Question

b. How does a central bank mange Balance of Payments (BOP) deficit or surplus?  
note: no plagrism

Answer 1

Balance of Payment Deficit is the scenerio in which the imports of the country are higher than the total exports. This means that more and more currency is paid to the foreign countries from where the goods and services are imported. In this situation the person or company which imports goods from the foreign country will have to pay of the money also in the foreign currency. In such a situation we will have to borrow from the foreign countries to pay off the foreign suppliers of goods and services

As the imports will be higher the need to pay the suppliers in the foreign currency will lead to higher demand for foreign currency which leads to higher fluctuation of the exchange rate. As the demand is high there should be equivalent supply of foreign currency also because when the foreign currency moves outwards there is shortage of foreign exchange reserves. In order to tackle this situation the central bank will intervene and will sell the foreign exchange to increase the foreign exchange flow and buy domestic currency. In this way the demand and supply of foreign reserves will be continuous.

Balance of Payment Surplus is the scenerio in which the exports of the country are higher than the total imports. This means that more and more currency is paid to the domestic supplier from where the goods and services are exported to foreign country. In this situation the country which imports goods from the domestic market will have to pay of the money also in the domestic currency. In such a situation there will be additional foreign exchange reserves and the central bank intervenes to buy the foreign currency and sell the domestic currency.