Question 1.
What is meant by depreciation of domestic currency? (All India 2017)
Answer:
Depreciation of domestic currency means that the value of domestic currency decreases in relation to the value of foreign currency under flexible exchange rate system.
Question 2.
Give the meaning of managed floating exchange rate. (All India 2014; Delhi 2012)
Answer:
Under this system, the exchange rate is determined by the market forces of demand and supply. However, excessive fluctuation is checked by the Central Bank.
Question 3.
Define foreign exchange rate. (All India 2014; Delhi 2011)
Answer:
Foreign exchange rate refers to the rate at which one currency can be exchanged for the other currency in foreign exchange market, e.g. If ₹ 58 is paid, to buy one US dollar, then ₹/$ exchange rate will be 58, i.e. ₹ 58 per dollar.
Question 4.
What is floating exchange rate? (All India 2014)
Answer:
The rate of exchange which is determined by the market forces of demand and supply of foreign currencies in the foreign exchange market, is termed as floating or flexible exchange rate system.
Question 5.
What is a fixed exchange rate? (All India 2013, 2012)
Or
Give the meaning of fixed foreign exchange rate. (All India 2012)
Answer:
Fixed exchange rate is the system under which the central authority or government maintains their exchange rate fixed either against gold or some other foreign currency, (say USD)
Question 6.
How can increase in foreign direct investment affect the price of foreign exchange? (Delhi 2013)
Answer:
Increase in foreign direct investment will reduce the price of foreign exchange.
Question 7.
How can Reserve Bank of India help in bringing down the foreign exchange rate which is very high? (All India 2013)
Answer:
The Reserve Bank of India can help in bringing down the high foreign exchange rate by selling foreign exchange from its reserve.
Question 8.
What is foreign exchange? (All India 2011)
Answer:
Foreign exchange refers to all currencies other than domestic currency of a given country, e.g. currency of US and UK are the foreign exchanges for India.
Question 9.
State two sources of supply of foreign exchange. (Delhi 2010)
Answer:
Two sources of supply of foreign exchange are
- Export of goods and services from domestic country to foreign country.
- Foreign direct investment.
Question 10.
State two sources of demand for foreign exchange. (All India 2010)
Answer:
Two sources of demand for foreign exchange are
- Payment of loans and interests to international organisations.
- Gifts and grants to the rest of the world.
Question 11.
Describe any three sources of demand for foreign exchange. (All India (C) 2016,2015; Delhi 2015)
Answer:
The three sources of demand for foreign exchange are described below
- Purchase of foreign goods by domestic residents: To purchase of foreign goods domestic residents need foreign exchange. So, this results in demand for foreign exchange.
- Re-payments of international loans: International loans have to be paid back in foreign exchange, so, this also results in demand for foreign exchange.
- Tourism to abroad: When Indian tourists visit abroad, they need foreign exchange to meet their expenses related to boarding and lodging. So, they demand foreign exchange.
Question 13.
Why are foreign exchange rate and supply of foreign exchange directly related? Explain. (Delhi (C) 2016)
Or
When price of a foreign currency rises, its supply also rises. Explain why? (Delhi 2011)
Or
Explain why there is an increase in supply of foreign currency when its price rises. (All India (C) 2012)
Answer:
Rise in exchange rate of foreign currency refers to appreciation of foreign currency in relation to domestic currency. When there is rise in foreign exchange rate (Say from ₹ 55 per $ to ₹ 60 per $), it leads to depreciation of domestic currency and rise in exports leading to rise in supply of foreign exchange.
Question 14.
What are fixed and flexible exchange rates? (All India 2015)
Or
Distinguish between fixed and flexible foreign exchange rate. (All India 2010)
Answer:
Fixed exchange rate refers to the rate of exchange which is fixed by the central authority of the country. It is not affected by change in demand or supply of foreign exchange. It discourages venture capital.
Flexible exchange rate refers to the rate of exchange which is determined by the demand and supply of foreign exchange in the foreign exchange market, with no intervention from any central authority. It incourages venture capital.
Question 15.
Explain the meaning of managed floating exchange rate. (All India 2015)
Answer:
Managed floating exchange rate refers to the rate, which is determined by the demand and supply of foreign exchange in the foreign exchange market with excessive fluctuations if any, being checked by some central authority. It is a hybrid system of exchange rate determination which combines the features of both fixed exchange rate and flexible exchange rate. It encourages venture capital.
Question 16.
Describe any three sources of supply of foreign exchange. Delhi (C) 2015
Answer:
Three sources of supply of foreign exchange are
- Exports of goods and services When goods and services are exported to other countries then the foreign exchange earned is a source of supply of foreign exchange.
- Gifts and remittances from abroad Gifts and remittances from abroad are also a source of supply of foreign exchange.
- Foreign Direct Investments (FDI) Foreigners invest in India. This is also an important source of foreign exchange.
