Question 6. Giving reasons, state whether the following statements are true or false

(i) Current account of Balance of Payment account records only export and import of goods and services.

(ii) Foreign investments are recorded in the capital account of Balance of Payments.

Answer. (i) False, as current account of Balance of Payments account also records unilateral transfers.

(ii) True, as all kind of foreign investments (foreign direct investments and portfolio investments) are included in the
capital account of Balance of Payments as they affect the assets positions of the country.
Question 7. What is Balance of Payments account? Where are borrowings from abroad recorded in it and why?

Answer. Balance of Payment The Balance of Payment (BoP) of a country is a systematic record of all economic
transactions between its residents and residents of foreign countries.

Balance of Payments account are classified into current account and capital account. Borrowing from abroad are
recorded in the capital account (credit side) of Balance of Payments as it is a foreign liability on the country and it is to
be repaid with interest.

Question 8. Explain the concept of surplus in the Balance of Payments account.

Answer. Balance of surplus When the receipts of the country on account of autonomous transactions exceed the
payments of a country on account of autonomous transactions, this difference is termed as BoP surplus.

BoP Surplus = R>P, where R = Receipts of the country, P = Payment of the country, e.g., if the receipts of the country
is Rs. 200 crore and the payments are Rs. 190 crore, then BoP surplus will be (200 -190) = Rs. 10 crore.
 Four marks questions:
Question 1. Where will sale of machinery to abroad be recorded in the balance of payment accounts? Give reasons.

Answer:1.Sale of machinery to abroad is a part of Current accounts.

2.Current account records imports and exports of goods and services and unilateral transfers.

3.Sale of machinery to abroad leads to inflow of foreign currency and receipt from exports is shown on the positive side (credit items).

Question 2. State four items of current account of BOP account.

Answer: Current account records imports and exports of goods and services and unilateral transfers.

Components of Current Account The main components of Current Account are:

Export and Import of Goods (Merchandise Transactions or Visible Trade): A major part of transactions in foreign trade is in the form of export and
import of goods (visible items). Payment for import of goods is written on the negative side (debit items) and receipt from exports is shown on the
positive side (credit items). Balance of these visible exports and imports is known as balance of trade (or trade balance).

Export and Import of Services (Invisible Trade): It includes a large variety of non-factor services (known as invisible items) sold and purchased by the
residents of a country, to and from the rest of the world. Payments are either received or made to the other countries for use of these services. Services
are generally of three kinds: (a) Shipping,

(b) Banking, and (c) Insurance. Payments for these services are recorded on the negative side and receipts on the positive side.

Unilateral or Unrequisted Transfers to and from abroad (One sided Transactions): Unilateral transfers include gifts, donations, personal remittances and
other ‘one-way’ transactions. These refer to those receipts and payments, which take place without any service in return. Receipt of unilateral transfers
from rest of the world is shown on the credit side and unilateral transfers to rest of the world on the debit side.

Income receipts and payments to and from abroad: It includes investment income in the form of interest, rent and profits.
Question 3. What do you understand by loans?

Answer:Loans: Borrowing and lending of funds are divided into two transactions:

(a) Private Transactions

• These are transactions that are affecting assets or liabilities by individuals, businesses, etc. and other non-government
entities. The bulk of foreign investment is private.

• For example, all transactions relating to borrowings from abroad by private sector and similarly repayment of loans by
foreigners are recorded on the positive (credit) side.

• All transactions of lending to abroad by private sector and similarly repayment of loans to abroad by private sector is
recorded as negative or debit item.

(b) Official Transactions

• Transactions affecting assets and liabilities by the government and its agencies.

• For example, all transactions relating to

borrowings from abroad by government sector and similarly repayment of loans by foreign government are recorded on
the positive (credit) side.

• All transactions of lending to abroad by government sector and similarly repayment of loans to abroad by government
sector is recorded as negative or debit item.
Question 4. What do you know about Foreign investment?

Answer:Foreign Investment (Investments to and from abroad) It includes:

(a) Investments by rest of the world in shares of Indian companies, real estate in India, etc. Such investments from
abroad are recorded on the positive (credit) side as they bring in foreign exchange.

(b) Investments by Indian residents in shares of foreign companies, real estate abroad, etc. Such investments to abroad
are recorded on the negative (debit) side as they lead to outflow of foreign exchange.

Question 5.What is Foreign exchange reserves?

Answer:Change in Foreign Exchange Reserves

(a) The foreign exchange reserves are. the financial assets of the government held in central bank. A change in reserves
serves as the financing item in India’s BOP.

(b) So, any withdrawal from the reserves is recorded on the positive (credit) side and any addition to these reserves is
recorded on the negative (debit) side.

(c) It must be noted that ‘change in reserves’ is recorded in the BOP account and not ‘reserves’.
Question 6. Where is ‘borrowings from abroad’ recorded in the Balance of Payments Accounts? Give reasons.

Answer:Borrowing from abroad is a part of Capital Account.

Borrowing from abroad can be private transactions or official transactions.

For example,

(a) All transactions relating to borrowings from abroad by private sector are recorded on the positive (credit) side as it
is inflow of foreign currency.

(b) Similarly, transactions relating to borrowings from abroad by government sector are recorded on the positive
(credit) side as it is inflow of foreign currency.

