Fixed versus floating exchange rates:
To begin with, we will briefly review the balance of payments (BOP) table of a nation that you studied in the course on international economics as that will give us an idea of how exactly exchange rate regimes work. A country's BOP accounts summarises its dealings with the rest of the world. The BOP table has two main parts: (a) the current account and (b) the capital account.
The current account includes exports and imports of merchandise; exports and imports of services; inflows and outflows of investment income; and grants, remittances and transfers. The current account shows all flows that directly affect the national income accounts. Every transaction in the current account is an income-related flow.
The capital account includes direct investment by foreigners into the domestic economy and direct investment by citizens in foreign countries; portfolio investment, which includes net purchases of Indian securities and net lending to Indian residents; net purchases by Indian residents of foreign securities and net lending to foreigners; and changes in cash balances. The capital account shows all flows that directly affect the national balance sheet. Every transaction in the capital account is an asset-related flow.