Question 17.
Give the meanings of devaluation and depreciation of domestic currency. (All India (C) 2015)
Or
Distinguish between devaluation and depreciation of domestic currency. (Delhi 2010)
Or
Distinguish between Depreciation of a Currency and Devaluation of a Currency. (All India 2019)
Answer:
Differences between Devaluation and Depreciation of domestic currency are
| Basis | Devaluation | Depreciation |
| Meaning | Devaluation is the fall in the value of domestic currency in relation to foreign currency. It is planned by the Central Bank in situation, when exchange rate is not determined by the forces of demand and supply. | It occurs when the value of domestic currency decreases in relation to the value of foreign currency in the foreign exchange market. |
| Example | The government has changed the $/₹ exchange rate from ₹ 40 to ₹ 45. | The increase in demand or decrease in supply for the foreing exchange causes depreciation of domestic currency, e.g. $/₹ exchanges rate is ₹ 45 instead of ₹ 40 due to the market forces of demand and supply. |
Question 18.
Explain the effect of rise in price of foreign currency on exports. (Delhi (C) 2015)
Or
Foreign exchange rate in India is on the rise recently. What impact is it likely to have on exports and how? (All India 2014)
Or
Explain the effect of depreciation of domestic currency on exports. (All India 2013)
Or
Explain the effect of a rise in the price of foreign currency on exports. (Delhi (C) 2012; All India (C) 2012)
Answer:
With the rise in foreign exchange rate in India, the demand for foreign currency increases. This rise in exchange rate implies depreciation in domestic currency. It encourages exports from a country, because due to depreciation of the domestic currency, domestic goods become cheaper in the international market.
Question 19.
When foreign exchange rate in a country is on the rise, what impact is it likely to have on imports and how? (All India 2014)
Or
Foreign exchange rates have risen considerably in a country. What is its likely impact on imports of that country and why? (All India (C) 2013)
Answer:
With the rise in foreign exchange rate in India, the demand for foreign currency increases. This rise in exchange rate implies depreciation in domestic currency. It encourages exports from a country and discourages imports from rest of the world as the residents of the country have to pay more to buy foreign goods.
Question 20.
What is ‘appreciation’ of domestic currency? What is its likely effects on export and how? (Foreign 2014)
Or
Explain the effect of appreciation of domestic currency on exports. (All India 2014)
Answer:
Appreciation of domestic currency implies that there is a fall in the foreign exchange rate. A fall in the exchange rate means that the foreigners will have to pay more for the goods and services purchased by them. This will reduce their demand and accordingly exports will fall.
Question 21.
How is exchange rate determined in the foreign exchange market? (All India 2013)
Answer:
Foreign exchange rate is determined by the market forces of demand and supply in foreign exchange market. The rate at which demand and supply of foreign exchange are equal, gives the equilibrium rate of exchange, as shown in the figure.
Question 22.
How can Reserve Bank of India helps in bringing down the foreign exchange rate which is very high? All India 2013
Answer:
A high rate of exchange implies that the demand for foreign exchange is quite high. So, to bring down the exchange rate, the supply for foreign exchange has to be increased. So, the Reserve Bank of India starts selling foreign exchange from its reserve to increase the supply of foreign exchange. As the supply increases, the exchange rate comes down, as is illustrated in the graph given above.
Question 23.
How can increase in foreign direct investment affect the price of foreign exchange? (Delhi 2013)
Answer:
Increase in foreign direct investment will result in more supply of foreign exchange therefore, due to excess supply, price of foreign exchange will fall. i.e. exchange rate falls which leads to appreciation of domestic currency.
Question 24.
When the price of a foreign currency falls, the demand for that foreign currency rises. Explain why? (All India 2011)
Or
Explain why there is a rise in demand for foreign exchange, when its price falls? (All India 2011)
Answer:
Foreign exchange rate shares an inverse relationship with the demand for that currency. With a fall in the price of foreign exchange, value of domestic currency increases (i.e. appreciation of domestic currency) and that means foreign goods become cheaper and their domestic demand (i.e. imports) increases. The rising domestic demand for
foreign goods implies higher demand for foreign exchange which increases from OQ1 to OQ2 as shown in the figure.
Question 25.
When the price of a foreign currency falls, the supply of that foreign currency also falls. Explain why? (All India 2011)
Or
Explain why there is an increase in demand for foreign currency when its price falls. (All India (C) 2012)
Answer:
The supply of foreign currency is directly proportional to the price of foreign exchange. When the price of a foreign currency falls, it leads to cheaper imports and costlier exports because it leads to appreciation of domestic currency.
The exporters are discouraged due to costlier exports. This results lesser inflow or supply of foreign currency in the economy. As a result supply of foreign exchange decreases from OQ2 to OQ1.
Question 26.
