(A) Identify, which of the following is not a source of supply of foreign exchange for India. (Choose the corr

Question 40 of 77

Q. (A) Identify, which of the following is not a source of supply of foreign exchange for India. (Choose the correct alternative)

(a) Exports of goods and services abroad

(b) Remittances by Indian workers working abroad

(d) Foreign Direct Investment (FDI) by a German automobile manufacturer

(OR)

(B) Read the items given in Columns I and II carefully and choose the correct pair of statements from the given alternatives. Column I : i. Export of software by an Indian company ; ii. Accommodating nature of transactions ; iii. Autonomous nature of transactions ; iv. Loan forwarded to Sri Lanka during its economic crisis | Column II : 1. Demand of foreign currency ; 2. Profit motive ; 3. Non-Profit motive ; 4. Supply of foreign exchange. Alternatives :

(a) i – 1

(b) ii – 2

(d) iv – 4

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Part (a)Concept understanding — Real Exchange Rate

The Real Exchange Rate: What Your Rupee Actually Buys

Think about this. You walk into a shop in Delhi and see a pair of sneakers for ₹4,000. Your cousin in New York sends you a photo of the same sneakers — they cost $80 there. Which is cheaper? You can't just compare ₹4,000 and $80. You need to convert one into the other using the exchange rate.

If 1 US dollar = ₹83, then $80 = ₹6,640. So the sneakers in Delhi (₹4,000) are cheaper. That's the nominal comparison — just using the market exchange rate.

But what if you're not comparing sneakers? What if you're comparing an entire haircut in India (₹200) versus a haircut in the US ($30)? At ₹83 per dollar, that $30 haircut equals ₹2,490. The Indian haircut is far cheaper. But does that mean everything in India is cheaper? Not exactly. Some things — like imported electronics or petrol — might cost more in India than abroad.

This is where the real exchange rate comes in. It answers a deeper question: After adjusting for the general price level in each country, how many Indian goods can you get for the price of one foreign good?

The Precise Meaning

The real exchange rate (RER) compares the purchasing power of two currencies within their own economies. It tells you the rate at which you can trade the goods and services of one country for those of another.

\text{Real Exchange Rate} = \frac{e \times P_f}{P_d}

Let's break this down with a concrete example.

Suppose India is the domestic country and the US is foreign. Let:

$e = 83$ (₹83 per $1)
$P_f = 100$ (a basket of US goods costs $100)
$P_d = 100$ (the same basket of Indian goods costs ₹100)

Then:

$\text{RER} = \frac{83 \times 100}{100} = 83$ …

Part (b)Concept understanding — Official Reserve Transactions

Let’s start with something you already know from everyday life.

Suppose you buy a phone from a shop in another country. You pay in dollars. The shopkeeper now has dollars, not rupees. If you are a country, and you buy more from the world than you sell to it, the world ends up holding your currency — or you end up paying them in foreign currency (like dollars). Either way, the country’s central bank (the RBI in India) has to step in to settle the difference. That stepping in is what Official Reserve Transactions are about.

The precise meaning

Official Reserve Transactions are the purchases or sales of foreign exchange (dollars, euros, gold, SDRs, etc.) by a country’s central bank to balance the Balance of Payments (BoP).

The BoP has two main accounts: the Current Account (trade in goods, services, and transfers) and the Capital Account (financial flows like loans, investments). These two accounts must always sum to zero — but in practice, they don’t automatically balance. The difference is covered by the central bank’s official reserve transactions.

\text{Current Account} + \text{Capital Account} + \text{Official Reserve Transactions} = 0

Or equivalently:

\text{Official Reserve Transactions} = -(\text{Current Account} + \text{Capital Account})

What each symbol means:

Current Account: net earnings from exports minus imports, plus net transfers.
Capital Account: net inflow of foreign investment minus outflow.
Official Reserve Transactions: the change in the central bank’s stock of foreign exchange reserves.

If the sum of current and capital accounts is positive (a surplus), the central bank buys foreign exchange (adds to reserves). If the sum is negative (a deficit), the central bank sells foreign exchange (draws down reserves).

Why it matters

Official reserve transactions are the shock absorber of the external sector. They prevent the rupee from crashing or soaring uncontrollably when there is a temporary mismatch between dollars coming in and going out.

Example: India runs a trade deficit (imports > exports). Foreign investors also pull money out. The combined deficit means more dollars are leaving than entering. Without intervention, the rupee would depreciate sharply. The RBI steps in, sells dollars from its reserves, and supplies the missing dollars — keeping the exchange rate stable.

