Question

Read the passage below and answer the questions that follow.

India’s Balance of Payments (BOP) encountered pressure during 2022-23. While the impact of sharp rise in prices led to widening of the Current Account Deficit (CAD), notwithstanding the cushion provided by the surplus in the invisibles (services, transfers and income). Monetary Policy lightening of the US Federal Reserve and strengthening of the US dollar led to Foreign Portfolio Investment outflow. As a result, the surplus of Capital Account was lower than the CAD, leading to depletion of foreign exchange reserves. Over time, trade opening of countries across globe has been increasing as measured by trade as a proportion of GDP. For India as well, the share of trade as percentage of GDP has been steadily increasing, which stood at 46% in 2021. India maintained its domination in the world services during 2022-23 recording a growth of 23.5 per cent during 2021-22. The exchange rate of the Indian Rupee is market-determined as the RBI's intervention in the foreign exchange market is mainly to contain instances of economic volatility. The Indian Rupee depreciated by 10.8 per cent in 2022. (Economic Survey 2022-23)

1. What is current account deficit?  [1]
2. What is meant by balance of capital account?  [1]
3. Define rate of foreign exchange.  [1]
4. What exchange rate system prevails in India?  [2]
5. Distinguish between depreciation and devaluation of currency.  [2]
6. State the trend in India’s foreign trade as percentage of GDP.  [1]

Answer 1

1. A current account deficit (CAD) arises when total current account payments imports of goods and services, income payments and unilateral transfer payments exceed total current account receipts (exports of goods and services, income receipts and transfer receipts). In other words, it is a negative balance of the current account.
2. Balance of capital account is the difference between inflow and outflow of capital. It records international transactions relating to changes in assets and liabilities, borrowing and lending from abroad, sale and purchase of assets, and movements of gold and foreign exchange reserves.
3. Rate of foreign exchange is the rate at which the currency of one country is exchanged for the currency of another country; it is the price of one currency expressed in terms of another currency.
4. India follows a flexible (managed floating) exchange rate system. The exchange rate of the rupee is market-determined by the demand for and supply of foreign exchange, and the RBI intervenes in the foreign exchange market mainly to contain excessive volatility.

5. Basis of Difference	Depreciation	Devaluation
   Meaning	Fall in the free-market value of domestic currency in terms of foreign currency.	Deliberate official reduction in the value of domestic currency.
   Exchange rate system	Occurs under flexible exchange rate system.	Occurs under fixed exchange rate system.
   Cause	Caused by market forces of demand and supply of foreign exchange.	Caused by government/central bank policy decision.
   Initiative	Automatic market adjustment.	Official action by the central bank.
   Example	Rise from ₹75 per dollar to ₹80 per dollar due to market forces.	Same rise in the rupee cost of a dollar, but by official decree under fixed rates.

6. India’s foreign trade as a percentage of GDP has been steadily increasing; it stood at 46% in 2021.