Give the meaning of foreign exchange rate. How it is determined under flexible exchange rate system? All India 2011
Answer:
Foreign exchange rate:
Foreign exchange rate refers to the rate at which one currency can be exchanged for the other currency in foreign exchange market, e.g. If ₹ 58 is paid, to buy one US dollar, then ₹/$ exchange rate will be 58, i.e. ₹ 58 per dollar.
Determination of flexible exchange rate:
Foreign exchange rate is determined by the market forces of demand and supply in foreign exchange market. The rate at which demand and supply of foreign exchange are equal, gives the equilibrium rate of exchange, as shown in the figure.
Question 27.
Giving two examples, explain the relation between the rise in price of a foreign currency and its demand. (Delhi 2011,2010)
Answer:
The following two examples explain the relation between the rise in price of a foreign currency and its demand
- When the price of a foreign currency rises, the imports become costlier so, the value of imports will fall with time, hence the demand for foreign exchange will fall.
- When the price of foreign currency rises, residents of a country find it costlier to travel abroad. So, the number of foreign travellers decrease, and consequently the demand for foreign currency also decreases.
Question 28.
By giving two examples, explain why there is a rise in demand for a foreign currency when its price falls? (All India 2010)
Answer:
The following two examples explain why there is a rise in demand for a foreign currency when its price falls
- When there is a fall in the price of foreign currency, the import gets cheaper. It encourages the importers to import more and consequently, the demand for that foreign currency increases.
- When the price of a foreign currency falls, the price of foreign assets also falls.
It encourages domestic people and companies to buy foreign assets and consequently, the demand for that foreign currency increases.
Question 29.
Give the meanings of fixed, flexible and managed floating exchange rates. (All India 2010: Delhi 2010)
Answer:
Fixed rate of exchange:
Fixed exchange rate is the system under which the central authority or government maintains their exchange rate fixed either against gold or some other foreign currency, (say USD)
flexible exchange rate:
The rate of exchange which is determined by the market forces of demand and supply of foreign currencies in the foreign exchange market, is termed as floating or flexible exchange rate system.
Managed floating exchange rate:
Under this system, the exchange rate is determined by the market forces of demand and supply. However, excessive fluctuation is checked by the Central Bank.
Question 30.
What is meant by appreciation and depreciation of domestic currency? Explain. (All India 2010)
Answer:
When the value of domestic currency increases in relation to a foreign currency due to demand and supply forces in a free market, it is termed as appreciation of the domestic currency.
Depreciation of the domestic currency occurs when the value of domestic country’s currency decreases in relation to a foreign currency.
For example, Increase in exchange rate is currency depreciation and decrease in exchange rate is currency appreciation.
- When ₹/$ exchange rate falls from 55 to 50, it is termed as appreciation of domestic currency. (i.e. Indian rupee)
- When ₹/$ exchange rate rises from 50 to 55,
it is termed as depreciation of domestic currency.
Question 31.
Explain the meaning and two merits of fixed foreign exchange rate. (Delhi 2010)
Answer:
Fixed exchange rate is the system under which the central authority or government maintains their exchange rate fixed either against gold or some other foreign currency, (say USD)
Two merits of fixed foreign exchange rate are
- Less speculation in the currency market.
- Encourages international trade and investment flows.
Question 32.
Explain the effect of appreciation of domestic currency in imports. (All India 2014: Delhi 2013)
Answer:
Appreciation of domestic currency implies fall in foreign exchange rate in India and therefore, the demand for foreign currency decreases.
It encourages imports from rest of the world as the residents of country have to pay less to buy foreign goods, e.g. When ₹/ $ exchange rate falls from 55 to 50, it leads to currency appreciation and this will help in buying more and more units of foreign goods. As a result, demand for foreign goods will rise, i.e. imports will rise.
Question 33.
(a) Distinguish between appreciation of home currency and depreciation of home currency.
(b) What is meant by “current account surplus”?
(c) State any one source of supply of foreign currency for a country are (All India 2019)
Answer:
(a) Difference between appreciation and depreciation of domestic currency:
(i) Depreciation of domestic currency refers to decrease in the value of domestic currency as compared with foreign currency due to change in market forces of demand and supply, while appreciation of domestic currency refers to increase in the value of domestic currency as compared with foreign currency due to change in market forces of demand and supply.
(ii) Due to depreciation, exports increase and imports fall while due to appreciation, exports fall and imports increase.
(iii) Depreciation is shown by increase in exchange rate, while appreciation is shown by decrease in exchange rate.
(b) Current account surplus refers to the state where credit side balance is greater than debit side balance on current account, i.e. inflows are more than outflows.
(c) Export of goods and services.
Question 34.
