CLASS: XII

SUBJECT: ECONOMICS(MACRO)
CHAPTER:12 (BALANCE OF PAYMENTS)

1. What is Balance of Payment?

Ans.: Balance of Payment is an accounting statement that provides a systematic
record of all the economic transactions, between Residents of a country and the rest
of the world, in a given period of time, typically a year.

2. Who all are included in Residents?

Ans.: Residents of a country include individuals, firms and government agencies.
However, residents do not include Diplomatic staff, foreign military personnel,
tourists, etc.

3. What do you mean by economic transaction? What are the various

categories of economic transaction?
Ans.: Economic transactions refer to those transactions which involve transfer of the
title or ownership of goods, services, money and assets.
Economic transactions are broadly categorised as:
(i) VISIBLE ITEMS: These include all types of physical goods which are exported
and imported. These are called ‘visible items’ as they are made of some matter or
material and can be seen, touched and measured. The movement of such items is
open.

(ii) INVISIBLE ITEMS: Invisible items of trade refer to all types of services like
shipping, banking, insurance, etc., which are exported and imported. These are
called invisible items as they cannot be seen, felt, touched or measured.

(iii) UNILATERAL TRANSFERS: Unilateral transfers are ‘one-way transactions’

which do not involve any claim for repayment. For example, gifts, personal
remittances, etc. Unilateral transfers are also known as unrequited transfers.

(iv) CAPITAL TRANSFERS: Capital transfers relate to capital receipts (through

borrowings or sale of assets) and capital payments (through capital repayment or
purchase of assets).

4. ‘Balance of Payments uses ‘Double Entry System’. Explain.

Ans.: Balance of Payments accounting uses ‘Double Entry System’ for recording
the transactions with the rest of the world. Like a typical business account, BOP
account also has two sides:
(i)CREDIT SIDE: All inflows or sources of foreign exchange are recorded on the
credit side.
(ii)DEBIT SIDE: All outflows or uses of foreign exchange are recorded on the debit
side.
5. Define the following:
(a) Balanced BOP
(b) Surplus BOP
(c) Deficit BOP
Ans.: (a) BALANCED BOP: BOP is balanced when receipts of foreign exchange
are equal to payments of foreign exchange.
(b) SURPLUS BOP: BOP is in surplus when receipts of foreign exchange are more
than payments of foreign exchange.
(c) DEFICIT BOP: BOP is in deficit when receipts of foreign exchange are less than
payments of foreign exchange.

6. Is BOP a flow concept?

Ans.: Yes, BOP is a flow concept as it is related to a given period of time.

7. What is Balance of Trade?

Ans.: Balance of Trade (BOT) refers to difference between the amounts of exports
and imports of visible items (goods).
Balance of Trade = Export of goods – Import of goods
Exports are entered as credit (positive) items in the BOP account, while imports are
entered as debit (negative) items. BOT is also known as ‘Balance of Visible Trade’
or ‘Trade Balance’.

8. What is Surplus BOT/favourable BOT and Deficit BOT/unfavourable BOT?

Ans.: Surplus BOT: If a country exports more goods than what it imports, then the
balance of trade is said to be in surplus, i.e., balance of trade is ‘favourable’ for the
country.
Deficit BOT: If import of goods exceeds the export of goods, then the country is
said to have a deficit BOT, i.e., balance of trade is ‘unfavourable’ for the country.

9. Differentiate between Balance of Trade (BOT) and Balance of Payment

(BOP).
Ans.: The differences are as follows:
Basis Balance of Trade Balance of Payments

Meaning Balance of trade refers to Balance of Payment is an

difference between accounting statement that
amounts of exports and provides a systematic
imports of visible items. record of all the economic
transactions, between
Residents of a country and
the rest of the world, in a
given period of time,
typically a year.

Components BOT includes only visible BOP includes visible

 items. items, invisible items,
unilateral transfers and
capital transfers.

Capital It does not record any It records all transactions

transactions transaction of capital. of capital nature.

