BALANCE OF PAYMENTS AND FOREIGN EXCHANGE RATE
Foreign Exchange refers to all currencies other than the domestic currency of a given country.
Foreign exchange rate is the rate at which currency of one country can be exchanged for currency of another country.
Foreign Exchange Market: The Foreign Exchange market is the market where the national currencies are traded for one another.
Functions of Foreign Exchange Market:
FIXED EXCHANGE RATE SYSTEM: Fixed exchange rate is the rate which is officially fixed by the government, monetary authority and not determined by market forces.
FLEXIBLE EXCHANGE RATE: Flexible exchange rate is the rate which is determined by forces of supply and demand in the foreign exchange market.
DEMAND FOR AND SUPPLY OF FOREIGN EXCHANGE
Demand for foreign exchange:
Supply of foreign exchange:
Foreign currencies flow into the domestic economy due to the following reason.
EQUILIBRIUM IN THE FOREIGN EXCHANGE MARKET
The equilibrium exchange rate is determined at a point where demand for and supply of foreign exchange are equal. Graphically interaction of demand and supply curve determines the equilibrium exchange rate of foreign currency.
Managed Floating: This is the combination of fixed and flexible exchange rate. Under this, country manipulates the exchange rate to adjust the deficit in the B.O.P by following certain guidelines issued by I.M.F.
Dirty floating: If the countries manipulate the exchange rate without following the guidelines issued by the I.M.F is called as dirty floating.
BALANCE OF PAYMENTS: MEANING AND COMPONENTS
Meaning: The balance of payments of a country is a systematic record of all economic transactions between residents of a country and residents of foreign countries during a given period of time.
BALANCE OF TRADE AND BALANCE OF PAYMENTS
Balance of trade: Balance of trade is the difference between the money value of exports and imports of material goods (visible item)
Balance of payments: Balance of payments is a systematic record of all economic transactions between residents of a country and the residents of foreign countries during a given period of time. It includes both visible and invisible items. Hence the balance of payments represents a better picture of a country’s economic transactions with the rest of the world than the balance of trade.
STRUCTURE OF BALANCE OF PAYMENT ACCOUNTING
A balance of payments statement is a summary of a Nation’s total economic transaction undertaken on international account. There are two types of account.
1. Current Account: It records the following 03 items.
a) Visible items of trade: The balance of exports and imports of goods is called the balance of visible trade.
b) Invisible trade: The balance of exports and imports of services is called the balance of invisible trade E.g. Shipping insurance etc.
c) Unilateral transfers: Unilateral transfers are receipts which resident of a country receive (or) payments that the residents of a country make without getting anything in return e.g. gifts.
The net value of balances of visible trade and of invisible trade and of unilateral transfers is the balance on current account.
2. CAPITAL ACCOUNT: It records all international transactions that involve a resident of the domestic country changing his assets with a foreign resident or his liabilities to a foreign resident.
VARIOUS FORMS OF CAPITAL ACCOUNT TRANSACTIONS
OTHER ITEMS IN THE BALANCE OF PAYMENT
They are included since the full balance of payments account must balance. These items are as follows.
AUTONOMOUS AND ACCOMMODATING ITEMS
Autonomous items: Autonomous items in the B.O.P refer to international economic transactions that take place due to some economic motive such as profit maximization. These items are often called above the line items in the B.O.P.
The balance of payments is in a deficit if the autonomous receipts are less than autonomous payments. The monetary authorities may finance a deficit by depleting their reserves of foreign currencies, or by borrowing from I.M.F.
Accommodating items: Accommodating items in the B.O.P. refer to transactions that occur because of other activity with the B.O.P such as government financing. Accommodating items are also referred to as below the line of items.
DISEQUILIBRIUM THE BALANCE OF PAYMENTS
There are a number of factors that cause disequilibrium in the balance of payments showing either a surplus or deficit. These causes are categorized into 3 factors.
I Economic factors: Large scale development expenditure that may cause large imports.
II Cyclical fluctuations in general business activities such as recession or depression.
III High domestic prices may result in imports.
II Political factors: Political instability may cause large capital outflows and hamper the inflows of foreign capital.
III Social factors: Changes in tastes, preferences and fashions may affect imports and exports.