What are official reserve transactions? Explain their importance in the balance of payments.
The transaction carried by Monetary Authority of a country which causes change in official reserves is called official reserve transaction. It includes purchase or sale of currency in exchange market for foreign currencies or other assets. The reserves are drawn by selling foreign currencies in exchange market during deficit and foreign currencies are purchased during surplus. When the official reserves increase or decrease it is called overall balance of payment surplus or deficit respectively.
The importance of official reserve transactions in balance of payment is –
a) Purchase of own currency buy a country is a credit item in the balance of payments and vice a versa.
b) It helps to adjust the deficit or surplus in balance of payments.
Suppose it takes 1.25 yen to buy a rupee, and the price level in Japan is 3 and the price level in India is 1.2. Calculate the real exchange rate between India and Japan (the price of Japanese goods in terms of Indian goods). (Hint: First find out the nominal exchange rate as a price of yen in rupees).