Scope It is narrow concept as it is It is a wider concept and it

only a part of BOP includes BOT.
account.

Settlement Unfavourable BOT can be Unfavourable BOP cannot

met out of favourable be met out of favourable
BOP. BOT.

10. Explain the components of BOP.

Ans.: The components of BOP are:
(i) CURRENT ACCOUNT: Current account refers to an account which records all
the transactions relating to export and import of goods and services and unilateral
transfers during a given period of time. Current account contains the receipts and
payments relating to all the transactions of visible items, invisible items and
unilateral transfers. It does not impact assets and liabilities position of a country in
relation to rest of the world.

(ii) CAPITAL ACCOUNT: Capital account of BOP records all those transactions,
between the residents of a country and the rest of the world, which cause a change
in the assets or liabilities of the residents of the country or its government.

11. Explain the components of current account of BOP.

Ans.: The components are:
(i) Export and Import of Goods (Visible Trade): A major part of transactions in
foreign trade is in the form of export and import of goods (visible items). Payment for
import of goods is written on the negative side (debit items) and receipt from export
is shown on the positive side (credit items).
(ii) Export and Import of Services (Invisible Trade): It includes a large variety of
services sold and purchased by the residents of a country, to and from the rest of
the world. Payments of these services are recorded on the negative side and
receipts on the positive side. Services are generally classified as:
(a) Factor Services: The monetary transaction related to factor incomes
include Compensation of Employees and Investment Income. The investment
income consists of income in the form of interest, rent and profits. Factor income
receipts from abroad are recorded on the positive side (credit) of BOP account,
while payments made to abroad are recorded on the negative side.
(b) Non-Factor Services: It includes all services other than factor services.
Main non-factor services are shipping, banking and insurance.
(iii) Unilateral or Unrequited Transfers to and from abroad: These are one sided
transaction which does not involve any claim for repayment. It includes gifts,
personal remittances, etc. Receipts of unilateral transfers from the rest of the world
are shown on the credit side and unilateral transfers to rest of the world on the debit
side.

12. What do you mean by Current Account Surplus and Current Account
Deficit?
Ans.: Current Account Surplus (CAS): CAS arises when the value of export of
goods and services is more than the value of imports of goods and services. It
arises when credit items are more than debit items.
Current Account Deficit (CAD): CAD arises when the value of export of goods and
services is less than the value of imports of goods and services. It arises when debit
items are more than credit items.

13. Differentiate between Balance of Trade and Current Account Balance.

Ans.: The differences are as follows:
Basis Balance of Trade Current Account
Meaning Balance of Trade (BOT) Current account refers to an
refers to difference account which records all
between the amounts of the transactions relating to
exports and imports of export and import of goods
visible items (goods). and services and unilateral
transfers during a given
period of time. Current
account contains the
receipts and payments
relating to all the
transactions of visible items,
invisible items and unilateral
transfers.
Components BOT includes only visible Current Account records
items. both visible and invisible
items.
Scope It is a narrow concept as It is a wider concept and it
it is only a part of current includes BOT.
account.

14. Explain the components of capital account.

Ans.: The components of capital account are:
(i) Borrowings and lending to and from abroad: It includes all transaction relating
to borrowing from abroad by private sector, government, etc. Receipts of such loans
and repayment of loans by foreigners are recorded on the positive side (Credit) and
all transactions of lending to abroad by private sector and government. Lending
abroad and repayment of loans to abroad is recorded as negative or debit item.
(ii) Investment to and from abroad: It includes investments by rest of the world in
shares of Indian companies, real estate in India, etc. Such investments from abroad
are recorded on the positive (credit side) as they bring in foreign exchange. It also
includes investment by Indian residents in shares of foreign companies, real estate
abroad, etc. Such investments to abroad are recorded on the negative (debit) side
as they lead to outflow of foreign exchange.
(iii) Change in Foreign Exchange Reserves: The foreign exchange reserves are
the financial assets of the government held in the central bank. A change in
reserves serves as the financing item in India’s BOP. So, any withdrawal from the
reserves is recorded on the positive (credit) side and any addition to these reserves
is recorded on the negative (debit) side.

