Q.What is favourable balance of payments ?
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🔒 Start your 14-day free trial to unlock the full solution →Concept understanding — Official Reserve Transactions
Let’s start with something you already know from everyday life.
Suppose you buy a phone from a shop in another country. You pay in dollars. The shopkeeper now has dollars, not rupees. If you are a country, and you buy more from the world than you sell to it, the world ends up holding your currency — or you end up paying them in foreign currency (like dollars). Either way, the country’s central bank (the RBI in India) has to step in to settle the difference. That stepping in is what Official Reserve Transactions are about.
The precise meaning
Official Reserve Transactions are the purchases or sales of foreign exchange (dollars, euros, gold, SDRs, etc.) by a country’s central bank to balance the Balance of Payments (BoP).
The BoP has two main accounts: the Current Account (trade in goods, services, and transfers) and the Capital Account (financial flows like loans, investments). These two accounts must always sum to zero — but in practice, they don’t automatically balance. The difference is covered by the central bank’s official reserve transactions.
Current Account+Capital Account+Official Reserve Transactions=0
Or equivalently:
Official Reserve Transactions=−(Current Account+Capital Account)
What each symbol means:
- Current Account: net earnings from exports minus imports, plus net transfers.
- Capital Account: net inflow of foreign investment minus outflow.
- Official Reserve Transactions: the change in the central bank’s stock of foreign exchange reserves.
If the sum of current and capital accounts is positive (a surplus), the central bank buys foreign exchange (adds to reserves). If the sum is negative (a deficit), the central bank sells foreign exchange (draws down reserves).
Why it matters
Official reserve transactions are the shock absorber of the external sector. They prevent the rupee from crashing or soaring uncontrollably when there is a temporary mismatch between dollars coming in and going out.
Example: India runs a trade deficit (imports > exports). Foreign investors also pull money out. The combined deficit means more dollars are leaving than entering. Without intervention, the rupee would depreciate sharply. The RBI steps in, sells dollars from its reserves, and supplies the missing dollars — keeping the exchange rate stable.
The NCERT textbook (Class 12, Macroeconomics, Chapter 6) states: “Official reserve transactions are the transactions that are undertaken by the monetary authority of a country to settle the deficit or surplus in the balance of payments.”
A word-picture to hold in mind
Imagine a weighing scale. On the left pan: all foreign exchange coming into India (exports, foreign investment, remittances). On the right pan: all foreign exchange leaving India (imports, foreign loans repaid, dividends sent abroad). The scale rarely balances perfectly.
The central bank stands next to the scale with a bucket of foreign exchange. If the left pan is heavier (surplus), the central bank adds weight to the right pan by buying dollars — that’s an increase in reserves. If the right pan is heavier (deficit), the central bank removes weight from the right pan by selling dollars — that’s a decrease in reserves.
The bucket itself is the Official Reserve Assets — and every time the central bank dips into it or adds to it, that’s an Official Reserve Transaction.
A common confusion (and how to avoid it) …
Favourable BoP = receipts from abroad exceed payments abroad (a surplus).
The balance of payments records all economic transactions between residents of a country and the rest of the world. A favourable (surplus) balance of payments occurs when the country's total foreign receipts (from exports, services, income and capital inflows) are greater than its total foreign payments. The surplus increases the country's foreign-exchange res …
Showing the 12 most recent of 19 on this concept.
- CBSE 2025Set ANNUAL1 markMCQQ.Which one of the following is included in the item of Capital Account? (A) Government transaction (B) Private transaction (C) Foreign Direct Investment (D) All of these
›Reveal solutionSolution
Government transactions, private transactions and FDI are all recorded in the capital account, so the answer is (D).
The capital account of the balance of payments records all transactions that change the country's foreign financial assets and liabilities — borrowings and lendings, investments and changes in reserves. This covers official (government) capital flows such as external loans, private capital flows such as portfolio investment and bank ca …
- CBSE 2025Set ANNUAL1 markMCQQ.Which of the following does not come in Capital Account? (A) Government transaction (B) Direct investment (C) Unilateral transfer (D) None of these
›Reveal solutionSolution
Unilateral transfers are current-account items, not capital account, so the answer is (C).
