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External Sector Balance of Payments
Balance of Payments
What is the Balance of Payments?
The outcome of the total transactions of an economy with the out world in one year is known as the Balance of Payment.
Basically it is the net outcome of the current and capital accounts of an economy. It might be favourable or unfavourable for the economy.
The Capital Account
The current account shows the net amount a country is earning if it is in surplus, or spending if it is in deficit. It is the sum of the balance of trade (net earnings on exports minus payments for imports), factor income (earnings on foreign investments minus payments made to foreign investors) and cash transfers.
Which shows the capital kind of transactions of the economy with the outside economies. Every transaction in foreign currency considered as capital is shown in this account- external lending or borrowing, private remittance’s inflow or outflow, issuing of external bonds etc.
Convertibility
An economy might allow its currency full or partial convertibility in the current and the capital accounts.
If domestic currency is allowed to convert into foreign currency for all current account purpose, it is a case of full current account convertibility.
Similarly, in cases of capital outflow, if domestic currency is allowed to convert into foreign currency, it is a case of full capital account convertibility.
Convertibility in India
Current account
Current account is today fully convertible.
It means that the full amount of foreign exchange required by someone for current purposes will be made available to him at official exchange rate and there could be an unprohibited outflow of forign exchange
Capital account
After the recommendations of the Tarapore committee (1997) on the Capital Account Convertibility, India has been moving in the direction of allowing full convertibility. India is still a country of partial convertibility (40:60).
But full capital convertibility is allowed;
- Indian corporate are allowed full convertibility in the automatic route up to $ 500 million overseas ventures
- Individuals are allowed to invest in foreign assets, shares up to the level of $ 200000 per annum
- Unlimited amount of gold is allowed to be imported
The second committee on the Capital Account Convertibility again under S.S Tarapore handed over its report in 2006 on which RBI/Govt is having consultation
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FAQs on External Sector Balance of Payments - Economics, UPSC, IAS. - Indian Economy (Prelims) by Shahid Ali
| 1. What is the meaning of the external sector in the balance of payments? |  |
Ans. The external sector refers to the international trade and financial transactions of a country. It includes the export and import of goods and services, as well as the inflow and outflow of capital and financial investments. The balance of payments is a record of all these transactions.
| 2. How is the balance of payments calculated? | |
Ans. The balance of payments is calculated by taking into account the current account and the capital account. The current account includes the trade balance (exports minus imports), net income from abroad, and net transfers. The capital account includes capital flows such as foreign direct investment, portfolio investment, and loans. The balance of payments is calculated by summing up the current account and the capital account.
| 3. What does a surplus or deficit in the balance of payments indicate? | |
Ans. A surplus in the balance of payments indicates that a country's exports are greater than its imports, meaning it is a net creditor to the rest of the world. This can be a sign of economic strength. On the other hand, a deficit in the balance of payments indicates that a country's imports are greater than its exports, meaning it is a net debtor to the rest of the world. This can be a sign of economic weakness.
| 4. How does the balance of payments affect a country's currency exchange rate? | |
Ans. The balance of payments can influence a country's currency exchange rate. If a country has a surplus in its balance of payments, it means there is an excess supply of its currency in the foreign exchange market. This can lead to an appreciation of the currency's value. Conversely, if a country has a deficit in its balance of payments, it means there is an excess demand for its currency. This can lead to a depreciation of the currency's value.
| 5. Why is the balance of payments important for a country's economic stability? | |
Ans. The balance of payments is important for a country's economic stability because it reflects the overall health of its international financial transactions. A consistent deficit in the balance of payments can indicate a dependence on foreign borrowing and may lead to a build-up of debt. On the other hand, a surplus in the balance of payments can indicate a strong export sector and financial stability. Monitoring and managing the balance of payments is crucial for maintaining economic stability and avoiding financial crises.
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