Discuss briefly the meanings of
(a) Fixed Exchange Rate
(b) Flexible Exchange Rate
(c) Managed Floating Exchange Rate (April re-exam 2018)
Answer:
(a) Fixed Exchange Rate:
Fixed exchange rate is the system under which the central authority or government maintains their exchange rate fixed either against gold or some other foreign currency, (say USD)
(b) Flexible exchange rate:
The rate of exchange which is determined by the market forces of demand and supply of foreign currencies in the foreign exchange market, is termed as floating or flexible exchange rate system.
(c) Managed Floating Exchange Rate:
Under this system, the exchange rate is determined by the market forces of demand and supply. However, excessive fluctuation is checked by the Central Bank.
Question 35.
Why does the demand for foreign currency fall and supply rises when its price rises? Explain. (Delhi 2017)
Answer:
Foreign exchange rate shares an inverse relationship with the demand for the currency. With a fall in the price of foreign exchange, value of domestic currency increases (i.e. appreciation of domestic currency) and that means foreign goods become cheaper and their domestic demand (i.e. imports) increases.
The rising domestic demand for foreign goods implies higher demand for foreign exchanges which increases from OQ1 to OQ2 as shown in the figure
The supply of foreign currency is directly proportional to the price of foreign exchanges. When the price of a foreign currency falls, it leads to cheaper imports and exports because it leads to appreciation of domestic currency. The exporters are discouraged due to costlier exports. This results lesser inflow or supply of foreign currency in the economy. As a result supply of foreign exchange decreases from OQ2 to OQ1 as shown in the figure.
Question 36.
Give the meaning of foreign exchange and foreign exchange rate. Give the reason, explain the relation between foreign exchange rate and demand for foreign exchange. (All India 2012)
Answer:
Foreign exchange:
Foreign exchange refers to all currencies other than domestic currency of a given country, e.g. currency of US and UK are the foreign exchanges for India.
Foreign exchange rate:
Foreign exchange rate refers to the rate at which one currency can be exchanged for the other currency in foreign exchange market, e.g. If ₹ 58 is paid, to buy one US dollar, then ₹/$ exchange rate will be 58, i.e. ₹ 58 per dollar.
relation between foreign exchange rate and demand for foreign exchange:
Exchange rate of foreign currency is inversely related to the demand. When price of a foreign currency rises, it results into costlier imports for the country. As imports become costlier, the demand for foreign products also reduce. This leads to reduction in demand for that foreign currency and vice-versa.
Question 37.
Give the meaning of Balance of Payments. (Delhi 2017)
Answer:
Balance of Payments (BoP) of a country is a systematic record of all the economic transactions between the residents and non-residents of a country during an accounting year.
Question 38.
What is the meaning of deficit in Balance of Payments? (Delhi 2014,2010)
Or
How is Balance of Payment ‘deficit’ measured? Explain. (Foreign 2014)
Answer:
When the payments of a country on account of autonomous transactions exceed the receipts of the country on account of autonomous transactions, this difference is termed as BoP deficit.
Suppose, the receipts of the domestic country is ₹ 200 crore, whereas payments are ₹ 220 crore. Then, BoP deficit will be = 220 – 200 crore = ₹ 20 crore.
Question 39.
Give meaning of Balance of Trade. (Delhi 2014)
Or
What is trade balance? (All India 2010)
Answer:
The difference between export and import of goods i.e. only the visible items of economic transactions is termed as Balance of Trade.
Question 40.
What is ‘current account deficit’ in the Balance of Payments? (Delhi 2014)
Answer:
When receipts of current account of BoP falls short of expenditure of current account, then it is referred to as ‘current account deficit’.
Question 41.
Name two invisible items of the Balance of Payments account. (Delhi (C) 2010)
Answer:
Two invisible items of the Balance of Payments account are
- Banking services
- Insurance services
Question 42.
Give the meanings of ‘autonomous’ transactions and ‘accommodating’ transactions in the Balance of Payments account. (Foreign 2015)
Or
Distinguish between autonomous and accommodating transactions of Balance of Payments account. (All India 2014,2010; Delhi (C) 2010)
Or
Distinguish between Autonomous and Accommodating transactions of Balance of Payments account.
Answer:
Differences between Autonomous and Accommodating transactions are
| Basis | Autonomous Transactions | Accommodating Transactions |
| Meaning | Autonomous transactions are the transactions between the residents of two countries which take place due to consideration of profit. | Accommodating transactions are those transactions which help to restore identity of Balance of Payments. |
| Recorded in | These transactions can either be recorded in current account or capital account, depending on their nature. | These transactions are recorded only in capital account. |
| Example | Exports and imports of goods and services, unilateral transactions etc are examples of autonomous transactions. | Borrowings from IMF, change in foreign exchange reserves etc are examples of accommodating transactions. |
Question 43.
