BALANCE OF PAYMENTS
DETERMINATION OF FOREIGN EXCHANGE RATE
1. What is the exchange rate determined by the government called?
2. What is the exchange rate determined by market fox called?
3. What is the exchange rate although determined by the market forces but is influenced by government intervention in the market from time to time called?
4. How will government influence the foreign exchange rate under the following situation:
- government find the exchange rate too high.
- government find the exchange rate too low.
5. Why is managed to float also known as dirty floating?
6. State true or false with reasons:
- Suppose government finds the exchange rate too low. In this case, monetary authorities can start selling foreign currencies from their foreign exchange reserves.
- Government intervenes in the foreign exchange market through the monetary authorities.
- Write two merits and demerits each of fixed and floating exchange rates.
Put a tick against the correct column and give a reason in the space provided below
| Transactions in Indian BOP | Debit | Credit | Current account | Capital account |
| Hero Honda, India purchases 250million in production machinery from the Japanese company | ||||
| John Williams, the U.S entrepreneur, invests 500 million in India | ||||
| A Chinese company sells 100 million worth of berets to India | ||||
| BMW pays 100 million to an Indian shipper for transporting cars from Germany to India. | ||||
| Each month, Immigrant who recently arrived in the United States sends half her pay check to her sister in India. | ||||
| Bank of America pays $5 Million in interest to Indian depositors. | ||||
| Senor Ramos from Spain buys a shopping centre in India. | ||||
| German tourist spends $3 million in India. | ||||
| Indian tourists spend$ million in Germany. |
Give a reason for classifying under the following heads:
Debit:
Credit:
Capital Account:
Current Account:
Multiple-choice questions
1. The ‘current account’ of BOP records foreign exchange transactions including:
- Income
- Expenditure
- Both income and expenditure
- Borrowing and lending
2. The capital account of BOP records the foreign exchange transaction:
- Income
- Expenditure
- Both income and expenditure
- Borrowing and lending
3. Which of the following is recorded in the current account?
- Foreign investment
- Purchases from abroad
- Borrowings from abroad
- Lending from abroad
4. Which of the following is recorded in the capital account?
- Sales abroad
- Lending abroad
- Travelling abroad
- Dividends from abroad
1. Define the balance of payment?
2. The balance of trade shows a deficit of rupees (-)4000 crores. The values of imports are rupees 8000 crores. What is the value of exports?
3. A country’s balance of trade is rupees 100 crore and the value of export of goods is rupees 165 crores. Find out the value of imports of goods?
4. A country’s balance of trade is rupees600 crores. The value of export of goods is rupees 750 crores. How much is the value of imports of goods?
5. When is there a budget surplus?
6. Suppose the following data represent Mexico’s international transactions measured in pesos.
| Merchandise exports | 15 | Merchandise imports | 10 | |
| Change in foreign assets in Mexico | 12 | Change in assets abroad | 8 | |
| Exports of services | 7 | Imports of services | 5 | |
| Income receipts on investment | 5 | Income payments on investment | 10 | |
| Unilateral transfers | 6 |
- What is Mexico’s balance of trade?
- What is the balance on the current account?
- What is its balance on the capital account?
7. Fill in the blanks (Each question carries 1 mark)
1. ______________is the recorded of trade in goods and services and transfer payments.
2. _________________account records all international transactions of assets.
3. The price of foreign currency in terms of Domestic currency has increased and this is called ____________of Domestic currency.
4. ___________________is a mixture of a flexible and fixed exchange rate system.
5. The Bretton Woods conference held in the year________________
Match the following (Carries five marks)
| S No. | A | B |
| 1 | SDR | Dirty floating |
| 2 | Balance of payment | Flexible exchange rate |
| 3 | Balance of trade | Paper gold |
| 4 | Floating exchange rate | Trade-in goods |
| 5 | Managed floating | Trade-in goods and service |
REASON BASED QUESTIONS
State true or false:
- Fixed exchange rate is determined by the forces of supply and demand in the international money market.
- Current account balance of payment includes exports and imports of goods only.
- Autonomous items of trade are undertaken by the government to restore equilibrium in the balance of payment.
- The rising demand for foreign goods implies higher demand for foreign exchange.
- Flexible exchange rate is determined by the WTO.
- Borrowing and lending in the international money market is a part of the current account balance of payments.
- If the balance of trade is in deficit, the balance of payments is also in deficit.
- Appreciation of the Indian currency occurs when more rupees are to be paid for US $.
