SOLVED QUESTION BANK

1. Balance of payments of an economy records_______ for a fiscal year. (CBSE 2022)

a. Income and expenditure of the government
b. Inflow and outflow of funds of the government
c. Inflow and outflow of foreign exchange to/from the economy.
d. Inflow and outflow of loans to from the rest of the world

2. Identify the incorrect statement with reference to Balance of Payments. (CBSE 2022)
a. Current account records export and import transactions of a nation.
b. Export of machinery is recorded in capital account.
c. Transfer of funds to the relatives abroad, entered on debit side of current account.
d. Current account records all such transactions, which do not impact Asser of liability status of a
country.

3. Find the odd one out among the following, with respect to ‘Balance of Payments’ in India.
(CBSE 2022)
a. Investments by Indian investors under the make in India Programme.
b. Loan received from Australia
c. Investments from abroad
d. Purchase of machinery from abroad

4. A company located in India receives a loan from a company located abroad. How is this
transaction recorded in India’s balance of payments account? (Delhi 2017C)
a. Credit side of current account
b. Debit side of current account
c. Credit side of capital account
d. Debit side of capital account

5. The World Bank has been extending loans to country X on favorable terms for infrastructure,
poverty alleviation, and rural development projects for four decades’’
Identify the reason for these loans to be listed as external assistance under the capital account of
the Balance of Payments. (CBSE Practices Paper 2023)
a. The loans have been taken from an entity outside the country.
b. The loans aim to improve the standard of living in the country.
c. The loans have crossed the three-decade period.
d. The loans can be paid off over a longer period.

6. Deficit in Balance of Payments refer to the excess of :

a. Current account payments over current account receipts.
b. Capital account payments over capital account receipts.
c. Autonomous payments over autonomous receipts.
d. Accommodating payments over accommodating receipts.

7. Exports and imports of which of the following items will be a component of‘Balance of Trade’?
(CBSE 2021)
(a)Banking (b)Shipping
(c)Merchandise (d)Insurance
8. Foreign exchange transactions dependent on other foreign exchange transactions are called:
(CBSE 2016)
(a)Current account transaction (b)Capital account transactions
(c)Autonomous transactions (d)Accommodating transaction

9. Foreign exchange transactions which are independent of other transaction in the Balance of
Payments Account are called: (All India 2016)
(a) Current transactions (b)Capital transactions
(c)Autonomous transactions (d)Accommodating transactions

10. Suppose, the price of one UK Pound has increased from Rs. 70 to 80, owing to market forces,
This means that value of Indian currency (Rs.) has __________ (CBSE 2021)
(a)Appreciated (b)Depreciated
(c)Revalued (d)Devalued

11. Identify which of the following statements is true? (CBSE Sample Paper 2020)
a. The flexible exchange rate system gives the government more flexibility to maintain large
stocks of foreign exchange reserves.
b. In the managed floating exchange rate system. The government intervenes to buy and sell
foreign currencies.
c. In the managed floating exchange rate system, The central bank intervenes to moderate
exchange rate fluctuation.
d. In the fixed exchange rate system, market forces in the exchange rate.

12. What is the relationship between demand for foreign exchange and exchange rate. (KVS)
(a)Inverse (b)Direct
(c)One to one (d)No relationship

13. The exchange rate at which demand for foreign currency becomes equal to its supply is called.
(KVS)
(a)Equal rate of exchange (b)Unequal rate of exchange
(c)Equilibrium rate (d)All of these

14. Owing to the Russia-Ukraine crisis, the world is experiencing rising crude prices due to supply-
side issues. ‘Identify the most likely impact on the Balance of Payment situation of the Indian
economy from the following. (CBSE Sample Paper 2023)
a. Production of cars in India will rise
b. Production and sale of cycles in India will rise
c. Inflow of US Dollars in India will rise
d. Outflow of US Dollars from India will rise
15. Consider the following statements about ‘Portfolio Investments in India’ and choose the correct
alternative: (CBSE 2022)
(i) Investments by a foreign company to start its subsidiary company in India.
(ii) Investments by a foreign company to acquire some company in India.
(iii) A foreign investor buying shares in Indian markets.
(iv) A foreign investor buying goods in Indian markets.
Alternatives:
a. (i), (ii) and (iii)
b. (ii), (iii) and (iv)
 c. (iii) only
d. (iii) and (iv)