Give the meanings of Balance of Trade and Balance on Current Account of Balance of Payments Account. (Foreign 2015)
Or
Distinguish between Balance of Trade and Balance on Current Account. (Delhi (C) 2013,2012)
Or
Distinguish between Balance of Trade and Balance on Current Account of Balance of Payments. (All India (C) 2014,2013)
Answer:
Differences between Balance of Trade and Balance on Current Account are:
| Basis | Balance of Trade | Balance on Current Account |
| Meaning | Balance of Trade includes only visible items. It is the difference between exports and imports of goods of a country. | Balance on Current Account is the difference between sum of credit items and sum of debit items on current account. |
| Coverage | Balance of Trade does not record any transactions of invisible items and unilateral transfers. | Balance of Current Account includes balance of visible items, balance of invisible items and balance of unilateral transfer. |
| Concept | Balance of Trade is a narrow concept and it is only a part of the Balance of Payment Account. | Balance of Current Account includes the Balance of Trade hence, it is a broader concept. |
| Financing of deficit | A deficit in Balance of Trade can be met from the surplus of Current Account. | Deficit in Current Account cannot be met from the surplus of BoT. |
Question 44.
Name the broad categories of transactions recorded in the capital account of the Balance of Payments Account. (Delhi 2015)
Or
State the components of capital account of Balance of Payments. (Delhi 2011)
Answer:
Components of Capital Account of Balance of Payments are
- Investments It includes investments to and from abroad in the form of Foreign Direct Investment (FDI) and Foreign Institutional Investor (FII). Investment from abroad is a ‘credit’ item, whereas investment to abroad is a ‘debit’ item.
- Borrowing and lending It includes the borrowings by residents from the residents of abroad (credit item). And lending to the residents of foreign country (debit item) by residents of domestic country.
- Foreign exchange It includes the reserve of foreign currency gold and Special Drawing Rights (SDRs)
with the domestic country.
Question 45.
Name the broad categories of transactions recorded in the Current Account of the Balance of Paynjents Account. (Delhi 2015)
Or
List the transactions of Current Account of the Balance of Payments. (All India 2011)
Or
State the components of current account of Balance of Payments. (Delhi 2011)
Answer:
The transactions included in the Current Account of the Balance of Payments are
- Export and import of visible items
- Export and import of services (invisible items)
- Unilateral transfers
Question 46.
Where will sale of machinery to abroad be recorded in the Balance of Payments Account? Give reasons. (Delhi 2015)
Answer:
Sale of machinery will be recorded in Current Account of Balance of Payments account, as it is export of goods to abroad.
Question 47.
Where is ‘Borrowings from Abroad’ recorded in the Balance of Payments Account? Give the reasons. (All India 2015)
Answer:
‘Borrowings from Abroad’ will be recorded in the Capital Account of Balance of Payments account, as it is concerned with the assets and liability position of the country. And borrowings from abroad will increase liabilities hence it will be recorded in the credit side of Capital Account.
Question 48.
Giving reason, explain where charity to foreign countries is recorded in the Balance of Payments account. (Foreign 2015)
Answer:
Charity given to foreign countries is a form of unilateral transfer. So, it will be recorded in the debit side of the Current Account of the Balance of Payments account.
Question 49.
Distinguish between current account and capital account of the Balance of Payments account on the basis of its components. Delhi [Cl 2014
Answer:
Current account includes:
- Export and imports of visible and invisible items.
- Unilateral transactions to and from abroad.
Capital account includes:
- Investment to and from abroad.
- Borrowings and lendings to and from abroad.
- Official reserves which contains foreign, currency, SDRs and gold.
Question 50.
Explain the meaning of Balance of Payments deficit. (Delhi 2014)
Or
Explain the meaning of deficit in Balance of Payments. (Delhi 2010)
Or
Explain the concept of ‘Deficit’ in the Balance of Payments. (All India (c) 2013)
Answer:
When the receipts of the country on account of autonomous transactions are less than the payments of the country on account of autonomous transactions, then this difference is termed as deficit in Balance of Payments.
So, BoP Deficit = R < P, Where R = Receipts of the country and P = Payments of the country, e.g. If the receipts of the country is 1200 crore and the payments are ₹ 250 crore, then BoP deficit will be ₹ 50 (250-200) crore.
Question 51.
List the items included as invisibles in the Balance of Payments account. (All India (C) 2012)
Answer:
The following items are included as invisibles in the Balance of Payments account
- Income from abroad and income to abroad.
- Export and import of services.
- Current transfers from abroad and current transfers to abroad.
Question 52.
What does a Balance of Payments account show? Name the two parts of the Balance of Payments account. (Delhi 2011)
Answer:
The Balance of Payment (BoP) of a country is a systematic record of all economic transactions between its residents and residents of foreign countries during an accounting year. It summarises the exports and imports and other international transactions of a country with other countries.
Two parts of Balance of Payments account are as follows
- Current account
- Capital account
Question 53.
Which transactions determine the Balance of Trade? When is Balance of Trade in surplus? (All India 2011)
Answer:
The transactions involving export and import of goods, i.e. only the visible items of economic transactions, determines the Balance of Trade. Balance of Trade is in surplus, when the value of export of goods are more than the value of import of goods.
