International Trade — UPSC Mains Model Answer

The BoP comprises the current account, capital account, and financial account, with an 'errors and omissions' item ensuring the accounts balance arithmetically. The financial account records cross-border investment flows, including FDI, portfolio investment, and reserve assets. FDI inflows represent a liability to the receiving country and are recorded as a credit in its financial account.

The 'errors and omissions' entry captures statistical discrepancies arising from data collected through different sources at different times. It also reflects unrecorded or under-reported transactions, such as informal remittances or capital flight, making it a useful indicator of data quality and potential illicit financial flows.

Under a pure floating exchange rate system, currency depreciation or appreciation automatically corrects BoP disequilibria without official reserve intervention — a surplus causes currency appreciation, reducing exports and increasing imports until balance is restored. Under a fixed exchange rate regime, the central bank intervenes using official reserves, meaning a capital account surplus need not mechanically require a current account deficit; official reserve changes absorb the imbalance.

India operates a managed float, where the Reserve Bank of India intervenes selectively to curb excessive volatility. Persistent current account deficits financed by volatile capital flows create external vulnerability, underscoring the importance of monitoring BoP components for timely policy response.