The capital account records transactions that create or discharge foreign assets and liabilities — government and private borrowings/lendings, and direct investment. Unilateral (or unrequited) transfers, such as gifts, remittances from workers abroad, and grants, involve no corresponding claim or repayment, so they are recorded in the current account, not the capital account. …
- CBSE 2025Set ANNUAL1 markMCQQ.Mr. Vijay, an Indian has invested ₹ 5 lakh in the shares of multinational company in rest of the world then such transaction is referred as ______ .(a) Foreign direct investment(b) Portfolio investment(c) Commercial borrowing(d) Domestic investment
›Reveal solutionSolution
Buying shares of a foreign company as a financial investment, without management control, is classified as portfolio investment in the Balance of Payments capital account.
The capital account of the Balance of Payments records international transactions in financial assets, including cross-border investment, which is classified as:
- Foreign Direct Investment (FDI): investment made in a foreign enterprise with the intention of acquiring a LASTING interest and a significant degree of MANAGEMENT CONTROL/influence over the enterprise (e.g., setting up a subsidiary, or buying a controlling stake).
- Portfolio investment: investment in foreign financial assets (shares, bonds, securities) made PURELY for financial return (dividends, capital gains, interest), WITHOUT seeking any management control over the foreign enterprise — the investor is a passive shareholder. …
- CBSE 2025Set ANNUAL1 markQ.Fill in the blank with the correct answer : When the net balance of all receipts and all payments is positive, it is a ________.
›Reveal solutionSolution
A positive net balance of all international receipts and payments is a BoP surplus — the country earns more foreign exchange than it spends, and its reserves rise.
- Autonomous transactions (normal trade and capital flows, undertaken for their own economic reasons) are compared: total receipts vs. total payments.
- If receipts > payments, the net balance is positive — this is a surplus / favourable BoP, and it typically results in an addition to the country's official foreign exchange reserves (an Official Reserve Transaction of accumulation). …
- CBSE 2024Set 58/1/11 markMCQQ.Surplus in Balance of Payments (BOP) refers to the excess of ________. (Choose the correct alternative to fill in the blank) (A) Autonomous payments over Autonomous receipts (B) Current Account payments over Autonomous receipts (C) Capital Account receipts over Capital Account payments (D) Autonomous receipts over Autonomous payments
›Reveal solutionSolution
A surplus in the Balance of Payments means the country is receiving more foreign exchange through autonomous (market-driven) transactions than it is spending — the correct fill-in is Autonomous receipts over Autonomous payments.
The key to this question lies in understanding what the Balance of Payments (BOP) actually measures and, more importantly, what "surplus" means in that context.
The BOP is a record of all economic transactions between residents of a country and the rest of the world over a period. These transactions are divided into two broad categories: the Current Account (trade in goods and services, income, and transfers) and the Capital Account (financial flows like loans, investments, and changes in reserves). But there is a deeper, more useful classification: Autonomous versus Accommodating transactions.
Autonomous transactions are undertaken for their own sake — profit, utility, or business reasons. They are independent of the BOP situation. Think of an exporter selling goods, a foreign company investing in a factory, or a tourist spending abroad. These are the "real" economic flows. Accommodating transactions, on the other hand, are undertaken to finance any gap left by autonomous transactions. They are the "balancing item" — the official reserve transactions that the central bank (like the RBI) undertakes to settle the difference.
Now, a surplus in the BOP means that the total foreign exchange inflow from autonomous transactions exceeds the total outflow from autonomous transactions. The country is earning more than it is spending on its own accord. This surplus is then reflected as an increase in the country's official foreign exchange reserves (an accommodating transaction). A deficit is the opposite: autonomous payments exceed autonomous receipts, leading to a decrease in reserves.
Watch outA common mistake is to think of a BOP surplus as simply a surplus on the Current Account or Capital Account individually. The BOP surplus is the overall surplus from all autonomous transactions combined. A country could have a Current Account deficit but a larger Capital Account surplus, resulting in an overall BOP surplus. …
- CBSE 2024Set 58/3/11 markMCQQ.According to the Reserve Bank of India's (RBI's) Statistical Supplement released on 19th May, 2023 : "India's foreign exchange reserves grew for the third straight week and reached near an approximate level of $ 600 billion." The above situation will __________ the __________ side of Balance of Payments account of India. (Choose the correct alternative to fill in the blanks) (A) Increase, Credit (B) Decrease, Credit (C) Decrease, Debit (D) Increase, Debit
›Reveal solutionSolution
An increase in a country's foreign exchange reserves is recorded on the debit side of the Balance of Payments (it is an acquisition of foreign reserve assets by the RBI). Since reserves grew, the situation will increase the debit side. The correct fill-in is Increase, Debit — option (D).