Question 54.
Explain the concept of surplus in the Balance of Payments account. (All India 2010)
Answer:
When the receipts of the country on account of autonomous transactions exceed the payments of a country on account of autonomous transactions, this difference is termed as BoP surplus.
BoP Surplus = R > P, Where R = Receipts of the country, P = Payment of the country, e.g. If the receipts of the country is ₹ 200 crore and the payments are ₹ 190 crore, then BoP surplus will be (200 – 190) = ₹ 10 crore.
Question 55.
In the context of Balance of Payments Account, state whether the following statements are true or false. Give reasons for your answer.
(i) Profits received from investments abroad is recorded in capital account.
(ii) Import of machines is recorded in current account. (All India (C) 2015)
Answer:
(i) False, profit received from investments abroad affect neither the assets not the liabilities of a country or its residents. Therefore it is recorded in Current Account
(ii) True, machine is a visible item. Therefore, it’s import is recorded in the Current Account.
Question 56.
Distinguish between autonomous transactions and the accommodating transactions in the balance of payments. What is the significance of this distinction? (Delhi (c) 2015)
Answer:
Differences between Autonomous and accommodating Transactions:
| Basis | Autonomous Transactions | Accommodating Transactions |
| Meaning | Autonomous transactions are the transactions between the residents of two countries which take place due to consideration of profit. | Accommodating transactions are those transactions which help to restore identity of Balance of Payments. |
| Recorded in | These transactions can either be recorded in current account or capital account, depending on their nature. | These transactions are recorded only in capital account. |
| Example | Exports and imports of goods and services, unilateral transactions etc are examples of autonomous transactions. | Borrowings from IMF, change in foreign exchange reserves etc are examples of accommodating transactions. |
The distinction between these two transactions is important to understand the causes of disequilibrium and to restore the identity of Balance of Payments account.
Question 57.
Are the following entered (i) on the credit side or the debit side and (ii) in the current account or capital account in the Balance of Payments account? You must give reasons for your answer.
(i) Investments from abroad.
(ii) Transfer of funds to relatives abroad. (All India (C) 2013)
Answer:
(i) Investments from abroad are entered in the credit side of capital account because they increase the assets of the country by increasing the flow of foreign exchange in the country.
(ii) Transfer of funds to relatives abroad are entered on the debit side of current account as they result in outflow of domestic currency with no returns.
Question 58.
What is Balance of Payments Account? Where are borrowings from abroad recorded in it and why? (Delhi 2011)
Answer:
The Balance of Payments (BoP) account of a country is a systematic record of all economic transactions between its residents and residents of foreign countries during an accounting year. Balance of Payments account is classified into Current Account and Capital Account.
Borrowing from abroad are recorded in the Capital Account (credit side) of Balance of Payments as it is a foreign liability on the country and it is to be repaid with interest.
Question 59.
What is Balance of Payments? Give meanings of Trade balance and Current Account balance. Delhi 2011; All India 2011
Answer:
Balance of payments:
Balance of Payments (BoP) of a country is a systematic record of all the economic transactions between the residents and non-residents of a country during an accounting year.
Trade balance The difference between export and import of goods, i.e. only the visible items of economic transactions is termed as Balance of Trade.
Balance of Trade = Export of Goods – Import of Goods
Current account balance Current account is that account of BoP, which records exports and imports of visible and invisible items and unilateral transfers.
Question 60.
Give reasons and state whether the following statements are true or false.
(i) Current Account of Balance of Payment account records only export and import of goods and services.
(ii) Foreign investments are recorded in the Capital Account of Balance of Payments. (All India 2011)
Answer:
(i) False, as Current Account of Balance of Payments Account also records unilateral transfers.
(ii) True, as all kind of foreign investments (foreign direct investments and portfolio investments) are included in the Capital Account of Balance of Payments as they affect the assets positions of the country.
Question 61.
Give reasons and state whether the following statements are true or false.
(i) Excess of foreign exchange receipts over foreign exchange payments on account of accommodating transactions equals deficit in the Balance of Payments.
(ii) Export and import of machines are recorded in Capital Account of Balance of Payments account. (Delhi (C) 2011)
Answer:
(i) False, as accommodating transactions removes both surplus and deficit from Balance of Payments account.
(ii) False, export and import of machine, will be recorded in Current Account as it is a producer good.
Question 62.
State whether the following statements are true or false. Give reasons for your answer.
(i) Difference between value of exports and imports of goods and services are called Balance of Trade.
(ii) External assistance is not recorded in Balance of Payments account. (Delhi (C) 2011)
Answer:
(i) False, because Balance of Trade only records the export and import of visible items, i.e. goods.
(ii) False, because external assistance is recorded in the Current Account of Balance of Payments as unilateral receipts.
