Assignment on Balance of Payment
Assignment on Balance of Payment is meant for class XII, CBSE students.
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1. ‘Devaluation and Depreciation of currency is one and the same thing’. Do you agree? How do they affect the exports of a country?
Answer. Both imply a fall in the external value of a currency; however, the term depreciation is used under the floating exchange rate system when the exchange rate is determined by the market forces of demand and supply.
The term devaluation is used in a system of fixed exchange rates. Under this, the exchange value of a currency is decided by the government.
Devaluation is done deliberately by the government. But both encourage exports from a country, as exports become cheaper and foreign currency can buy more domestic goods.
2. What is meant by ‘official reserve transactions’? Discuss their importance in Balance of payments.
Answer. These transactions are made by the Central Bank which causes a change in its official reserves of foreign exchange. These involve the purchase or sale of its own currency in the foreign exchange market.
In Balance of Payment:
- Purchase of a country’s own currency is a credit item in Balance of Payment, whereas, sale of the currency is a debit item.
- It helps to adjust the deficit and surplus in Balance of Payment.
3. Define fixed exchange rate. How is the exchange rate determined in a flexible exchange rate system?
Answer. The fixed exchange rate is that rate is not determined by the forces of the demand and supply in the market. It is fixed or declared officially by the government of the country concerned.
Flexible exchange rate systems or free-market exchange rate systems are the same. It is that the exchange rate is determined by the demand for and supply of different currencies in the foreign exchange rate market.
4. In recent times the Indian rupee depreciated to an all time low against the US dollar. Discuss its impact on India’s imports.
Answer. This means that now the rupee is the weaker currency as its value has decreased. For example, if INR 60=$1 and now INR80=$1, this means that the rupee has depreciated against the dollar. For the same $ now Indians will be paying more rupees.
The final impact will be that imports will become costlier and therefore, imports will fall.
5. “A country with trade deficit cannot have current account surplus in its Balance of Payments”. Do you agree with the given statement? Discuss.
Answer. No, a country can have a trade deficit and current account surplus simultaneously because Balance of payment is a wider term, it includes the balance in the current account as well as capital account.
Balance of payment can be in deficit due to capital account deficit exceeding current account surplus.
6. Define autonomous transactions in Balance of Payments of an economy.
Answer. Autonomous transactions are called above-the-line transactions.
These are referred to as economic transactions with the rest of the world which take place due to some economic motive for maximizing profit.
These are independent of the countries balance of payment situations.
These transactions are undertaken by both private and government sectors.
It takes place on both current and capital account.
7. Define accommodating transactions is BOP of an economy.
Answer. Accommodating transactions are called below-the-line transactions.
These are undertaken to establish a Balance of payment equilibrium.
Accommodating transactions are affected by the BOP situation.
These are undertaken by only the government sector.
These transactions take place only in the capital account.
8. Name any two sources of demand for foreign exchange by households in an economy.
Answer. Demand for foreign exchange
- To purchase goods and services from other countries, that is imports.
- To purchase financial assets and shares and bonds of other countries.
- To speculate on the value of foreign currency.
- To undertake foreign tours.
- To invest directly in shops, factories, buildings.
- To make payments of international trade.
9. In which sub-account and on which side of BOP account will foreign investment in India be recorded? Give reasons.
Answer. The foreign investment includes foreign direct investment (FDI) and foreign institutional investment (FII) or portfolio investment by the residents of a nation abroad or by the rest of the world in the domestic country. Investments made in the assets of a foreign country are FDI. Here, the assets of the foreign country are owned and controlled by the government or any resident within the domestic territory. On the other hand, Flls means investment made in the assets of a foreign country. Here, the assets of the foreign country are not owned and controlled by the government or any resident within the domestic territory. These investments lead to an inward flow of foreign exchange and hence are treated as positive items in the capital account of the balance of payments.
10. What will be the effect of foreign investments in India on exchange rate? Explain.
Answer. Foreign investment will lead to rising in the supply of foreign currency. Hence, the supply curve will shift to the right and the new equilibrium point will be reached at point E’. The exchange rate declines from OR to OR’ because the demand and supply of foreign currency increases to OQ1. As shown below:
11. What do we call the foreign exchange transactions which are dependent on other foreign exchange transactions?
Answer. Accommodating Transactions
12 A) According to recent media reports: “USA has accused China of currency devaluation to promote its exports”. In the light of the given media report comment, how exports can be promoted through the currency devaluation?