15. Differentiate between Current Account and Capital Account BOP

Ans.: The differences are:
Basis Current Account Capital Account

Meaning Current account refers to Capital account records all

an account which records those transactions,
all the transactions relating between the residents of a
to export and import of country and the rest of the
goods and services and world, which cause a
unilateral transfers during change in the assets or
a given period of time liabilities of the residents
of the country or its
government.

Concept It is a flow concept as it It is a stock concept as it

includes all items of flow includes all items
nature. expressing changes in
stock.

Components Visible items, invisible Borrowings and lending to

items, unilateral transfers and from abroad,
and income receipts and investment to and from
payments. abroad and change in
foreign exchange
reserves.

16. What is the difference between Foreign Direct Investment and Portfolio
Investment?
Ans.: Foreign Direct Investment refers to purchase of an asset, such that it gives
direct control to the purchaser over the asset. For example, purchase of land and
building.
Portfolio Investment refers to purchase of an asset, such that it does not give any
direct control over the asset to the purchaser. For example, purchase of shares.
17. What is ‘Errors and Omissions’?
Ans.: In addition to current account and capital account, there is one more element
in BOP, known as ‘Errors and Omissions’. It is the balancing item, which reflect the
inability to record all international transactions accurately.

18. What are Autonomous Transactions?

Ans.: Autonomous items refer to those international economic transactions, which
take place due to some economic motive such as profit maximisation. These items
are also known as ‘above the line items’. Autonomous transactions are independent
of the state of BOP account. It takes place on both current and capital accounts.

19. What are Accommodating Transactions?

Ans.: Accommodating items refer to the transactions that are undertaken to cover
deficit or surplus in autonomous transactions, i.e., such transactions are determined
by net consequences of autonomous transactions. These items are also known as
‘below the line items’. Accommodating transactions are compensating capital
transactions which are meant to correct the disequilibrium in autonomous items of
balance of payments.

20. Differentiate between Autonomous and Accommodating Items.

Ans.: The differences are as follows:
Basis Autonomous Items Accommodating Items
Meaning Autonomous items refer to Accommodating items
those international refer to the transactions
economic transactions, that are undertaken to
which take place due to cover deficit or surplus in
some economic motive autonomous transactions,
such as profit i.e., such transactions are
maximisation. determined by net
consequences of
autonomous transactions.
Effect on BOP Autonomous transactions Accommodating
Account are independent of the transactions are
state of BOP account. undertaken to maintain the
balance in BOP account.
Current/Capital It takes place on both It takes place only on
Account current and capital capital account.
accounts.
Alternate Name These items are also These items are also
known as ‘above the line known as ‘below the line
items’. items’.

21. Indian investors lend abroad. Answer the following questions:

(a) In which sub-account and on which side of the Balance of Payments
Account such as lending is recorded? Give reasons.
(b) Explain the impact of this lending on market exchange rate.
Ans.: (a) Indian investors lending abroad is recorded in Capital account of Balance
of Payments account because it leads to creation of foreign exchange assets. It is
recorded on the debit side because it leads to outflow of foreign exchange.
(b) Lending abroad increases demand for foreign currency. Supply of foreign
exchange remains unchanged. So, exchange rate rises.

22. What are official reserve transactions? Explain their importance in the
balance of payments.
Ans.: Official reserve transactions refer to transactions by the central bank that
cause changes in its official reserves of foreign exchange. Such transactions take
place when a country withdraws from its stock of foreign exchange reserves to
finance deficit in its overall balance of payments. A country with surplus in its overall
BOP leads to rise in foreign exchange reserves.
Official reserve transactions are very important as they help to bring a balance in the
country’s overall balance of payments. So, such transactions act as accommodating
item of BOP.

*GO THROUGH HOTS AND NCERT QUESTIONS*

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