Note

The NCERT textbook (Class 12, Macroeconomics, Chapter 6) states: “Official reserve transactions are the transactions that are undertaken by the monetary authority of a country to settle the deficit or surplus in the balance of payments.”

A word-picture to hold in mind

Imagine a weighing scale. On the left pan: all foreign exchange coming into India (exports, foreign investment, remittances). On the right pan: all foreign exchange leaving India (imports, foreign loans repaid, dividends sent abroad). The scale rarely balances perfectly.

The central bank stands next to the scale with a bucket of foreign exchange. If the left pan is heavier (surplus), the central bank adds weight to the right pan by buying dollars — that’s an increase in reserves. If the right pan is heavier (deficit), the central bank removes weight from the right pan by selling dollars — that’s a decrease in reserves.

The bucket itself is the Official Reserve Assets — and every time the central bank dips into it or adds to it, that’s an Official Reserve Transaction.

A common confusion (and how to avoid it) …

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Part (a): imports are an outflow → demand, not supply, of forex → option (c).

Part (b): the only correct match is (d) iv – 4 — forwarding a loan to Sri Lanka = India supplying foreign exchange.

Part (a): Which is not a source of supply of foreign exchange

Supply of foreign exchange arises when foreign currency flows into India; demand arises when it flows out.

(a) Exports of goods and services — foreigners pay India in foreign currency → inflow → supply.
(b) Remittances by Indian workers abroad — earnings sent home in foreign currency → inflow → supply.
(c) Imports of goods and services — India pays foreigners in foreign currency → outflow → demand for forex, not supply. …

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Same / Similar Concept — real previous-year questions on the same or a closely similar concept, not this exact question.

Showing the 12 most recent of 30 on this concept.

CBSE 2025Set 58/6/11 markMCQ
$Q. Read the following statements carefully : Statement 1 : The price of a given currency in terms of another is known as bank rate. Statement 2 : Demand curve for foreign exchange is a downward sloping curve. In the light of the given statements, choose the correct option from the following : (A) Statement 1 is true and Statement 2 is false. (B) Statement 1 is false and Statement 2 is true. (C) Both Statements 1 and 2 are true. (D) Both Statements 1 and 2 are false.$
›Reveal solutionSolution
Statement 1 incorrectly defines the exchange rate as the bank rate. Statement 2 correctly describes the inverse relationship between the exchange rate and the quantity demanded of foreign exchange.

Let's break down each statement to understand the underlying economic concepts.

Understanding Statement 1: The price of a given currency in terms of another is known as bank rate.

The "price of a given currency in terms of another" refers to how much one currency is worth when exchanged for another. This fundamental concept in international economics is known as the exchange rate. For instance, if one US dollar can be exchanged for ₹83, then ₹83 is the exchange rate for one US dollar in Indian rupees. It tells us how many units of the domestic currency are needed to buy one unit of a foreign currency, or vice versa.
$Exchange Rate: The price of one currency expressed in terms of another currency.$
On the other hand, the bank rate is a monetary policy tool used by the central bank of a country (like the Reserve Bank of India). It is the interest rate at which the central bank lends money to commercial banks without demanding any collateral. It influences the overall interest rate structure in the economy and is distinct from the exchange rate.

Since the statement incorrectly equates the exchange rate with the bank rate, Statement 1 is false.

Understanding Statement 2: Demand curve for foreign exchange is a downward sloping curve.

The demand for foreign exchange arises from various international transactions. For example, when residents of a country want to:

Import goods and services from abroad.

Travel to foreign countries (tourism).

Invest in foreign assets (e.g., buying foreign stocks or bonds).

Send remittances to relatives living abroad.

All these activities require converting domestic currency into foreign currency, thus creating a demand for foreign exchange.

Now, let's consider the relationship between the exchange rate and the quantity demanded of foreign exchange. Suppose the exchange rate is expressed as the price of foreign currency in terms of domestic currency (e.g., rupees per US dollar).

If the exchange rate falls (i.e., foreign currency becomes cheaper in terms of domestic currency), then:

Imports become cheaper for domestic consumers, leading to an increase in import demand.

Foreign travel becomes cheaper, encouraging more tourism abroad. …
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CBSE 2025Set MARCH1 markMCQ
$Q. The Price of one currency in terms of another currency is known as :$
(a) Balance of Trade
(b) Exchange rate
(c) Balance of Payment
(d) Export rate
›Reveal solutionSolution

The price of one currency in terms of another is the exchange rate — option (b).