B) What is meant by Current Account Deficit (CAD) and Current Account Surplus (CAS)?
State their significance.
Answer. China has been devalued the currency for promoting exports. Exports can be promoted by the devaluation. Devaluation is the process of devaluing the domestic currency purposefully by the government. This is mainly done by the government to promote the exports of the country. When the devaluation takes place, the domestic currency becomes cheaper in the international market compared to other countries currencies. When the Chinese Yuan is devalued, it becomes cheaper in the international market compared to US Dollar. This will lead to the purchase of a good by other countries from China. When all other nation purchases commodities from China, it increases the exports of China. And also it will decrease the exports of other nation which has a high value of the currency. Hence the devaluation by the country will increase the exports of the country.
b) The current account of the country consists of all the transactions relating to the trade in goods and services and unilateral transfers. In the current account, imports and exports are the main components. The difference between exports and imports makes the balance of invisible trade.
The current account deficit is the situation in which the imports of goods and services exceed the exports. The current account measures the trade plus transfer capital. A current account deficit is created when a country relies on foreigners for capital to invest and spend. This situation implies that sales for the domestic goods in the market are very less. The country is over-dependent on imports from foreign countries.
Current Account Surplus is the situation in which the exports of the goods and services are more than imports of goods and services of the country. This is a favorable situation for the country when the exports are higher. When the exports are higher will increase the revenue of the country.
The current account deficit is the situation which the country faced when the resources are very little. Therefore that country will be bound to import from other countries. This will increase the dependency of the importing countries on the exporting countries. When dependency increases from developing countries to developed countries there are huge chances of exploitation by the developed country to the developing or underdeveloped country.
Current account surplus is a favorable condition for any country. But there will be only fewer countries that have huge resources that face this condition. This will increase the revenue of the country and makes a favorable condition for the Balance of Trade for the country.
Q13 Define Balance of Payments. Discuss briefly the components of current account.
Answer. Balance of payment of a country is a systematic record for the economic transactions between residents of a country and residents of a foreign country during a given period of time.
Components of Balance of Payment
Balance of payment component or parts includes:
- Current account BOP
- Capital account BOP
Current Account BOP
It is that account that records exports and imports of goods and services (invisible).
The current account includes the following:
- Exports and imports of goods (visible) – Like the sale of a machine.
- Exports and imports of services (invisible) – It includes the following: a. Non Factor services, that are exports and imports of services of doctors, teachers. b. Income from factor services like plumber, electrician, etc. More examples includes, air and sea transport, postal and courier services and education-related travel.
3. Unilateral Transfers- These are those receipts that resident of a country receives or the payments that the resident of a country make without getting anything in return. For example, gifts, charity, donation, etc.
Capital Account BOP
It is that account that records all such transactions between residents of a country and the rest of the world which cause a change in the ownership of goods. It is the statement of all the capital inflow and outflow during a period of an accounting year.
The capital account of BOP includes the following:
1. Borrowing (External assistance and commercial borrowings)
It is recorded in the capital account as it impacts changes in the ownership of assets abroad. It does not involve the movement of goods and services across borders.
Borrowings are recorded with a plus or credit side of the BOP account because it leads to receipts of foreign exchange from the rest of the world.
2. Investment
The investment includes FDI as well as portfolio investment or Foreign investment or foreign institutional investment. Foreign investment in India is recorded in the capital account of the BOP.
It is reflected in the capital account as it impacts changes in the ownership of assets. It does not involve the movement of goods and services across borders.
3. Other capital like lending
India lending abroad is recorded in the capital account of the BOP. It is reflected in the capital account as it impacts changes in the ownership of assets. It does not involve the movement of goods and services,
Also lending abroad is recorded with a negative or on the debit side of the BOP account. This is because it leads to the payment of foreign exchange to the rest of the world.
14 Explain how ‘depreciation of currency’ promotes exports of a country.
Answer. Depreciation of currency means the value of the currency has reduced relative to other currencies.
Depreciation occurs when the foreign exchange rate increases, this boosts the purchase of goods and services by foreign companies. As of now, they would purchase more products as the prices would be reduced due to the reduced value of the currency. Hence, this would boost the economy.