16. An Indian real estate company receives rent from Google in New York. This transaction would be
recorded on _________ side of _________account. (CBSE Sample Paper 2020)
(a)Credit, Current (b)Credit, capital
(c)Debit, capital (d)Debit, Current

17. An Indian company located in India invests in company located abroad. This transaction is
entered in India’s Balance of Payments Account on : (All India 2017C)
(a)Credit side of current account (b)Debit side of current account
(c)Credit side of capital account (d)Debit side of capital account

18. All currencies other than the domestic currency of a country are called as __________.
(All India 2017C)
(I) Foreign exchange rate
(II) Foreign exchange
(III)Foreign aid
Alternatives:-
(a) (i) and (ii) (b) (i) and (iii)
(b) (i),(ii) and (iii) (d) (ii) only

19. Two friends Anjali and Hemant were discussing the exchange rate systems.
‘Under this system, the exchange rates are determined by the market forces of demand and
supply.
However, deliberate efforts are made by the competent authority to keep the exchange rate
within a specific range.
The above-mentioned statement was given by Hemant identify the type of exchange rate system
was she talking about?
(a) Fixed Exchange Rate
(b) Floating Exchange Rate
(c) Managed Floating Exchange Rate
(d) Managed Fixed Exchange Rate

Answers: 1.C 2.B 3.A 4.C 5.B 6.C 7.C 8.D 9.C 10.B 11.C 12.A 13.C 14.D 15.C 16.A 17.D 18.D
19.C

Short Answer Type Questions

1. What will be the effect of the following on the balance of payments account?
(a)Make in India programme
(b)Import of pulses
Ans. (a) Make in India programme improve balance of payment condition because it increase
inflow of foreign exchange in home country.
(b). Import of pulses worsen or deteriorate balance of payment condition because it increase
outflow of foreign exchange from home country.

2. Give the meanings of Balance of Trade and Balance on current Account of Balance of Payments
Accounts. (CBSE 2021)
 Ans. BOT- it is the difference between value of exports and imports of goods of a country.
Current account balance is a record of exports and imports of goods, services and unilateral
transfers.

3. Name the broad categories of transactions recorded in the ‘current account’ of the Balance of
Payments Account.
Ans. Current account of the Balance of Payments Account records the following transactions:
a. Exports and imports of goods
b. Exports and imports of services
c. Factor income receipts from abroad and factor payments to abroad
d. Transfers from and abroad

4. Where are ‘borrowings from abroad’ recorded in the balance of Payments Accounts? Give
reasons. (All India 2015)
Ans. All transactions related to borrowing from abroad by private sector, government etc. are
recorded on the positive side of capital account. They cause inflow of foreign currency but they
are liability on us. Those transactions between the residents of a country and the rest of the
world which cause a change in the assets or liabilities of the residents of the country or its
government are recorded under capital account.

5. Name the broad categories of transactions recorded in the’ capital account’ of the Balance of
Payments Accounts. (Delhi 2015)
Ans. Capital account of the Balance of Payments Accounts records the following transactions.
a. Borrowings from and to abroad
b. Investments from and to abroad
c. Decrease and increase in foreign exchange reserves.

6. “India is taking huge leaps in the index of Ease Of Doing Business; as a result many MNCs are
shifting their production base to India”. In the light of the above statement, comment upon the
flow of foreign exchange and its likely impact on the Indian Economy.
Ans. India with greater ease of doing business, may attract many more MNC’s to shift their
production base to India, thereby increasing the inflow of foreign exchange to the Indian
economy. This increase in foreign direct investments (FDI) by MNCs will lead to increase in
the supply of foreign exchange in India leading to a fall in the rate of foreign exchange, i.e.
Indian Rupee may appreciate. Increase in FDI will result in increase in production and hence
may also generate employment opportunities in the Indian economy.

