Answer to Question #182464 in Accounting for Kaju

Question

Explain different accounts maintained under balance of payments with its components. Also, explain why a stronger rupee could enlarge the India’s balance of trade deficit and why a weaker rupee could affect the India balance of trade deficit.

Answer 1

Balance of Payments (BOP) records all international transactions in finance made by the residents of the country.

It is composed of the current account, capital account and the official settlements account.

Current account records values of current outflows and inflows between residents of the home country and the rest of the world which include import and exports of goods and services alongside foreign investments.

The capital account records international lending and borrowing and purchases and sales of assets by individuals, firms and government agencies. It could be securities such as bonds and treasury bills.

The official settlements account balances the BOP deficits or surpluses. It acts as an adjustment account.

A stronger rupee makes India's exports more expensive to importers and may reduce imports leading to an unfavourable balance of trade.

A weaker rupee makes exports become cheaper to foreigners because they can get more Indian rupees for the same amount of their currency to buy Indian goods. A weak currency may help a country's exports gain market share when its goods are less expensive compared to goods priced in stronger currencies. This will lead to a favourable balance of trade.