CBSE Class 12 Economics Foreign Exchange Rate and Balance of Payments Worksheet

Question. The balance of trade shows a surplus of 10000 Crore and the import of merchandise is half of the export of merchandise. Find the value of export.
(i) 20000
(ii) 10000
(iii) 5000
(iv) 1000

Answer: B

Question. Statement I: Unilateral transfers made by way of gifts, grants and remittances are treated as current transfers.
Statement II: Expenditure by tourists is included in balance of trade.
(i) Both statements are incorrect
(ii) Both statements are correct
(iii) Statement I is correct and statement II is incorrect
(iv) Statement I is Incorrect and statement II is correct

Answer: D

Question. Foreign exchange transactions which are independent of other transactions in the balance of payments account are called. Choose the correct alternative)
(a) Current transactions
(b) Capital transactions
(c) Autonomous transactions
(d) Accommodating transactions

Answer: C

Short Answer type Questions

Question. (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.
Answer: (i) Foreign investments will be recorded in the Capital Account of the BOP Account because these give rise to foreign exchange liabilities. Foreign investment will be recorded on the credit side because these bring in foreign exchange to the economy.
(ii) Foreign investment adds to supply of foreign exchange. Demand remaining unchanged, it brings downward influence on exchange rate.

Question. Indian investors borrow from abroad. Answer the following
(i) In which sub-account and on which side of the Balance of Payments Account will this borrowing be recorded ? Give reason.
(ii) Explain what is the impact of this borrowing on exchange rate.
Answer: (i) Borrowings from abroad are recorded in the Capital Account of the BOP because these give rise to foreign exchange liabilities. These are recorded on the credit side because these bring foreign exchange into the country.
(ii) Borrowing from abroad raise supply of foreign exchange. Demand for foreign exchange remaining unchanged, exchange rate is likely to fall.

Question. What is meant by ‘Official Reserve Transactions’? Discuss their importance in Balance of Payments.
Answer: Transactions by a Central Bank that cause changes in its official reserves. These are usually purchases or sales of its own currency in the exchange market in exchange for foreign currencies or other foreign-currency-denominated assets. 2 They may be Autonomous Receipts and Autonomous Payments, disequilibrium between which may occur as deficit/surplus in Balance of payments.

Question. Are the following entered
(a) On the credit side or debit side and
(b) In the Current Account or Capital Account in the Balance of Payments Account?
You must give reason for your answer.
(i) Investment from Abroad.
(ii) Transfer of funds to relatives abroad.
Answer: (a) (i) Investment from abroad-It is entered to credit side.
(ii) Transfer of Funds to relatives abroad: It is entered to debit side.
(b) (i) Investment from abroad-Capital Account because Capital Account records capital transfers between one country and rest of the world.

Question. 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.
Answer: (i) False, it is recorded in current account as it neither affects foreign exchange assets nor foreign exchange liabilities.
Ii True, all imports and exports of goods are recorded in trade account which is a part of current account, because it is simply import/export of a good.

Question. 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 is called Trade Balance.
(ii) External assistance is not recorded in Balance of Payments Account.
Answer: (i) False. Difference between the value of exports and imports of goods and services is called Balance of Payment not Balance of Trade.
(ii) False. It is a part of Balance of Payments or external assistance is recorded in Balance of Payments Account.

Question. Giving reasons state whether the following:-
(i) Excess of foreign exchange receipts over foreign exchange payments on account of accommodating transactions equals deficit in Balance of Payments.
(ii) Export and Import of machines are recorded in Capital Account of the Balance of Payments Account.
Answer: (i) False. As Accommodating Transactions remove both surplus and deficit of Balance of Payments Account.
(ii) False. As export and import of machines are recorded in Current Account of Balance of Payments Account.

Question. Giving reasons state whether the following statements are true or false:
(i) Current Account of Balance of Payments Account records only exports and imports of goods and services.
(ii) Foreign investments are recorded in Capital Account of Balance of Payments.
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 Port Folio Investments) are included in the Capital Account of Balance of Payments.

Question. What is ‘appreciation’ of domestic currency? What is its likely effects an exports and how?
                                           or
Explain the effect of appreciation of domestic currency on imports.
Answer: Domestic currency appreciates when there is a fall in foreign exchange rate, the domestic economy can now buy more quantity of goods and services from foreign countries with the same amount of domestic currency. As a result imports rise. e.g. When Rs. / $ 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. Explain the effect of depreciation of domestic currency on exports.
Answer: Domestic currency depreciates when there is a rise in foreign exchange rate. Depreciation has an expansionary effect on Aggregate Demand and output. Depreciation increases the demand for domestically produced goods by reducing their relative price. This will lead to increase in exports and hence fall in imports, as now foreign country can buy greater units in the domestic country with same amount of their currency.

Question. How can increase in foreign direct investment affect the price of foreign exchange?
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. Do you think that a surplus in capital account BoP reflects prosperity of the nation?
Answer: No, it is incorrect to say because surplus in capital account balance of payments may have been achieved through loan which are a financial obligation to rest of the world.

Question. Explain the Different Concepts of Foreign Exchange Rate
Answer: (i) Nominal exchange rate It refers to the number of units of domestic currency, one must give up to get an unit of foreign currency. In simple term, it refers to the price of foreign currency in terms of domestic currency.
(ii) Real exchange rate The real exchange rate is the ratio of foreign to domestic prices, measured in the same currency. It is defined as
(iii) Nominal Effective Exchange Rate (NEER) It is that type of effective exchange rate which does not account for change in price level while measuring average strength of one currency in relation to the other.
(iv) Real Effective Exchange Rate (REER) It is that type of effective exchange rate which accounts for changes in the price level across different countries of the world.

Question. How would you argue for and against foreign investment?
Answer: Arguments against foreign investment:
Leads to rise in claims by foreigners against assets in the domestic economy.
Arguments in favors of foreign investment:
Overall investment in the domestic economy is expanded.

Question. Distinguish between trade account and current account of balance of payments account.
Answer: In trade account import and export of goods are recorded.
In current account import and export of goods and services are recorded. Factor income and transfer payment are also recorded.

Question. State the effect of the following on the balance of payments situation.
(i) Increase in import duty of gold.
(ii) Rise in the price of foreign currency.
Answer: (i) This will reduce import of gold and thus will have a favorable effect on BOP situation, as demand for foreign exchange will fall.
(ii) Rise in price of foreign currency will make imports costlier, so import will fall and it will be favorable for BOP, as demand for foreign exchange will fall.

Question. What will be the effect of the following on the balance of payments ?
(i) ‘Make in India’ programmed.
(ii) import of pulses.
Answer: (i) ‘Make in India’ will increase supply (inflow) of foreign exchange in India causing improvement in the balance of payments position.
(ii) Import of pulses will lead to outflow of foreign exchange from the country causing adverse effect on balance of payment position.