7. Evaluate ‘autonomous’ and accommodating transaction. (CBSC learning from work)

Or
Distinguish between autonomous and accommodating transaction. (CBSE 2023)
Ans
Difference between autonomous items and accommodating items
Basis Autonomous items Accommodating items
Meaning Autonomous items refer to Accommodating items referred to
those international economic the transaction that are undertaken
transactions which take place to cover deficit or surplus in
due to some economic motive autonomous transactions
such as profit maximization
Effect on BOP These items are independent of These items are meant to maintain
the state of BOP account. the balance in BOP account.
 Occurrence These items take place on both These items tale place only on
current and capital accounts capital account.
Alternative Name These items are also known as These items are also known as
‘above the line’ items ‘below the line’ items

8.What is foreign exchange rate? Distinguish between fixed and flexible exchange rates.
Or
What are fixed and flexible exchange rates? (All India 2015)
Ans. Foreign exchange rate refers to the rate at which the currency of one country is exchanged
with the currency of another country.
(a). Fixed exchange rate is the rate which is officially fixed in terms of any other currency by
the government, whereas flexible exchange rate is that rate which is determined by the forces of
demand and supply of foreign exchange.
(b) Fixed exchange rate does not vary with changes in demand and supply of foreign currency,
only the government has the power to change it, whereas Flexible exchange rate is free to
fluctuate according to changes in demand and supply of foreign currency.

9.Explain the meaning of managed floating exchange rate. (All India 2015)
Ans. Another system of foreign exchange has emerged recently called’ Managed Floating
Exchange rate is termed as ‘managed’ because the central bank was to influence the exchange
rate by entering the floating exchange market as bulk buyer seller during the period, when the
floating rate is too high. Is status selling foreign exchange from its reserve so as to bring the rate
down. On the other hand when the floating rate too low, it starts buying foreign exchange in
order boost up the rate. This is done by the central bank of the interest of importers and
exporters another rate by which managed floating Rate is known as dry floating Rate..

10. A country deliberately keeps the value of its currency low under the managed floating system.”
Discuss briefly how it will affect the exports of the country. (CBSE 2020C)
Ans. If a country deliberately keeps the value of its currency low as compared to the foreign
exchange to keeps its currency cheaper vis-à-vis foreign currency under the managed floating
system.
Such a step ensures international competitiveness of the goods and services of the international
market feeding to an increase in the exports of the country to the rest of the world.

11. “Foreign institutional investors (FIIs) remained net seller in the Indian capital markets over the
last few weeks’’. –The Economic Times
State and discuss the likely effects of the given statement on foreign exchange rate with
reference to the Indian economy. (CBSE Sample Paper 2020)
Ans. Selling of securities by Foreign Institutional Investors (Flls) in Indian capital market will
lead to fall in the supply of foreign currency in economy. This situation might lead to excess
demand of foreign currency at the prevailing foreign exchange rate. As a result a new
equilibrium rate of foreign exchange will be determined which will be higher than the
prevailing foreign exchange rate. Leading to depreciation of domestic currency.

12. ‘Devaluation and depreciation of currency are one and the same thing. Do you agree’’ How do
they affect the exports of country? . (CBSE Sample Paper 2016)
Ans. Devaluation and depreciation of currency are not one and the same thing. This is because
devaluation refers to the fall in the value of domestic currency with respect to foreign currency
as planned by the government (it is fixed by the government) whereas depreciation refers to the
fall in the value of domestic currency in relation foreign currency with respect to a situation
 where exchange rate is determined by the market forces of supply and demand for foreign
exchange in international money market. No mater both cause a fall in value of domestic
currency. Both of them are measures undertaken to promote exports as the goods become
cheaper in domestic economy, Which thereby encourages exports.

13. Us dollar has recorded a jump of 0.75 paise per dollar in the last one month; this situation might
bring smiles and sorrows to different types of traders(exporters and importers).” Justify the
given statement. (CBSE Outside Delhi 2020)
Ans. The given condition indicates to the situation of depreciation of home currency(₹) vis-à-
vis foreign currency(US $). This implies that mote units of Indian currency(₹) is to be paid to
buy one unit of foreign($) currency. This may lead to sorrows for importers, as they have to pay
higher amount for their imports. Also, this may bring smiles for exporters, as they would be
getting higher earnings for their exports.

14. Explain the effect of appreciation of domestic currency (or a fall in the price of foreign
currency) on imports and exports. (Delhi 2020)
Ans. Analyzing the effect of fall in the price of foreign currency (appreciation of domestic
currency) upon imports and exports. We notice that the imports will become cheaper and
exports costlier so appreciation leads to more imports and less exports.

