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Official Reserve Transactions

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  • Last Updated : 09 Jun, 2022
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Official Reserve Transactions are transactions that are carried out by a country’s monetary authority to modify official reserves. These transactions take place in the exchange market for other assets and foreign currencies, such as the buying and selling of currency. When the economy is in deficit, these foreign currencies are sold in the exchange market, and when the economy is in surplus, they are purchased from there. Official reserve transactions are critical because they assist the country’s total balance of payments to be balanced. As a result, these transactions serve as accommodation items in the BOP.

A country’s official reserve is its gold reserves, special drawing privileges, and marketable foreign currency. The balance of payments surplus and deficit are defined as the rise and fall in the official reserve, respectively. Capital Account, Current Account, and Financial Account are the three parts/categories of the Balance of Payments. A country’s foreign exchange reserves grow when its total BOP is in surplus. Reserves are drawn during deficits by selling foreign currencies on the exchange market, while foreign currencies are bought during surpluses.

This reflects the current account and capital account of central banks in the international balance of payments accounting. The current account tracks a country’s imports and exports of commodities, services, revenue, and transfers, as well as whether it is a net creditor or debtor. Foreign and domestic investments, government borrowing, and private sector borrowing are all recorded in the capital account. Reserve asset inflows or outflows put the ledger back into balance when there is either a balance of payments deficit or surplus. The official settlement account reflects this.

Balance of Payments : 

The balance of payments, according to economists, is a record of all transactions. Over a given time period, transactions between entities in one country and the rest of the world. It records all transactions within and outside a country between individuals, corporations, and government agencies. The current account includes all product and service transactions, as well as investment income and current transfers. Financial instrument transactions and central bank reserves are included in the capital account. It only pertains to the trading of financial instruments. The current account is taken into consideration for calculating national production, while the capital account is not.

The Significance of the Official Reserve Transaction is as follows:

1. The official transaction reserve assists in bringing the country’s balance of payments into balance: 

Countries keep track of official settlement accounts to determine their economic health. Nations can monitor the inflows and outflows of other countries via official settlement accounts. Investments, loans, services, and products are among the inflows and outflows. These accounts reflect the current account and capital account of central banks in the international balance of payments accounting which is very important for an economy. Reserve asset inflows or outflows put the ledger back into balance when there is either a balance of payments deficit or surplus. The total of the current account should, under ideal conditions, balance with the total of the capital and finance accounts.

2. The procurement of a country’s own currency is a credit item in the balance of payments, but the sale of the currency is a negative item:

Different types of transactions can be used to determine the balance i.e. products, goods and services. For foreign transactions, the current account, capital account, and financial account balances are also computed. When an international transaction account has a negative net amount or balance, it is called a trade deficit. The balance of payments records all economic transactions between residents and non-residents that result in a change in ownership (international transaction accounts). A trade deficit or net amount can be calculated in a variety of categories under an international transaction account. Products, goods and services, as well as the current account and total current and capital account balances, are all included. Net lending/borrowing is equal to the sum of the current and capital account balances. This is also the financial account balance plus a statistical mismatch. In contrast to the current and capital accounts, which track purchases and payments, the financial account measures financial assets and liabilities.

3. It assists in the management of the deficit and surplus in the balance of payments:

An account that maintains track of central bank transactions is known as official reserve transactions. It may be seen in the financial account for balance of payments. The country is in balance of payments surplus if this account shows a net increase in official reserves over time. If the official reserve balance continues to decline over time. The country’s balance of payments will then be in deficit. 

In a fixed exchange rate system, suppose a country has a trade deficit. When the demand for imports exceeds the demand for our exports to other nations, a trade imbalance emerges. Domestic demand for foreign currency is higher than international demand for domestic currency, implying that domestic demand for foreign currency is greater than international demand for domestic currency. To maintain the exchange rate steady, the central bank would have to take action. If there are no more foreign demands for domestic currency on the financial account, the central bank can intervene by selling foreign money in exchange for domestic currency. As a result, foreign reserves would decline, resulting in a balance-of-payments deficit. A trade deficit and a steady exchange rate imply a balance of payments deficit in the absence of financial account activities. When there is an extra demand for anything, it results in a balance of payments deficit of foreign currency in the private Forex market at the government-regulated exchange rate. To accommodate the excess demand, the central bank will automatically act in the Forex market and sell (purchase) foreign reserves (supply). We can determine whether a country has a balance of payments deficit or surplus by tracking sales and purchases of foreign reserves in the official reserve account.

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