…

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CBSE 2025Set ANNUAL1 markMCQ
$Q. Which one of the following is included in the item of Capital Account? (A) Government transaction (B) Private transaction (C) Foreign Direct Investment (D) All of these$
›Reveal solutionSolution

Government transactions, private transactions and FDI are all recorded in the capital account, so the answer is (D).

The capital account of the balance of payments records all transactions that change the country's foreign financial assets and liabilities — borrowings and lendings, investments and changes in reserves. This covers official (government) capital flows such as external loans, private capital flows such as portfolio investment and bank ca …

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CBSE 2025Set ANNUAL1 markMCQ
$Q. Which of the following does not come in Capital Account? (A) Government transaction (B) Direct investment (C) Unilateral transfer (D) None of these$
›Reveal solutionSolution

Unilateral transfers are current-account items, not capital account, so the answer is (C).

The capital account records transactions that create or discharge foreign assets and liabilities — government and private borrowings/lendings, and direct investment. Unilateral (or unrequited) transfers, such as gifts, remittances from workers abroad, and grants, involve no corresponding claim or repayment, so they are recorded in the current account, not the capital account. …

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CBSE 2025Set ANNUAL1 mark
$Q. What is meant by foreign exchange market?$
›Reveal solutionSolution

The foreign exchange market is where currencies are bought and sold against each other, determining the exchange rate.

In the RBSE/CBSE Class-12 open-economy chapter, the foreign exchange market is the market in which one country's currency is exchanged for another's (for example, rupees for dollars). It brings together the demand for and supply of foreign currencies arising from international trade, investment and other transactions.

…

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CBSE 2025Set ANNUAL1 markMCQ
$Q. Generally accepted at international level-$
(a) currency with unstable purchasing power
(b) currency with stable purchasing power
(c) only gold
(d) only barter system
(a) currency with unstable purchasing power
(b) currency with stable purchasing power
(c) only gold
(d) only barter system
›Reveal solutionSolution

A currency needs STABLE purchasing power to be generally accepted internationally.

For a currency to function as an internationally accepted medium of exchange (or reserve currency), other countries, central banks, and traders must be confident that it will retain a broadly stable value over time — a currency with unstable (rapidly eroding or fluctuating) purchasing power would quickly lose the trust needed for others to hold or accept it in international dealings, since its real value could change sharply before it is used or converted. 'Only gold' and 'only barter' describe older or theoretical …

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CBSE 2025Set ANNUAL1 mark
$Q. What is foreign exchange?$
›Reveal solutionSolution

Foreign exchange = all foreign currencies (and claims on them) used for cross-border payments.

Foreign exchange refers to currencies of other countries (and near-money claims denominated in those currencies, such as foreign bank balances, bills of exchange and drafts) that a country's residents need in order to make payments to residents of other countries — for example, to pay for imports, to repay foreign loans, or to invest abroad. It is managed/held by a country's central bank (in India, the RBI) as foreign exchange reserves, and its market price in terms of the domestic currency is the exchange rate. Foreign exchange is essential because inter …

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CBSE 2025Set ANNUAL1 markMCQ
$Q. Mr. Vijay, an Indian has invested ₹ 5 lakh in the shares of multinational company in rest of the world then such transaction is referred as ______ .$
(a) Foreign direct investment
(b) Portfolio investment
(c) Commercial borrowing
(d) Domestic investment
›Reveal solutionSolution
Buying shares of a foreign company as a financial investment, without management control, is classified as portfolio investment in the Balance of Payments capital account.

The capital account of the Balance of Payments records international transactions in financial assets, including cross-border investment, which is classified as:

Foreign Direct Investment (FDI): investment made in a foreign enterprise with the intention of acquiring a LASTING interest and a significant degree of MANAGEMENT CONTROL/influence over the enterprise (e.g., setting up a subsidiary, or buying a controlling stake).

Portfolio investment: investment in foreign financial assets (shares, bonds, securities) made PURELY for financial return (dividends, capital gains, interest), WITHOUT seeking any management control over the foreign enterprise — the investor is a passive shareholder. …
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CBSE 2025Set ANNUAL1 mark
$Q. Fill in the blank with the correct answer : When the net balance of all receipts and all payments is positive, it is a ________.$
›Reveal solutionSolution
A positive net balance of all international receipts and payments is a BoP surplus — the country earns more foreign exchange than it spends, and its reserves rise.

Autonomous transactions (normal trade and capital flows, undertaken for their own economic reasons) are compared: total receipts vs. total payments.