15. State giving valid reasons whether the following statements are true or false:
(i) Trade deficit is always a great cause of worry for an economy.
(ii) Depreciation of currency has same effect on exports as devaluation of currency.
(iii) ‘Indians investing in assets abroad’ will be recorded under debit side of capital account in
Balance
of Payments. (CBSE Outside Delhi 2020, Set-I)
Ans. (i) False Trade deficit is not always a case of worry since it causes an imbalance in the
savings of the country and its rate of investment. The foreign lending and investments can helps
in finding a solution for the situation.
(ii) True. The prices of Indian exports in terms of foreign currency will fall making Indian
exports to increase.
(iii) True. This is because it creates foreign exchange assets and would seem more like an
investment. The problem however arises when exchange rates grow higher day by day as the
supply of foreign exchange for a particular country remains fixed and cannot be changed.

16. (a) Define "Trade Surplus". How is it different from "Current Account Surplus"?
(b) "Indian Rupee plunged to all time low of 74.48 against the US dollar ($)" - The Economic
Times. In the light of the above report, discuss the impact of the situation on Indian Imports.
(CBSE Delhi 2019, Set-I)
Ans. (a) Trade surplus refers to excess value of exports of visible items over the value of import
of visible items in the balance of payments account of a country. On the other hand, current
account surplus refers to excess of current account receipts from value of export of visible
items, invisible items and unilateral transfers over payment of value of import of visible items,
invisible items and unilateral transfers. It is a broader concept as compared to trade surplus.
(b) The statement by economic times indicates depreciation of Indian currency against the
foreign currency dollar ($). Depreciation means the fall in the value of rupee in terms of foreign
currency. More rupees are now required to buy a unit of foreign currency. This will make
foreign goods costlier to India. As a result, imports are likely to fall or become expensive.
 Long Answer Type Questions

1. (a) In which sub-account and on which side of balance of payments account will foreign
investments in India be recorded? Give reasons.
(b) What will be the effect of foreign investments in India on exchange rate? Explain.
(Delhi 2016)
Ans. (a) Foreign investments in India will be recorded in the capital account of BOP account
because these give rise to foreign exchange liabilities. Foreign investment will be recorded on
the credit side because it bring in foreign exchange.
(b) Foreign investments in India add to supply of the foreign exchange as they are an important
source of supply of foreign exchange. Demand for foreign exchange remaining unchanged. This
will bring a downward influence on exchange rate i.e. it will fall.

2. Name the broad categories of transactions recorded in the capital account of the balance of
payment accounts. (CBSE 2015 SET 1)
Ans. The following are three broad categories of transactions recorded under capital account of BOP
a) Borrowings and lendings to and from abroad: all transactions relating to borrowings
from abroad by private sector and government sector are recorded on the credit side in
capital account.
All transactions of lending to abroad by private sector and government sector are recorded on
the debit side in capital account.
b) Investments to and from abroad: It includes:
Foreign direct investment (FDI): it refers to purchase of an asset, such that it gives direct control
to the purchaser over the asset. Example, purchase land.
Portfolio investment(FII): It refers to purchase of an asset, such that it does not give any direct
control over the asset to the purchaser. Example, purchase of shares.
Investments by rest of the world in India are recorded on the credit side in capital account.
Investment by Indian residents in abroad are recorded on the debit side in capital account.

c) Change in foreign exchange reserves: The foreign exchange reserves are the financial
assets of the government held in the central bank. Any withdrawal from the reserves is
recorded in the credit side and any addition to these reserves is recorded on the debit side in
capital account

3. Give the meaning of foreign exchange and foreign exchange rate. Giving reasons, explain the
relation between foreign exchange rate and demand for foreign exchange.
(All India 2012)
Ans. Foreign exchange refers to any foreign currency. Thus US dollars, British pounds are
foreign exchange for India. Foreign exchange rate is the price of one currency in terms of
another currency. It is the rate at which exports and imports of a country are valued during a
period of time.
There is an inverse relation between foreign exchange rate and demand for foreign exchange.
Higher the foreign exchange rate, lower the demand for foreign exchange and lower the foreign
exchange rate, higher the demand for foreign exchange,.