- Current account deficit in the balance of payments occurs when the export of goods<import of goods.
- Foreign direct investment is a component of the current account balance of payments.
- Balance of payments is balanced through unilateral transfer.
- ‘Above the line items the in the balance of payments refer to autonomous as well as accommodating items.
- ‘Below the line items in the balance of payments are undertaken to maximize profits.
- ‘Transfer to rest of the world’ is a debit component of the balance of paying the mends on the current account.
- Compensation of employees from the rest of the world is a credit component of the balance of payments on the capital accounts.
- Foreign private loans are not considered in the construction of the balance of payments accounts.
- Depreciation of currency has the same effect on exports as the devaluation of the currency.
ASSIGNMENT
1 Mark Questions
1. Define foreign exchange.
2. Define the foreign exchange rate.
3. State the relation between price and demand for foreign exchange.
4. State the relation between price and supply of foreign exchange.
5. How is the equilibrium foreign exchange rate determined?
6. What is meant by the appreciation of currency?
7. The balance of trade shows a deficit of Rs.5, 000crores and the value of imports is Rs 9000 crores. What is the value of exports?
8. Name the two categories of transactions recorded in the current account of the BOP.
9. What is included in the balance of payment on the current account?
10. What is the balance of visible items in the BOP account called?
11. What does the deficit in the balance of trade indicate?
12. Define a flexible exchange rate system.
13. What is the difference between the values of exports and imports of goods called?
14. When will the balance of trade show a surplus?
15. What does a positive figure of net unilateral transfer in the BOP account signify?
16. Define depreciation of the domestic currency.
17. What does a depreciation of the Indian rupee imply for the US dollar?
18. What does a balance of payments account for in a country record?
19. What is the significance of errors and omissions in the BOP account?
The following questions are for 3/4 marks each:
1. Differentiate between the balance of trade and the balance of payments.
2. Higher the exchange rate, lower the demand for foreign exchange. Explain why?
3. Higher the foreign exchange rate, the higher the supply of foreign exchange. Explain why?
4. State four sources each of demand and supply of foreign exchange.
5. How is the foreign exchange rate determined? Explain with the help of a diagram.
6. State the components of (a) current account and (b) capital account of the BOP.
7. Distinguish between the balance on the current account and the balance of trade.
8. Why does a rise in foreign exchange rate cause a rise in its supply?
9. List and explain three economic factors that may lead to disequilibrium in the balance of payment of a country.
10. Differentiate between devaluation and depreciation of a currency.
11. Elaborate any three reasons that cause a deficit in the BOP account.
12. Show the effect of a decrease in demand for imports in the foreign exchange market.
13. Differentiate between a fixed and flexible exchange rate system.
14. Distinguish between autonomous and accommodating items in the BOP.
15. How is the official reserve account used to balance a balance of payments account?
16. using a diagram to explain the term “appreciation of a domestic currency”.
17. With the help of a diagram explain how a foreign currency appreciates.
18. What is meant by visible and invisible items in the balance of payments account? Give two examples of invisible accounts.
19. Distinguish between autonomous and accommodating items in the BOP.
The following questions are for 6 marks each:
1. Discuss the components of a balance of payments account.
2. How is the equilibrium rate of exchange determined?
3. Explain the following:-
- Direct relationship between the supply of foreign exchange and the price of foreign exchange.
- Inverse relationship between the demand of foreign exchange and the price of foreign exchange.
4. Discuss the economic factors that cause disequilibrium in the Balance of Payment.
HOTS
1. Balance of payment always balances.
2. Why do autonomous capital flows and accommodating capital flows take place?
3. ”Slump in global oil prices”.
How will it affect India?
Test 1
1. Mention two invisible items of exports? (1 mark)
2. ______________is called the difference between exports and imports of visible items. (1 mark)
(a) Balance of payments
(b) Balance of trade
(c) Both (a) and (b)
(d) neither (a) nor (b)
3. What do you mean by official reserve transactions? Are they necessarily accommodating transactions? (3 marks )
4. Which transactions determine the balance of trade? When is a balance of trade in surplus? (3 marks )
5. What does the balance of payments account show? Name the parts of the balance of payments accounts? (4 marks )
6. What is the current account deficit? Explain its significance (4 marks )
7. Distinguish between the balance of payments and the balance of trade? (6 marks )
8. Explain the distinction between autonomous and accommodating transactions in the balance of payments, Also explain the concept of balance of payments ’deficit’ in this context. (6 marks )