‘An important factor which influences the Balance of Payments of a country is the exchange rate of its currency vis-a- vis other major currencies.’ Briefly explain this statement.

The balance of payments (BOP) is defined by the OECD (Organization for Economic Co-operation and Development) as follows “The balance of payments is a record of a country’s international transactions with the rest of the world. This is equivalent to the transactions between residents of a country and non-residents. The balance of payments is divided up into the current account and investment and other capital transactions.

These transactions, which are recorded by a double- entry system of book-keeping, involve goods, services, transfers, loans granted or received, market securities, foreign exchange etc.

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International trade in services is shown in the current account balance of payments statistics and forms part of what is known as “invisibles”. The current account balance constitutes the sole source of comparable data on international cross-border statistics on services.” (Reference: OECD, http://stats.oecd.org/glossary/detail.asp?ID=150)

In essence the BOP sheet is a record of all economic transactions between a country and the rest of the world. Sources of incoming funds such as exports are noted as positive and out flow of funds such as imports are recorded as negative on the sheet. The BOP consists of three components:

a) Current account – This portrays the flow of goods and services (exports and imports), income and current transfers

b) Capital account – This account shows the volume of capital transfers such as foreign direct investment, loans and grants, and acquisition/disposal of non-produced, non- financial assets.

c) Official reserve assets – This account is a balancing item in the BOP equation which ensures the current account and capital account transactions sum up to zero. These comprise of assets held by the country’s national bank such as gold stock and convertible foreign currencies. Funds are used from this account when the total outflow of funds exceeds the total inflow of funds in the current and capital accounts. Thus if the balance in current and capital accounts is negative, its considered a deficit and if the balance is positive, it is considered as surplus.