Balance of Payments and Forex Important Questions
1. In the event of depreciation of the country’s currency, its exports tend to increase while imports tend to decrease. True or False. State with reason.
Ans. True, because due to depreciation, the value of domestic currency decreases in relation to the foreign currency. Accordingly, goods become cheaper in the domestic economy which encourages exports, and goods become costlier in the foreign market which discourages imports.
2. ‘ Above the line items’ in BoP accounts include autonomous as well as accommodating items. True or False. State with reason.
Ans. False, ‘Above the line items’ in BoP accounts include autonomous items only.
3. Improvement in the exchange rate of the country’s currency does not necessarily mean improvement in the BoP status of the country. True or False. State with reason.
Ans. True, Improvement in the country’s exchange rate may cause deficit BoP equilibrium because exports may decrease and imports may increase.
4. How can the Reserve Bank of India help in bringing down the foreign exchange rate which is very high?
Ans. Reserve Bank of India can increase the supply of foreign exchange by selling foreign exchange from its reserves to bring down its value.
5. Forward rate of exchange is a contractual rate of exchange. True or False. State with reason.
Ans. True, as it is a contract signed today to be honored sometime in the future.
6. Assertion (A): Disequilibrium in BoP causes the movement of official reserves.
Reason (R): Accommodating items lead to the restoration of equilibrium.
(a) Both A and R are true and R is the correct explanation of A
(b) Both A and R are true but R is not a correct explanation of A
(c) A is true but R is false
(d) A is false but R is true
Ans. (a)
7. Statement 1: In the BoP accounts, current transfers are treated as an element of Invisibles.
Statement 2: Goods bought by foreign tourists in the domestic markets are not treated as export.
a) Both the statements are true
b) Both the statements are false
c) 1 is true and 2 is false
d) 2 is true 1 is false
Ans. (a)
8. Bretton woods system of the exchange rate was replaced by a dirty floating system of the exchange rate.
Ans. False, as the Bretton Woods System of exchange is succeeded by a flexible exchange rate which is also known as the ‘floating exchange rate’.
9. Assertion (A): Appreciation and Revaluation of Domestic Currency with respect to foreign currency are one and the same thing.
Reason (R): Appreciation and Revaluation of domestic currency make the domestic goods relatively expensive. As a result, a decrease in exports and an increase in imports of the nation are observed.
(a) Both A and R are true and R is the correct explanation of A
(b) Both A and R are true but R is not a correct explanation of A
(c) A is true but R is false
(d) A is false but R is true
Ans. (d)
10. What is a parity value?
Ans. In the context of the exchange rate in the foreign exchange market, the parity value of one currency in terms of the other for a given basket of goods and services. If a USD buys 50 times the goods and services in India, compared to a rupee, the parity value of a dollar should be 50:1 means the exchange rate between rupee and dollar ought to be INR 50 = 1 USD.
11. BoP accounts reflect the growth potential of the economy. True or False. State with reason.
Ans. True. BoP accounts reflect the growth potential of the economy in terms of demand for domestically produced goods and services in the rest of the world.
12. Is a rise in reserves of India’s foreign exchange a sign of our rising exports?
Ans. Not necessarily; in the case of India, it is certainly not. Our forex reserves have tended to rise largely because of remittances from abroad by the NRIs.
13. How is external commercial borrowing different from external assistance?
Ans. External commercial borrowing refers to loans received from or given to the rest of the world at the market rate of interest. External assistance refers to loans received from or given to the rest of the world at the concessional rate of interest.
14. What impact will fall on the expenditure of an American citizen who comes to India for medical treatment if the foreign rate is increased?
Ans. Expenditure on treatment will reduce because with the increasing exchange rate, their purchasing power will increase.
15. Define Venture Capital.
Ans. Venture capital in the international money market refers to investments in the purchase of foreign exchange in the international money market with a view to earning profits.
