1. why current account can be in deficit but balance of payments must be in balance?
The current account is a country’s trade balance plus net income and direct payments. The trade balance is a country’s imports and exports of goods and services. The current account also measures international transfers of capital.
A current account is in balance when the country’s residents have enough to fund all purchases in the country. Residents include the people, businesses and government.
Funds include income and savings. Purchases include all consumer spending as well as business growth and government infrastructure spending. A deficit occurs when a country’s government, businesses and individuals export fewer goods and services than they import. They take in less capital from foreigners than they send out.
Balance of payments is the record of all international financial transactions made by a country’s residents. A country’s balance of payments tells you whether it saves enough to pay for its imports. It also reveals whether the country produces enough economic output to pay for its growth. The BOP is reported for a quarter or a year.
The balance of payments always balances because goods, services, and resources traded internationally are paid for; thus every movement of products is offset by a balancing movement of money or some other financial asset.
BOP uses a double-entry accounting system, where every entry MUST be balanced by an entry that is equal and opposite.
For example, say an American consumer buys $1,000 of sashimi from a Japanese fisherman. The American consumer pays with cash either USD of JPY. Then under the American BOP, the sashimi import is recorded as a debit (-$1,000) under the Current Account (CA) And credit (+$1,000) under the Financial Account so the result will be current account in deficit but BOP = $1000-$1000 = $0
2. What is the Official Reserves Account (ORA) and why is it more important for countries under a fixed exchange rate regime than for ones under a floating exchange rate regime?
The official reserves account is part of the financial account, which is the foreign currency held by central banks of domestic country and is used to pay balance-of-payment deficits. Each account is further divided into sub-accounts namely Current account, Capital account, Financial account.
The balance on this account is very important for a country with fixed exchange rate systems because the government may have to use these reserves to guarantee the stability of exchange rate.
For example if there is an oversupply of domestic currency, to prevent the value of currency falling the government has to have its official reserves standing by ready to exchange for and maintain the fixed rate.