Balance of Payments and Foreign Exchange
What this domain tests
This domain tests the structure of the balance of payments, current and capital accounts, and exchange-rate concepts including depreciation, appreciation, devaluation and revaluation.
Core rules
- BoP: a systematic record of all economic transactions between residents and the rest of the world in a year.
- Current account: goods, services, primary income and unilateral transfers.
- Capital account: foreign investment, loans, banking capital and changes in reserves.
- Balance: the BoP always balances in accounting terms because the current and capital accounts offset each other through reserves or borrowing.
- Exchange rate: price of one currency in terms of another. A rise in the rupee price of a dollar is rupee depreciation under a floating rate.
Worked example
If $1 = ₹80, an Indian good priced at ₹800 sells for $10. If the rupee depreciates to $1 = ₹85, the same good sells for about $9.41, making Indian exports cheaper abroad. Imports become costlier in rupees, which can reduce import demand.
Traps that cost marks
Do not say the BoP is in deficit because the current account is in deficit; the accounts must balance overall. Unilateral transfers belong to the current account, not the capital account. Depreciation occurs under a floating rate; devaluation is a deliberate official reduction under a fixed rate. Appreciation makes imports cheaper and exports dearer.