16. Define a wide band system of foreign exchange.
Ans. Wideband is a system that allows wider adjustment in the fixed exchange rate system. It allows adjustment up to 10% around the “parity” between any two currencies in the international money market. For example, if one USD is fixed as equal to 50 INR, 10% revision (upward or downward) is to be allowed in this exchange of 1:50. The exchange rate may be revised as,
1:50 + 10% = 1:55 or 1:50-10% = 1:45
17. Define the crawling peg system of foreign exchange.
Ans. This system allows “small” but regular adjustments in the exchange rate for different currencies. No more than (+-) 1% adjustments are allowed at a time. Indeed, it is a small adjustment. But it can crawl, i.e., it can be repeated at regular intervals.
18. If inflation is higher in country A than in country B, the exchange rate between the two countries is fixed. What is likely to happen to the trade balance between the two countries?
Ans. The exports from country B to country A will go up in this situation resulting in an improvement or surplus trade balance for B, but due to higher prices in country A, its imports will increase for country B and it will lead to a deficit in the trade balance for country A.
19. What is hedging?
Ans. Hedging means protection against the risk related to variations in the foreign exchange rates. The exchange rate is locked for future supplies of foreign exchange.
20. Monetary transactions arise only due to international sales and the purchase of financial assets. True or False. State with reason.
Ans. False, Monetary transactions arise due to export and import of goods, export and import services, international sale and purchase of financial assets as well as international sale and purchase of real assets.
21. Assertion (A): Devaluation of Domestic Currency leads to rising in National Income of the domestic currency.
Reason (R): Devaluation of Domestic Currency refers to a reduction in the value of the domestic currency with respect to foreign currency, under a fixed exchange rate system.
(a) Both A and R are true and R is the correct explanation of A
(b) Both A and R are true but R is not a correct explanation of A
(c) A is true but R is false
(d) A is false but R is true
Ans. (b)
22. Assertion (A): There is an inflow of foreign capital in India due to the recent launch of PM’s Atmanirbhar Campaign.
Reason (R): Due to the inflow of foreign capital in India, there is an increase in demand for foreign exchange.
(a) Both A and R are true and R is the correct explanation of A
(b) Both A and R are true but R is not a correct explanation of A
(c) A is true but R is false
(d) A is false but R is true
Ans. (c)
23. Identify which of the following is true?
- The exchange rate is the price of a currency expressed in terms of gold.
- Bretton woods system of exchange was replaced by a dirty floating system of the exchange rate.
- When foreign currency becomes cheaper ( in relation to domestic currency), fewer rupees are available for a US dollar.
- The Mint value of a currency implied the paper value of that currency.
Ans. (c)
24. India has attracted a total FDI inflow of USD 22.53 bn between April 2021 to June 2021.
The transaction will be recorded on ________ side of _________ account of balance of payments.
Ans. credit, capital
25. Assertion (A): Imports of crude oil have a favorable impact on India’s balance of payments.
Reason (R): Imports of goods are recorded on the debit side of the current account as it leads to an outflow of foreign exchange.
(a) Both A and R are true and R is the correct explanation of A
(b) Both A and R are true but R is not a correct explanation of A
(c) A is true but R is false
(d) A is false but R is true
Ans. (d)
26. Assertion (A): Trade of invisible items between two nations is a part of the capital account of BoP.
Reason (R): Transactions that affect the asset-liability status of a country in relation to the rest of the world are known as Capital Account transactions.
(a) Both A and R are true and R is the correct explanation of A
(b) Both A and R are true but R is not a correct explanation of A
(c) A is true but R is false
(d) A is false but R is true
Ans. (d)
27. Any withdrawal from the reserves is recorded on the ___________ side and any addition to these reserves is recorded on the __________ side of the BoP.
Ans. positive (credit), negative (debit)
Are the following entered (i) credit side or debit side and (ii) in the current account or capital account in the BoP account? Give reason.
28. KIA motors has just entered the Indian market will all its eclectic cars giving a tough competition to its rivals.
Ans. Credit side of capital account as it will lead to inflow of forex and also its a part of FDI by KIA motors.
29. Interest on loan received from Nepal.
Ans. It will be recorded on the credit side of the current account as it brings in funds to the country.
30. Purchase of toys from China.Ans. It is recorded on the debit side of the current account as it leads to an outflow of foreign exchange.