Question

Recently Government of India has doubled the import duty on gold. What impact is it likely to have on foreign exchange rate and how?

Answer 1

An increase in import duty will lead to a fall in the import of gold. This will control the demand and hence there is decline in the demand for foreign exchange. Assuming other things remain constant, a decline in the demand for foreign exchange will reduce the foreign exchange rate. Hence, this is reflected by a shift in the demand curve to the left as shown below.

DD and SS are the initial demand and supply curves of foreign currency, respectively. As there is a decline in the demand for foreign exchange rate, the new equilibrium is established at Point E′. Here, it states that the currency appreciates with a fall in the exchange rate from OR to OR₁