Test: Balance of Payments -2 - UGC NET MCQ

• A floating exchange rate is a regime where the currency price of a nation is set by the forex market based on supply and demand relative to other currencies.
• It is determined by market forces of demand and supply.
• It is in contrast to a fixed exchange rate.
• In  fixed exchange a currency is pegged or held at the same value relative to another currency.

Assertion Correctness: The assertion is correct as the BOP is indeed significant for evaluating a country's economic stability and financial health.

Reason Correctness: The reason is partially correct. While tracking imports and exports is a part of BOP data, the reason does not fully explain the assertion.

Explanation: The BOP encompasses not only trade data but also factors like foreign aid, investment insights, risk assessment, and more. While the Reason touches on a component of the BOP, it doesn't fully explain its multifaceted nature.

The correct answer is 1 and 3.

• The balance of payment is a record of all monetary transactions made between the residents of one country and the rest of the world.
• A balance of payments deficit means the nation imports are more than it exports.
• The two components of the Balance of Payments are the current account and capital account.
• The current account includes trade in goods and services (Invisibles) and transfer payments etc.
• The capital account includes Foreign Direct Investment, Foreign Portfolio Investment, External Commercial Borrowings, SDR.
• The capital account records all international purchases and sales of assets such as money, stocks, bonds, etc. 

• Assertion is correct as Country A indeed has a trade surplus of $20 billion.
• Reason is also correct as it is a general definition of trade surplus.
• However, the Reason is not the correct explanation of the Assertion in this case because having a trade surplus doesn't necessarily mean that the country exports more than it imports. It signifies that the value of exports exceeds the value of imports, not necessarily the quantity.

The correct answer is option 2, Both A and B. Tariffs and quotas are both trade barriers that restrict imports and protect domestic producers from foreign competition. Tariffs are taxes imposed on imported goods, while quotas limit the amount of a specific product that can be imported. Both measures increase the price of foreign goods, making domestic products more competitive.

The correct answer is  19 August 1994.

Currency convertibility

• It refers to the freedom to convert the domestic currency into other internationally accepted currencies and vice versa at the market-determined exchange rate.
• It gives freedom to convert domestic currency into foreign currency and vice versa to execute a trade in goods and Invisibles.

Important Points

• Introduction of full current account convertibility in Indi
• ​The current account is today fully convertible which was operationalized on August 19, 1994.
• A  series of measures were launched then to liberalize exchange controls and the exchange rate system was shifted to market-determined exchange rates in March 1993.
• After that, on August 20, 1993, the RBI announced that the rupee became fully convertible on the current account.
• This was after India accepted the status and obligations of Article VIII with the IMF.

• Assertion: The assertion is true. When a country imports more than it exports, it runs a deficit. This deficit can indeed be covered by selling assets or borrowing money.
• Reason: The reason is true. By trading long-term wealth for short-term goods, a country can receive money from abroad, which contributes to balancing the BOP.
• Explanation: The reason is the correct explanation of the assertion because selling assets or borrowing money to cover a trade deficit involves receiving money from abroad, which helps balance the BOP.

Key Points

• Trade deficit is a term used to describe a situation where the value of a country’s export of goods is less than import of goods during a given period.
• It is also referred to as a negative balance of trade (BOT).
• The balance can be calculated on different categories of transactions: goods, services, goods and services.
• Trade deficits can have advantages and disadvantages depending on impacts on production, jobs, national security, and how they are financed.

The Impact of Trade Deficit

• Initially, a trade deficit can enhance the standard of living as it offers residents access to a wider variety of products.
• If a trade deficit continues for an extended period, the government may need to source more foreign exchange to bridge the gap, leading to the depreciation of the local currency.
• A significant trade deficit necessitates finding foreign investors to help reduce the import-export gap.
• A high trade deficit can lead to job outsourcing to foreign countries as more imports reduce job opportunities locally.
• The demand for imported goods can cause a decline in demand for local products, leading to factory closures and job losses.

Benefits of Trade Deficit
A trade deficit does come with some advantages, including:

• It allows a country to consume more than its production capacity.
• It helps nations to avoid any shortage in goods.
• Trade deficit provides countries with a comparative advantage, increasing global wealth.
• It can lead to increased foreign direct investment.

•  "expands," is the correct answer because exporting manufactured goods can lead to increased trade and commerce.
• By exporting goods, a company can expand its customer base beyond its domestic market, leading to increased sales and revenue.
•  "reduces," is incorrect because exporting goods typically leads to increased trade and commerce, not a reduction.
•  "contracts," is also incorrect for the same reason as option 1.
• "weakens," is not a direct result of exporting manufactured goods and is therefore incorrect.
•  The keyword "manufactured goods" refers to products that have been processed or transformed from raw materials into finished products. This can include anything from electronics to clothing to furniture.

Assertion Correctness: The assertion is accurate as the BOP does play a role in influencing a country's currency stability.

Reason Correctness: The reason is also correct as BOP data is used by central banks to design effective monetary policies.

Explanation: While both the Assertion and Reason are true, they are not directly related. The BOP's impact on currency stability is more about managing exchange rates, while its role in monetary policy formulation is about broader economic management rather than currency stability specifically.