4. Give two sources of demand for foreign exchange. Giving reason, exchange. Giving reason
explain the relation between foreign exchange rate and supply of foreign exchange.
(Foreign 2012)
 Ans. Following are the main sources of demand for foreign exchange:
(a) To purchase goods and services from other countries by the domestic residents.
(b) To send gifts and grants to foreign countries (abroad).
(c) To invest and purchase financial assets in some other country.
(d) To speculate on the value of foreign currencies.
(e) To payments of international loans. (any two)
There is an direct relation between foreign exchange rate and supply of foreign exchange.
Higher the exchange rate. Higher the supply of foreign exchange and lower the exchange rate.
Lower the supply of foreign exchange.

5. Distinguish between ‘devaluation’ and ‘depreciation’ of domestic currency.

(All India 2018C)
Or
Explain by giving examples, the distinction between depreciation and devaluation of domestic
currency. (Foreign 2017)
Ans. ‘’Devaluation’’ of domestic currency is a phenomenon of the fixed exchange rate system,
because it is the government which decides when to change the existing exchange rate. Whereas
“Depreciation’’ of domestic currency is a phenomenon of the flexible exchange rate system.
Under this system. The exchange rate is determined by the free play of the forces of demand
and supply of foreign exchange in the foreign exchange market.

Practice

Short Answer Type Question

1.Giving reasons explain where charity to foreign countries is recorded in the Balance of
Payments Accounts? (Foreign 2015)
2.Where will sale of machinery to abroad be recorded in the Balance of Payments Accounts?
Give reasons? (Delhi 2015)
3. Explain why there is a rise in demand for foreign exchange when its price falls.
Or
Explain why there is an inverse relationship between price of foreign currency and its
demand.

Long Answer Type Questions

1. Explain the distinction between autonomous and accommodating transactions in
balance of payments. Also explain the concept of balance payments deficit in this
context. (Delhi 2012)
2. Differentiate between the concepts of ‘demand for domestic goods and services’ and
‘domestic demand for goods and services?
(Delhi 2020)

Answers
Short type Answer
Ans. 1 Charity to foreign countries is included in current account as debit item in the form of transfer
payment. It is included in current account as this outlaw of foreign currency is neither reducing liability
nor creating any asset of the country. Any outflow that neither affects the assets nor liabilities is a part
of current account in BoP.
Ans. 2 Sale of machinery to abroad is export of goods. As a result, it will be recorded in the current
account of the Balance of Payments Accounts it will be treated as credit item of the current account of
Balance of payments, as it brings in foreign exchange for the country.

Ans. 3 There is an inverse relation between foreign exchange rate and demand for foreign exchange.
Higher the foreign exchange rate, the lower the demand for foreign exchange and lower the foreign
exchange rate, higher the demand for foreign exchange. At a lower price of US dollar, India is ready to
buy more goods from USA. This raises the demand for US dollars. So. Lower the price of US dollar,
higher is the demand for US dollars and vice versa. Graphically, the demand curve of foreign exchange
is downward sloping signifying the inverse relation between foreign exchange rate and demand for
foreign exchange.

In the figure, at price OP, the demand for foreign exchange is OF. At a lower price OP 0. the demand is
OF1, i.e, higher. At a higher price OP1. Demand for foreign exchange is OF0 i.e, lower..

Long Answer
Ans. 1 A BoP transaction which is independent of all other BoP transactions is called an
Autonomous transaction whereas the BoP transaction which is undertaken to cover the deficit (or
surplus) in autonomous transaction is called an Accommodating transactions.
A deficit in the BoP takes place, when the autonomous inflow of foreign exchange is less than the
autonomous outflow, during the given year.
Now to cover the deficit in autonomous transactions, the BoP transactions which are undertaken are
called ‘Accommodating transactions’. For example. If the autonomous inflow of foreign exchange
is $2000 during the year, if while the total outflow of Foreign exchange is $ 2200. This implies that
there is a deficit to the amount of $200. To meet this deficit of $200, the country can resort to
borrowing from abroad. Such kind of borrowing is in the nature of an accommodating transaction,
because it is undertaken to cover the deficit in BoP account.

Ans. 2 Demand for domestic goods and services includes the total demand for goods and services from
within the domestic territory as well as outside the territory, i.e the total demand of goods and services
which is produced domestically, from people living within the domestic country as well as abroad.
On the other hand, domestic demand for goods and services includes only the demand for goods and
services from within the domestic country, i.e.it includes only the domestic demand of goods and
services by consumers living within the domestic territory.