Let us first understand what the Balance of Payments (BoP) records. The BoP is a systematic statement of all economic transactions between residents of India and the rest of the world during a given period. Every transaction is entered as either a credit (a receipt of foreign exchange — e.g. exports, capital inflows) or a debit (a payment/use of foreign exchange — e.g. imports, capital outflows).
Now consider foreign exchange reserves. These are official reserve assets — foreign currency, gold, SDRs — held by the RBI, and a change in them is the balancing/financing item of the BoP. The recording convention is:
- An increase in foreign exchange reserves means the RBI has acquired foreign assets (bought foreign currency). Acquiring a foreign asset is a use/outflow of foreign exchange, so it is recorded on the debit side (with a negative sign).
- A decrease in reserves means the RBI has drawn down or sold foreign assets, bringing foreign exchange in — recorded on the credit side. …
- CBSE 2024Set ANNUAL1 markQ.Very short answer:(v) What is official reserve sale?
›Reveal solutionSolution
Official reserve sale is the central bank's sale of foreign exchange reserves, used to cover a balance-of-payments deficit.
Official reserve transactions are purchases and sales of foreign exchange by the monetary authority (central bank). An official reserve sale occurs when the central bank sells foreign currency out of its reserves. This is done when there is a deficit in the balance of payments (autonomous payments exceed autonomous receipts) or to prevent the domestic currency from depreciating. Such a sale reduces the countr …
- CBSE 2024Set ANNUAL1 markMCQQ.The Balance of Payments is an annual accounting statement of a nation's:(a) Exports and Imports(b) Balance due on Imports and Exports(c) Holdings of Gold and Foreign Currencies(d) International Trade and Financial Transactions
›Reveal solutionSolution
The balance of payments is a systematic annual record of all international trade and financial transactions of a country, so the answer is (d).
The balance of payments (BoP) is a systematic accounting statement that records all economic transactions — both trade (exports and imports of goods and services) and financial (capital flows, investment, loans, transfers) — between the residents of a country and the rest of the world during a year. It is wider than the bal …
- CBSE 2023Set 58/1/11 markMCQQ.Read the following statements carefully : Statement 1 : Borrowings by a nation from the World Bank to finance Balance of Payment (BoP) deficit will be recorded in the capital account. Statement 2 : Autonomous transactions are independent of the condition of Balance of Payment (BoP) account. In light of the given statements, choose the correct alternative from the following : (A) Statement 1 is true and Statement 2 is false. (B) Statement 1 is false and Statement 2 is true. (C) Both Statements 1 and 2 are true. (D) Both Statements 1 and 2 are false.
›Reveal solutionSolution
Both statements are correct: borrowings from the World Bank are capital account transactions, and autonomous transactions are independent of the Balance of Payments (BoP) condition.
The Balance of Payments (BoP) is a systematic record of all economic transactions between residents of a country and the rest of the world during a specific period, usually a year. It is divided into two main accounts: the Current Account and the Capital Account. Understanding what each account records and the nature of different types of transactions is crucial for evaluating the given statements.
Let's examine Statement 1: "Borrowings by a nation from the World Bank to finance Balance of Payment (BoP) deficit will be recorded in the capital account."
- The Capital Account records all international transactions that involve a change in the assets or liabilities of residents of a country. This includes foreign investments (both direct and portfolio), external borrowings and lending, and changes in foreign exchange reserves.
- When a nation borrows from an international financial institution like the World Bank, it represents an inflow of funds into the country. This inflow creates a liability for the borrowing nation (it has to repay the loan). Such transactions, which involve the creation of liabilities or acquisition of assets, are fundamentally capital transactions.
- Specifically, external assistance (loans and grants from foreign governments and international institutions) is a major component of the capital account. The purpose of the borrowing, even if it is to finance a BoP deficit, does not change its classification as a capital account item. It is a capital receipt for the nation.
- Therefore, Statement 1 is true.
Now, let's examine Statement 2: "Autonomous transactions are independent of the condition of Balance of Payment (BoP) account."
