Macro

Balance of Payments

Easy

Comprehension:

THE FOREIGN EXCHANGE MARKET

The market in which national currencies are traded with one another is known as the foreign exchange market. The major participants in the foreign exchange market are commercial banks, foreign exchange brokers and other authorized dealers and monetary authorities. It is important to note that although participants themselves may have their own trading centers, the market itself is world-wide. There is close and continuous contact between the trading centers and the participants deal in more than one market.

Foreign currency flows into the home country for the following reasons: exports by a country lead to the purchase of its domestic goods and services by foreigners; foreigners send gifts or make transfers; and, the assets of a home country are bought by foreigners. A rise in the price of foreign exchange will reduce foreigners’ costs while purchasing products from India and other things will remain constant. This increases India’s exports and hence the supply of foreign exchange may increase.

Different countries have different methods of determining their currency’s exchange rate. It can be determined through Flexible Exchange Rate, Fixed Exchange Rate or Managed Floating Exchange Rate. Floating exchange rate is determined by the market forces of demand and supply. Where fixed exchange rate is determined by the government at a particular level. In floating exchange rate increasing value of currency is known as appreciation and a decreasing value is known as devaluation where in fix exchange rate decreased value is known as devaluation. Managed floating exchange rate is combination of flexible and fixed exchange rate where at certain movement central intervene through market operation to manage currency exchange rate.

In an economy, to control a high balance of payment problem if government decided to reduce its currency value against globally accepted foreign currency, this process this known as:

Appreciation of Domestic currency.

Depreciation of Domestic currency.

Dirty Floating.

Devaluation of Domestic Currency.

✅ Correct Option: 4

Option 1 -> Appreciation means increase in currency value, which worsens balance of payments.

Option 2 -> Depreciation is market-driven decline in currency value in floating exchange rate systems.

Option 3 -> Dirty Floating is a system where exchange rates float with occasional government intervention.

Option 4 -> Devaluation is deliberate government action to reduce currency value under fixed/pegged exchange rate system.

Hence, Devaluation of Domestic Currency -> When a government officially decides to reduce the value of its domestic currency against foreign currencies, it is called devaluation. This is a deliberate policy tool used in fixed or pegged exchange rate systems to correct balance of payments deficits. Devaluation makes exports cheaper and imports expensive, improving trade balance. The key difference from depreciation is that devaluation is an official government decision, while depreciation is market-driven in floating exchange systems -> correct

Question 46

An increase in exchange rate implies that the price of foreign currency in terms of domestic currency has increased; this is called ........

Question 47

When the central bank intervenes to control the exchange rate through sell/purchase of foreign currencies, this process is called______

Question 49

When income increases and due to increase in income the demand for foreign goods increases then in this scenario what impact does economy face on foreign exchange rate ?

Question 50

The place where currencies are traded is known as .........

In an economy, to control a high balance of payment problem if government decided to reduce its currency value against globally accepted foreign currency, this process this known as:

Solution

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