Question 7. What is meant by ‘official reserve transactions’? Discuss their importance in Balance of Payments.

Answer:Official reserve transactions are those transactions by a central bank that cause changes in its official reserves.

It is sale or purchase of its own currency in the exchange market in exchange for foreign currencies.So, any withdrawal
from the reserves is recorded on the positive (Credit) side and any addition to these reserves is recorded on the negative
(debit) side.

They may be Autonomous and Accommodating Transactions.

Question8.Distinguish between Balance of trade and
balance of Payments.

Balance of Tradee Balance of Payments

1. It consists of exports and imports of 1. It consists of ports and exports of

visible items visible and invisible items.
2. It's scope is narrow. 2. It has a wider scope.
3. It can show a deficit and surplus 3. It's always balanced.
4. It gives a partial picture of the 4. It gives a comprehensive picture of
economy economy.
5. It has limited practical applications. 5. It is widely used by government and
institutions while formulating various
policies
Six marks questions:
Question 1. What are the economic causes of disequilibrium in Balance of Payment (BOP)?

Ans. Various causes of dis-equilibrium in Balance of Payment (BOP) are:

Economic Factors:

(i) Inflation:Inflation phenomenon i.e., higher wages, higher cost of raw materials, wages etc. make the exports costlier and
decrease in exports. This leads to deficit in the BOP.

(ii) Exchange rate fluctuations:The exchange rate also affects the BOP. When the value of currency of a country increases,
imports become cheaper thus the value of imports rises and value of exports falls, which contributes to disequilibrium.

(iii) Population Growth:Uncontrolled growth of population leads to fall m aggregate demand / fall export surplus and thus BOP
becomes adverse.

(iv) Cyclic Business:In any capitalistic country, trade cycles cause inflation and depression situations. During depression the
exports to other countries are reduced. Thus disequilibrium in BOP may also arise due to depression m other countries.

(v) Demand Reduction:A fall in demand for a country’s goods abroad will also reduce exports thereby causing disequilibrium.

(vi) Import of Services:

Developed countries are forced to import capital and other services from developed countries. Such imports, being extremely
costly can cause major drop in BOP.
Question 2. What are the social and political cause for dis-equilibrium of Balance of Payments?

Answer:Social Factors:

People of an underdeveloped country tend to imitate the consumption pattern of the people of developed countries. Due
to ouch psychology, the imports of the former country increase which again triggers disequilibrium. ‘

(Political Aspects:

Political instability, non-cordial international relations can also have adverse impact. Partition, unification of nation also
affects the BOP.
Question 3. What is balance of payment? What are its main features?

Answer. Balance of Payment (BOP) is a systematic record of all economic transactions of a country with rest of the
world during a given period which is usually one year.

The main features of BOP are:

(i) Systematic record:It is a systematic record of all transactions of the residents of a country with rest of the world.

(ii) Fixed time:It is a statement of account for a fixed period of time which is usually one year.

(iii) Comprehensive statement:Balance of payment is a comprehensive statement of accounts which includes all
transactions visible, invisible and capital transfers.

(iv) Double Entry system:Balance of payment account is based on double entry system of book keeping. It means there
is a credit for every debit entry. Receipts are recorded on the credit side and payments are recorded on the debit side.

(v) Balanced system:In Double entry system debit and credit sides of the account are always equal i.e., total debits are
always equal to total receipts hence it is a balanced system.
Question 4. What are the various categories of economic transactions which are recorded in Balance of Payment
account?

Ans. Various categories of economic transactions in Balance of Payment are as follows:

(i) Visible items:All types of physical goods which are exported and imported by a country are called visible
items since such goods are made of some material and thus have physical existence.

(ii) Invisible Items:Invisible items include different types of services, investment income and unilateral
transfers. Shipping, banking, travel services, etc., are included in services. Interest, profit, dividend, royalties
etc. form part of investment income and gifts, remittances, etc. are included in unilateral transfers.

(iii) Capital transfers:Capital receipts and capital payments form part of capital transfers.
Question 5. What is balance of payment? What are its components?

Ans. Balance of Payment is a systematic record of all economic transactions of a country with rest of the world in a given period of time which
is usually one year.

The Balance of Payment account has two main components

(i) Current Account and

(ii) Capital Account.

(i) Current Account:

a. The current account of balance of payment records imports and exports of goods, services and unilateral transfers.

b. It includes record of services like shipping, banking, insurance etc.; interest and dividends flowing in and out of the country; receipts and
payments from foreign travel and tourism; miscellaneous items like royalties, subscription, consultancy, telephone and telegraph services and
transfer payments like gifts, remittances, donations etc.

c. The final balance of visible trade i.e., exports and imports of goods alone is known as trade balance. The total of visible and invisible items
gives current account balance, which is moved to capital account.

(ii) Capital Account:

i. The capital account of balance of payment records those capital transfers between one nation and all other countries which result in change in
the assets or liabilities of the citizens of that country or of its government.

ii. It consists of capital of various kinds e.g., gold. The flows of capital can be in the form of borrowings or lending’s to abroad by private sector
and government or both.

iii. The final balance of capital account shows a country’s final position. It may be surplus or deficit