- Transactions in the BoP are broadly classified into autonomous transactions and accommodating transactions. …
- CBSE 2023Set 58/3/11 markMCQQ.(A) Identify, which of the following is not a source of supply of foreign exchange for India. (Choose the correct alternative)(a) Exports of goods and services abroad(b) Remittances by Indian workers working abroad(c) Imports of goods and services from abroad(d) Foreign Direct Investment (FDI) by a German automobile manufacturer(OR)(B) Read the items given in Columns I and II carefully and choose the correct pair of statements from the given alternatives. Column I : i. Export of software by an Indian company ; ii. Accommodating nature of transactions ; iii. Autonomous nature of transactions ; iv. Loan forwarded to Sri Lanka during its economic crisis | Column II : 1. Demand of foreign currency ; 2. Profit motive ; 3. Non-Profit motive ; 4. Supply of foreign exchange. Alternatives :(a) i – 1(b) ii – 2(c) iii – 3(d) iv – 4
›Reveal solutionSolution
Part (a): imports are an outflow → demand, not supply, of forex → option (c).
Part (b): the only correct match is (d) iv – 4 — forwarding a loan to Sri Lanka = India supplying foreign exchange.
Part (a): Which is not a source of supply of foreign exchange
Supply of foreign exchange arises when foreign currency flows into India; demand arises when it flows out.
- (a) Exports of goods and services — foreigners pay India in foreign currency → inflow → supply.
- (b) Remittances by Indian workers abroad — earnings sent home in foreign currency → inflow → supply.
- (c) Imports of goods and services — India pays foreigners in foreign currency → outflow → demand for forex, not supply. …
- CBSE 2023Set 58/4/11 markMCQQ.Read the following statements carefully : Statement 1 : Balance of Payment account is always balanced in accounting sense. Statement 2 : Autonomous transactions, restore balance in Balance of Payment account. In light of the given statements, choose the correct alternative from the following :(a) Statement 1 is true and Statement 2 is false.(b) Statement 1 is false and Statement 2 is true.(c) Both Statements 1 and 2 are true.(d) Both Statements 1 and 2 are false.
›Reveal solutionSolution
The Balance of Payments account is always balanced in an accounting sense, but autonomous transactions are the ones that create a surplus or deficit, which is then balanced by accommodating transactions.
The Balance of Payments (BOP) account is a comprehensive record of all economic transactions between residents of a country and the rest of the world during a specific period, usually a year. It provides a systematic summary of a country's international economic dealings, encompassing trade in goods and services, transfers, and capital flows. Understanding its structure and the nature of different transactions is crucial for interpreting a nation's economic health and its interactions with the global economy.
Let's examine the two statements in light of these principles.
Statement 1: Balance of Payment account is always balanced in accounting sense.
This statement is true. The Balance of Payments account is prepared using the double-entry bookkeeping system, similar to how a company's financial statements are prepared. Every international transaction is recorded twice: once as a credit and once as a debit, with equal values.
- Credit entries represent an inflow of foreign exchange into the country (e.g., exports of goods and services, foreign investment coming into the country, remittances received).
- Debit entries represent an outflow of foreign exchange from the country (e.g., imports of goods and services, domestic investment going abroad, remittances sent).
Because of this inherent accounting methodology, the sum of all credit entries must, by definition, always equal the sum of all debit entries. This means that the overall Balance of Payments account, when all transactions (including official reserve transactions) are considered, will always show a net balance of zero. It is balanced in an accounting sense, even if there is a deficit or surplus in specific sub-accounts like the current account or capital account before official financing.
ImportantThe accounting identity ensures that total debits always equal total credits in the Balance of Payments. This is why the BOP is said to always balance in an accounting sense.
Statement 2: Autonomous transactions, restore balance in Balance of Payment account.
This statement is false. To understand why, we need to distinguish between autonomous and accommodating transactions.
- Autonomous Transactions: These are international economic transactions undertaken for their own sake, primarily driven by the motive of profit maximization (for private individuals and firms) or welfare considerations (for the government). They are independent of the country's BOP status. Examples include exports and imports of goods and services, foreign direct investment, and portfolio investment. These transactions are often referred to as "above the line" items. It is the net effect of these autonomous transactions that determines whether a country has a surplus or a deficit in its BOP before official financing. If autonomous receipts exceed autonomous payments, there's a BOP surplus; if autonomous payments exceed autonomous receipts, there's a BOP deficit. …
- CBSE 2023Set ANNUAL1 markQ.What do you mean by capital account?
›Reveal solutionSolution
The capital account records cross-border transactions in financial assets and liabilities (FDI, portfolio investment, loans, banking capital).
The balance of payments has two main parts: the current account and the capital account. The capital account records all international transactions that create or extinguish financial claims — foreign direct investment, portfolio investment, external borrowing and lending, and changes in official reserves. A surplus on the capital account (net inflow of foreign capital) helps finance a deficit on the current account, and vice versa. It thus shows how the …
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