Question 63.
(a) Define‘Trade Surplus’ and ‘Trade Deficit’.
(b) Discuss briefly the concept of managed floating system of foreign exchange rate determination. (All India 2019)
Answer:
(a) Trade surplus:
When the receipts of the country on account of autonomous transactions exceed the payments of a country on account of autonomous transactions, this difference is termed as BoP surplus.
BoP Surplus = R > P, Where R = Receipts of the country, P = Payment of the country, e.g. If the receipts of the country is ₹ 200 crore and the payments are ₹ 190 crore, then BoP surplus will be (200 – 190) = ₹ 10 crore.
Trade deficit:
Charity given to foreign countries is a form of unilateral transfer. So, it will be recorded in the debit side of the Current Account of the Balance of Payments account.
(b) Managed floating system of foreign exchange rate determination:
Managed floating exchange rate refers to the rate, which is determined by the demand and supply of foreign exchange in the foreign exchange market with excessive fluctuations if any, being checked by some central authority. It is a hybrid system of exchange rate determination which combines the features of both fixed exchange rate and flexible exchange rate. It encourages venture capital.
Question 64.
(a) Distinguish between ‘Trade Deficit’ and ‘Current Account Deficit’.
(b) Discuss briefly the concept of flexible exchange rate system of foreign exchange rate determination. (All India 2019)
Answer:
(a) Trade deficit is the situation where exports of goods are less than import of goods. While deficit in current account is the situation where inflow from visible (BOT) and invisible items are less than outflow from visible and invisible items, i.e. trade deficit is only one component of current account account deficit other factors including balance on invisible trade, balance on capital transfer. So, a deficit in balance of trade may not lead to deficit in current account.
(b) Flexible exchange rate system:
The rate of exchange which is determined by the market forces of demand and supply of foreign currencies in the foreign exchange market, is termed as floating or flexible exchange rate system.
Question 65.
(a) State any two factors responsible for inflow of foreign currency.
(b) State on which side of capital account/ current account will the following transactions be recorded and why
(i) Interest on loan received from Nepal
(ii) Import of mobile phones from China (All India 2019)
Answer:
(a) Two factors responsible for inflow of foreign currency:
Two sources of supply of foreign exchange are
(i) Export of goods and services from domestic country to foreign country.
(ii) Foreign direct investment.
(b) (i) It will be recorded in the credit side of current account of BoP, as it doesn’t affects the assets or liabilities of the country.
(ii) It will be recorded in debit side of current account of BoP, as it leads to outflow of foreign currency but doesn’t affects assets or liabilities of the country.
Question 66.
(a) Define ‘Trade Surplus’. How is it different from ‘Current accounts surplus’?
(b) “Indian Rupees (₹) plunged to all time low of ₹ 74.48 against the US Dollar (S)”.
In the light of the above repon, discuss the impact of the situation on Indian Imports. (Delhi 2019)
Answer:
(a) Trade surplus is a situation where exports of goods are more than import of goods. While surplus )n current account is the situation where inflow from visible and invisible interns is more than outflow from visible and invisible items, i.e. trade surplus is only one components of current account, while current account includes other factors including balance of visible trade, balance of unilateral transfers and balance of capital transfer.
(b) As the price of Indian rupees reached to its highest, this shows that the value of Indian rupee is falling as compared with USD. Also, due to depreciation of rupee, Indians will find imported goods costlier. So, our imports will decrease and at the same time, exports from India will become cheaper for foreigners, leading to increase in exports.
Question 67.
(a) Explain the impact of rise in exchange rate on National Income.
(b) Explain the concept of ‘deficit’ in . Balance of Payments. (March 2018)
Answer:
(a) Impact of rise in exchange rate on National Income Domestic currency depreciates when there is a rise in foreign exchange rate. The foreign countries can now purchase more quantity of goods and services from the same amount of foreign currency from the domestic country. As a result, exports will rise and imports will fall.
A rise in the export raises the level of aggregate demand which further raises the level of output and income. Hence, as the domestic currency depreciates an economy experiences trade surplus. This in turn boosts the National Income.
(b) Deficit in Balance of Payment (BoP) It refers to a situation when receipts of the country arising out of autonomous transactions are less than the corresponding payments to the rest of the world during the period of an accounting year. It highlights our net liabilities towards rest of the world.
Question 68.
