Balance of Payments and Foreign Exchange
What this domain tests
This domain covers the current and capital accounts, trade balance, convertibility, exchange-rate systems, depreciation and appreciation, devaluation and revaluation, and foreign exchange reserves.
Core rules
- BOP records all economic transactions between residents and the rest of the world.
- Current account includes goods, services, income, and unilateral transfers.
- Trade balance = exports - imports of goods only.
- Capital account records FDI, FPI, loans, banking capital, and changes in reserves.
- BOP always balances in accounting terms; a current account deficit must be financed by capital inflows or reserve depletion.
- Depreciation and appreciation occur under floating rates; devaluation and revaluation are official changes under fixed rates.
Worked example
Exports = 300, imports = 400, services = 50, transfers = 30. Current account = 300 - 400 + 50 + 30 = -20, a deficit of 20. If capital inflow is 30, the overall balance is a surplus of 10, so reserves rise by 10.
Traps that cost marks
Trade balance is not the current account balance. Depreciation is a fall in the external value of a currency under market forces; devaluation is a deliberate official action. A BOP deficit does not mean the accounts fail to balance. FDI is a lasting capital inflow; FPI is more volatile portfolio investment.