15. Explain the impact of rise in exchange rate on national income.
Answer. A rise in the foreign exchange rate means appreciation in the value of foreign currency in relation to the domestic currency, i.e., one unit of foreign currency can buy more goods and services from India. It makes exports cheaper to foreign buyers and imports costlier to Indian buyers. As a result, exports rise and imports fall leading to rise in net exports. A rise in net exports may lead to rise in national income.
When the foreign exchange rate rises, imports become costly for domestic customers. This reduces demand for imports causing a fall in demand for foreign exchange. When the foreign exchange rate rises, domestic goods become cheaper for foreign buyers. This raises demand for exports, causing a rise in the supply of foreign exchange.
16. Explain the concept of ‘deficit’ in balance of payments.
Answer. Deficit in BoP 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 the rest of the world.
Significance of deficit in BoP:
There is positive as well as negative significance of deficit in BoP. The positive significance is that, BoP deficit may be occurring on account of such capital imports which are essential to speed up the process of growth and development in the economy. The negative significance is that it highlights our liabilities to the rest of the world. Greater the liability, greater is the strain on our GDP by the way of payments to the rest of the world.
17. Foreign exchange transactions which are independent of other transactions in the BOP account are called
Answer. Autonomous transactions.
18. Indian investors lend abroad. Answer the following questions: 6 (a) In which sub account and on which side of BOP account such lending is recorded? Give reasons
(b) Explain the impact of this lending on market exchange rate.
Answer.
- Indians lending abroad is recorded in Capital Account of BOP Account because it leads to creation of foreign exchange assets. It is recorded on the debit side because it outflow of foreign exchange.
- Lending abroad increases demand for foreign exchange. Supply of foreign exchange remains unchanged, exchange rate may rise.
- In Capital Account, and on debit side of BOP, the lending of Indian investors to abroad will be recorded. Indian investors lending abroad cause an outflow of foreign exchange from the country. Thus, it is recorded as negative item in the Capital Account of BOP.
- Lending to abroad by Indian investors will decrease the supply of foreign currency. This would shift the supply curve from $5 to ‘S’. With the shift in supply curve, the new equilibrium is established at point E’, where the exchange rate rises from OR to OR1.
19. Define trade surplus. How is it different from “Current account surplus”?
Answer. The trade surplus is a situation in which the value of goods a country exports (= sells to other countries) is greater than the value of goods it imports
A current account surplus means an economy is exporting a greater value of goods and services than it is importing. A country with a current account surplus will have a deficit on the financial/capital account. i.e. a country with a current account surplus will have surplus foreign exchange it can use to invest in other countries. The trade balance is the amount a country receives for the export of goods and services minus the amount it pays for its import of goods and services.
The current account is the trade balance plus the net amount received for domestically-owned factors of production used abroad.
Try some questions on your own as well:
20. “Indian Rupee plunged to all time low of Rs 74.48 against the US Dollar”. In the light of this report, discuss the impact of the situation on Indian imports.
21. Distinguish between current account and capital account, also between autonomous transactions and accommodating transactions of balance of payments account.
Answer.
22. What is depreciation of domestic currency?
23. Name the market exchange rate system in which the central bank can actively intervene.
Answer. Managed Floating Exchange rate.
24. The price of one USD has fallen from Rs 56 to Rs 55. Has the US currency appreciated or depreciated?
Answer. Depreciated.
25. What is the role of a Central Bank in the following exchange rate:
a. Fixed exchange b. Floating Exchange c. Managed floating
Answer. The role of the central bank in maintaining the foreign exchange rates under different regimes is:
A. Fixed exchange rate- A central bank actively uses its foreign currency reserves to maintain the officially determined exchange rate.
b. Floating exchange rate system- A central bank does not maintain any reserves of foreign currency as the market automatically adjusts to determine the market-driven exchange rate.
c. Managed floating- A central bank enters the foreign exchange market to buy/sell foreign exchange in order to control fluctuations and volatility in the market.
26. Difference between Fixed and Flexible exchange rate.
Answer.
27. Revaluation and appreciation of currency are one and the same thing.
Answer. False.
Revaluation refers to an increase in the value of the domestic currency by the government under a fixed exchange rate. On the other hand, currency appreciation refers to an increase in the value of the domestic currency in terms of foreign currency under a flexible exchange rate system.
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- National income
- National income formula list
- Value-added method
- Income method
- Expenditure method
You can read more posts by me on national income:
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