Q: Short Answer Type Questions:Distinguish between devaluation and depreciation of domestic currency.

Currency depreciation is a situation of a rise in exchange rate. More rupees are needed to buy one dollar. Increase in demand and decrease in supply for foreign exchange cause depreciation of domestic currency.Devaluation is an official lowering of the value of a country's currency within a fixed exchange rate system.

Question 1

Devaluation and depreciation of currency are one and the same thing.

Accepted Answer

Devaluation is reduction in value of domestic currency by the government under fixed exchange rate system.It is a deliberate effort. On the other hand, Depreciation is decrease in value of domestic currency due to market forces of demand and supply under flexible exchange rate system.

Question 2

What are official reserve transactions? Explain their importance in the balance of payments.

Accepted Answer

Official reserve transactions refer to transactions by the central bank that cause changes in its official, reserves of foreign exchange. Such transactions take place when a country withdraws from its stock of foreign exchange reserves to finance deficit in its overall balance of payments (BOP). A country with surplus in its overall BOP leads to rise in foreign exchange reserves. Official reserve transactions are very important as they help to bring a balance in the country's overall balance of payments. So, such transactions act as accommodating Item in BOP.

Question 3

(a) In which sub-account and on which side of balance of payments account will foreign investments in India be recorded? Given reasons.(b) What will be the effect of foreign investments in India on exchange rate? Explain.

Accepted Answer

(a) In Capital account, and on credit side of BOP, foreign investments in India will be recorded. Foreign investment refers to the investment in the assets of a foreign country. By investing, the government or any resident of domestic country owns the control over the asset of the foreign country. Foreign Investment cause an inflow of foreign exchange into the country. Thus, it is recorded as positive items in the Capital Account of BOP.(b) Foreign investments in India will increase the supply of foreign currency. This would shift the supply curve from $SS$ to $S'S$. With the shift in supply curve, the new equilibrium is established at point E, where the exchange rate falls from $OR$ to $OR_1$ and the demand and supply of foreign currency rises to $QQ_1$.

Question 4

Why does the demand for foreign currency fall and supply rises when its price rises? Explain.

Accepted Answer

When price of foreign exchange rises, import becomes costlier, demand for imports will fall. As a result demand for foreign currency falls. When price of foreign exchange rises, domestic goods become cheaper for foreign buyers, because they can now buy more from one unit of foreign currency. As a result demand for exports rise, leading to increase in supply of foreign exchange.Thus, it can be concluded, that the demand for foreign currency and its price has an inverse relationship, while, supply has a direct relationship with the price of foreign exchange.

Question 5

Which one of the following pairs is not correctly matched with regard to balance of payments accounts?

Accepted Answer

The balance of payments account for one country records all the payments that effect funds transfers between that nation and the rest of the world. Payments from foreigners to the domestic country are credited to the account. These include all foreign payments for exports, payments from foreign tourists for services, investment income made by the domestic country in foreign markets, unilateral transfers and capital inflows.

Question 6

'Devaluation and Depreciation of currency are one and the same thing'. Do you agree? How do they affect the exports of a country?

Accepted Answer

Devaluation is the fall in the value of domestic currency in relation to foreign currency as planned by the government in a situation when exchange rate is not determined by the forces of demand and supply, but is fixed by the government of different countries. Whereas, Depreciation is the fall in the value of domestic currency in relation to foreign currency in a situation when exchange rate is determined by the forces of demand and supply in the international currency market. As a general phenomena, any depreciation/devaluation of currency may result into increase in exports of the goods and services from the country since it would increase the global competitiveness of the goods by making them cheaper.

Question 7

Which of the following are the components of foreign capital?$1$. Grants and loans.$2$. External commercial borrowings.$3$. Foreign direct investment.$4$. Deposits from non-residents.Select the correct answer using the code given.

Accepted Answer

Foreign capital, in general terms, refers to the capital receipts from foreign sources, its components are:(i) Private foreign investment(ii) Indirect investment(iii) External commercial borrowings(iv) Non-resident deposit(v) Public foreign investment(vi) United loans(vii) Inter-government grants.

Question 8

Other things remaining unchanged, when in a country the price of foreign currency rises, national income is _____.

Accepted Answer

Other things remaining unchanged, when in a country the price of foreign currency rises, national income is likely to rise as it indicates the greater flow of foreign exchange in the domestic economy and that promotes a higher level of development. So national income rises as the price of foreign currency rises.Hence, the correct option is A.

Question 9

Which one of the following is true statement?

Accepted Answer

The balance of payments account comprises of the current account and the capital account. The current account consists of the visible and invisible imports and exports of the country as well as unilateral transfers and income receipts and payments. The capital account includes the capital receipts and capital payments such as portfolio investments.

Question 10

Short Answer Type Questions:Distinguish between devaluation and depreciation of domestic currency.

Accepted Answer

Currency depreciation is a situation of a rise in exchange &#10;rate. More rupees are needed to buy one dollar. Increase in demand and &#10;decrease in supply for foreign exchange cause depreciation of domestic &#10;currency.Devaluation is an official lowering of the value of a country's currency within a fixed exchange rate system.