Chapter 5 – Balance of Payments
Q1. What is the Balance of Payments (BoP)?
BoP is a systematic record of all economic transactions between residents of a country and the rest of the world during a year.
Q2. What are the components of BoP?
- Current Account
- Capital Account
- Errors and Omissions
- Official Reserve Transactions
Q3. What is the current account?
It records exports and imports of goods and services, income from abroad, and unilateral transfers.
Q4. What is the capital account?
It records capital transfers and purchase/sale of financial assets like shares, bonds, loans, and investments.
Q5. What is the current account deficit?
When current account payments exceed receipts — meaning a country imports more than it exports in terms of goods, services, and transfers.
Q6. What is the capital account surplus?
When capital receipts (FDI, loans, portfolio investment) exceed capital payments — shows foreign funds are flowing into the economy.
Q7. What is the balance of trade (BoT)?
It is the difference between exports and imports of visible goods only.
BoT = Exports – Imports
Q8. What is the difference between BoP and BoT?
BoT includes only goods, while BoP includes goods, services, transfers, capital flows, and official transactions.
Q9. What are autonomous transactions?
BoP transactions done for economic motives like trade or investment, also called “above the line” items.
Q10. What are accommodating transactions?
BoP transactions made to balance any deficit or surplus in autonomous transactions — like RBI’s foreign exchange interventions.
Q11. What are unilateral transfers?
One-sided payments like gifts, donations, or remittances from abroad — recorded in current account as receipts or payments.
Q12. What is foreign exchange?
Foreign currency used for international trade and financial transactions. Examples: USD, Euro, Yen.
Q13. What is foreign exchange rate?
The price of one currency in terms of another — e.g., 1 USD = 83 INR.
Q14. What is a fixed exchange rate?
When a country’s currency is fixed by the government in terms of another currency or basket of currencies.
Q15. What is a flexible exchange rate?
Currency value determined by market forces of demand and supply in the foreign exchange market.
Q16. What is managed floating exchange rate?
A system combining flexible rates with occasional central bank intervention to stabilize or guide currency value.
Q17. What is appreciation of currency?
When the value of domestic currency increases in terms of foreign currency — imports become cheaper, exports costlier.
Q18. What is depreciation of currency?
When the value of domestic currency falls relative to foreign currency — exports become cheaper, imports costlier.
Q19. What is devaluation of currency?
Intentional reduction in the fixed value of domestic currency by the government or central bank under a fixed exchange system.
Q20. What is revaluation of currency?
Intentional increase in the fixed value of domestic currency under the fixed exchange rate regime.
Q21. What is foreign direct investment (FDI)?
Investment in a country’s businesses or assets by foreign entities with significant control or long-term interest.
Q22. What is portfolio investment?
Investment in financial assets like shares and bonds by foreign investors without direct control over operations.
Q23. What is official reserve transactions?
Transactions conducted by central banks (like RBI) involving foreign currency reserves to maintain BoP equilibrium.
Q24. What is disequilibrium in BoP?
When BoP shows persistent surplus or deficit, causing currency instability and requiring corrective measures.
Q25. What are the causes of BoP deficit?
High imports, low exports, inflation, currency depreciation, large FDI outflow, political instability, or oil price shocks.
Q26. How can BoP deficit be corrected?
By boosting exports, reducing imports, borrowing from abroad, devaluing currency, or using foreign exchange reserves.
Q27. What is IMF?
International Monetary Fund provides short-term financial assistance to member countries facing BoP problems.
Q28. What is WTO?
World Trade Organization regulates global trade rules and promotes free, fair trade among nations.
Q29. Why is BoP always balanced?
Because accommodating transactions (reserves, borrowings) are used to offset any deficit/surplus in autonomous transactions, making total inflows = total outflows.
Q30. What is the importance of BoP data?
It helps analyze a country’s economic stability, trade competitiveness, exchange rate health, and guides government policy decisions.