Question

Read the passage below and answer the questions that follow.

Economic crises in Sri Lanka in June and July 2020 arose from years of high fiscal deficits, translating into high current account deficits, empty foreign exchange reserves and hence soaring inflation and debt default. This holds lessons for India. At the present juncture (July, 2022) India has a high combined fiscal deficit of 11 percent for the center and the states. The current account deficit is likely to be 3 percent of GDP. Consumer inflation is 7 percent, and wholesale price inflation is 15 percent. We need to overcome this situation so as to avoid a likely economic crisis.

1. What is meant by foreign exchange?    [1]
2. What is balance of current account?     [2]
3. Define depreciation of rupee.     [1]
4. What is public debt. State two adverse effects?     [2]
5. Distinguish between demand-pull inflation and cost-push inflation.    [2]

Answer 1

1. Foreign currencies like American dollars, British pounds, etc. and claims on them in the form of bank deposits, cheques, etc. payable in those currencies, are known as foreign exchange.
2. The balance of the current account records the receipts and payments of a country arising from exports and imports of visible (goods), invisible (services), factor incomes and unilateral transfers (like gifts) during a year. It is a measure of all receipts and payments made for currently produced goods and services plus non-traded flow of funds comprising factor income from abroad and international transfer payments. The balance of the current account need not be equal; it can show a surplus or deficit.
3. Depreciation of the rupee refers to a fall in the value of the Indian rupee relative to foreign currencies in a flexible exchange rate system. This means more rupees are needed to buy a unit of foreign currency, such as the US dollar.
4. Public debt refers to the debt which the government owes to its subjects or to the nationals of other countries.
   Two adverse effects of public debt are:
   1. The government may sometimes indulge in reckless borrowing. This imposes a heavy burden of interest payments on future generations.
   2. Foreign loans lead to a constant drain of wealth out of the country, particularly when loans are taken for unproductive purposes. It may lead to the problem of 'debt trap'.

5. Demand-Pull Inflation	Cost-Push Inflation
   When the aggregate demand increases at a faster rate than aggregate supply, it is known as demand-pull inflation.	When there is an increase in the price of inputs, resulting in a decrease in the supply of outputs, it is known as cost-push inflation.
   Monetary and real factors.	Monopolistic groups of the society.
   Monetary and fiscal measures.	Administrative control on price rise and income policy.