Distinguish between (i) Current account and Capital Account, and (ii) Autonomous Transactions and accommodating transactions of Balance of Payments account. (All India 2017)
Answer:
(i) Differences between Current and Capital Account of Balance of Payments (BoP) are
| Basis | Current Account of BoP | Capital Account of BoP |
| Nature of transaction | These are the transactions which do not affect the assets or liabilities position of the country. | These are the transactions which affect assets or liabilities position of the country. |
| Concept | It is a flow concept. | It is a stock concept. |
| Formula/Components | Current Account = Exports and Imports of Visible and Invisible Items + Unilateral Transactions + Income Received and Paid to Abroad. | Capital Account = Borrowings and Lending from and to Abroad + Investment to and from Abroad + Change in the Reserve of Foreign Exchange. |
(ii) Differences between autonomous and accommodating transactions:
| Basis | Autonomous Transactions | Accommodating Transactions |
| Meaning | Autonomous transactions are the transactions between the residents of two countries which take place due to consideration of profit. | Accommodating transactions are those transactions which help to restore identity of Balance of Payments. |
| Recorded in | These transactions can either be recorded in current account or capital account, depending on their nature. | These transactions are recorded only in capital account. |
| Example | Exports and imports of goods and services, unilateral transactions etc are examples of autonomous transactions. | Borrowings from IMF, change in foreign exchange reserves etc are examples of accommodating transactions. |
Question 69.
(i) In which sub-account and on which side of Balance of Payments Account will foreign investments in India be recorded? Give reasons.
(ii) What will be the effect of foreign investments in India on exchange rate? Explain. (Delhi 2016)
Answer:
(i) Foreign investments in India will be recorded in the credit side of the capital account of the Balance of Payments Accounts. Capital account records the capital transactions such as loans and investments between India and the rest of the world, which causes a change in the assets and liabilities status of the residents of the country or the government. One of the component of capital account is ‘foreign investment’, which records Foreign Direct Investment (FDI), Foreign Institutional Investment (FII) or portfolio investment by the residents of India in abroad or by the rest of the world in the domestic territory. So, foreign investments in India will be a part of this component and therefore will be recorded in the capital account.
In the capital account, all transactions causing flow of foreign exchange in the country are recorded on the credit side. Since investments from abroad will cause a flow of foreign exchange in the country, therefore it will be recorded in the credit side.
(ii) The market exchange rate will tend to fall due to the foreign investment. The foreign investors who want to invest in India will increase the supply of foreign exchange.
At the supply of foreign exchange rises, with demand remaining unchanged, the market exchange rate will fall, as is explained in the diagram given below
As the supply of foreign exchange increase, the exchange rate falls from OR to OR1. This is a situation of appreciation of the domestic currency.
Question 70.
Indian investors lend abroad. Answer the following questions.
(i) In which sub-account and on which side of the Balance of Payments Accounts such lending is recorded? Give reasons.
(ii) Explain the impact of this lending on market exchange rate. (All India 2016)
Answer:
(i) Indian investors lend abroad. This will be recorded in the debit side of the capital accounts of the Balance of Payments Accounts. Capital account records the capital transactions such as loans and investments between India and the rest of the world, which causes a change in the assets and liabilities status of the residents of the country or the government.
One of the component of capital account is ‘Foreign Investment’, which records Foreign Direct Investment (FDI), Foreign Institutional Investment (FII) or portfolio investment by the residents of India in abroad or by the rest of the world in the domestic territory. So, lending by Indian investors will be a part of this component and therefore will be recorded in the capital account.
In the capital account, all transactions causing flow of foreign exchange out of the country are recorded in debit side. Since, lendings to abroad will cause a flow of foreign exchange out of the country, therefore it will be recorded in the debit side.
(ii) The market exchange rate will tend to rise due to this lending.
The investors who want to lend abroad will demand foreign exchange. As the demand for foreign exchange rises, with supply remaining the same, the market exchange rate will also rise, as is explained in the diagram given above. As the demand for foreign exchanges rises, the exchange rate rises from OR to OR1. This is a situation of depreciation of domestic currency.
Question 71.
Explain the distinction between autonomous and accommodating transactions in Balance of Payments. Also explain the concept of Balance of Payments deficit in this context. (Delhi 2012)
Answer:
Autonomous items, also termed as ‘above the line items’, are those items, which are related to transactions which are determined by considerations of profit (economic motive). Autonomous transactions are that transaction between the residents of two countries which take place due to the considerations of profit. Autonomous items are not conditioned by the BoP status of the country, i.e. these are independent. Autonomous transactions are not done to establish identity of BoP, i.e. Current Account and Capital Account.
Accommodating items, also termed as ‘below the line items’, are those items of BoP that are not determined by considerations of profit but to restore identity of BoP. These are undertaken to maintain balance in the BoP accounts. These transactions correct the disequilibrium in autonomous items of BoP account. Accommodating transactions are also known as ‘below the line items’ and include foreign exchange reserve and borrowings to meet BoP deficit.
BoP deficit:
When the payments of a country on account of autonomous transactions exceed the receipts of the country on account of autonomous transactions, this difference is termed as BoP deficit.
Suppose, the receipts of the domestic country is ₹ 200 crore, whereas payments are ₹ 220 crore. Then, BoP deficit will be = 220 – 200 crore = ₹ 20 crore.