If receipts > payments, the net balance is positive — this is a surplus / favourable BoP, and it typically results in an addition to the country's official foreign exchange reserves (an Official Reserve Transaction of accumulation). …
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CBSE 2024Set 58/1/11 markMCQ
$Q. Surplus in Balance of Payments (BOP) refers to the excess of ________. (Choose the correct alternative to fill in the blank) (A) Autonomous payments over Autonomous receipts (B) Current Account payments over Autonomous receipts (C) Capital Account receipts over Capital Account payments (D) Autonomous receipts over Autonomous payments$
›Reveal solutionSolution

A surplus in the Balance of Payments means the country is receiving more foreign exchange through autonomous (market-driven) transactions than it is spending — the correct fill-in is Autonomous receipts over Autonomous payments.

The key to this question lies in understanding what the Balance of Payments (BOP) actually measures and, more importantly, what "surplus" means in that context.

The BOP is a record of all economic transactions between residents of a country and the rest of the world over a period. These transactions are divided into two broad categories: the Current Account (trade in goods and services, income, and transfers) and the Capital Account (financial flows like loans, investments, and changes in reserves). But there is a deeper, more useful classification: Autonomous versus Accommodating transactions.

Autonomous transactions are undertaken for their own sake — profit, utility, or business reasons. They are independent of the BOP situation. Think of an exporter selling goods, a foreign company investing in a factory, or a tourist spending abroad. These are the "real" economic flows. Accommodating transactions, on the other hand, are undertaken to finance any gap left by autonomous transactions. They are the "balancing item" — the official reserve transactions that the central bank (like the RBI) undertakes to settle the difference.

Now, a surplus in the BOP means that the total foreign exchange inflow from autonomous transactions exceeds the total outflow from autonomous transactions. The country is earning more than it is spending on its own accord. This surplus is then reflected as an increase in the country's official foreign exchange reserves (an accommodating transaction). A deficit is the opposite: autonomous payments exceed autonomous receipts, leading to a decrease in reserves.

Watch out

A common mistake is to think of a BOP surplus as simply a surplus on the Current Account or Capital Account individually. The BOP surplus is the overall surplus from all autonomous transactions combined. A country could have a Current Account deficit but a larger Capital Account surplus, resulting in an overall BOP surplus. …

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CBSE 2024Set 58/3/11 markMCQ
$Q. According to the Reserve Bank of India's (RBI's) Statistical Supplement released on 19th May, 2023 : "India's foreign exchange reserves grew for the third straight week and reached near an approximate level of $ 600 billion." The above situation will __________ the __________ side of Balance of Payments account of India. (Choose the correct alternative to fill in the blanks) (A) Increase, Credit (B) Decrease, Credit (C) Decrease, Debit (D) Increase, Debit$
›Reveal solutionSolution
An increase in a country's foreign exchange reserves is recorded on the debit side of the Balance of Payments (it is an acquisition of foreign reserve assets by the RBI). Since reserves grew, the situation will increase the debit side. The correct fill-in is Increase, Debit — option (D).

Let us first understand what the Balance of Payments (BoP) records. The BoP is a systematic statement of all economic transactions between residents of India and the rest of the world during a given period. Every transaction is entered as either a credit (a receipt of foreign exchange — e.g. exports, capital inflows) or a debit (a payment/use of foreign exchange — e.g. imports, capital outflows).

Now consider foreign exchange reserves. These are official reserve assets — foreign currency, gold, SDRs — held by the RBI, and a change in them is the balancing/financing item of the BoP. The recording convention is:

An increase in foreign exchange reserves means the RBI has acquired foreign assets (bought foreign currency). Acquiring a foreign asset is a use/outflow of foreign exchange, so it is recorded on the debit side (with a negative sign).

A decrease in reserves means the RBI has drawn down or sold foreign assets, bringing foreign exchange in — recorded on the credit side. …
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CBSE 2024Set ANNUAL1 markMCQ
$Q. Foreign exchange rate is determined by (A) Demand of foreign currency (B) Supply of foreign currency (C) Demand and supply in Foreign Exchange market (D) None of these$
›Reveal solutionSolution

The flexible foreign exchange rate is set where demand for and supply of foreign exchange meet, so the answer is (C).

In the BSEB Inter / Class-12 Economics open-economy unit, the exchange rate is the price of one currency in terms of another. Under a flexible/floating system it is determined in the foreign exchange market by the interaction of the demand for foreign currency (for imports, foreign travel, investment abroad) and the supply of foreign currency (from exports, foreign investment inflows, remittances).

…

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Q.(A) Identify, which of the following is not a source of supply of foreign exchange for India. (Choose the correct alternative)

Part (a): Which is not a source of supply of foreign exchange

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