(a) "The central bank needs to intervene under the managed floating system." Do you agree with the given state

Question 45 of 77

Q. (a) "The central bank needs to intervene under the managed floating system." Do you agree with the given statement? Support your answer with valid reasons.

(OR)

(b) Differentiate between Surplus in Balance of Trade and Current Account Surplus.

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Part (a)Concept understanding — Managed Floating System

You’ve probably seen this on the news: “The rupee fell today against the dollar.” Or maybe you’ve heard that the government sometimes “intervenes” to stop the rupee from falling too much. That tug-of-war — between letting the market decide the exchange rate and the central bank stepping in — is exactly what a managed floating system is about.

The everyday intuition

Imagine a fruit market where the price of mangoes is usually set by how many people want to buy and how many are available. That’s a free market. But suppose one day, a sudden rumor makes everyone panic and prices crash. The market regulator might step in and buy a bunch of mangoes to stop the price from falling too low. That’s intervention.

Now imagine the opposite: the regulator never touches the price at all, no matter what. That’s a pure floating system. A managed floating system sits in between — the price is mostly decided by demand and supply, but the central bank (in India, the RBI) occasionally steps in to smooth out extreme swings.

The precise meaning

In a managed floating exchange rate system (also called a dirty float), the exchange rate is primarily determined by market forces — the demand for and supply of foreign currency. But the central bank does not stay completely aloof. It buys or sells foreign currency to prevent the exchange rate from moving too sharply in either direction.

The NCERT Class-12 Macroeconomics textbook (Chapter 6, Open Economy Macroeconomics) puts it clearly: under this system, the central bank intervenes actively in the foreign exchange market without any fixed target for the exchange rate. The goal is not to defend a particular level, but to manage volatility.

Note

The word “managed” is key: the central bank manages the pace of change, not the level of the exchange rate. It’s like a parent letting a child ride a bicycle but holding the seat to prevent a fall — not steering, just steadying.

Why it matters

A pure floating system can be brutal. If a country’s exports suddenly fall, its currency can depreciate sharply, making imports expensive and fueling inflation. A pure fixed system, on the other hand, requires the central bank to constantly defend a target rate, which can drain its foreign exchange reserves.

The managed float gives the central bank the best of both worlds: it lets the market do most of the work (so the exchange rate reflects economic fundamentals), but it can step in to prevent disorderly movements — like a sudden panic or speculative attack.

Watch out

A common mistake is to think that “managed” means the central bank sets the rate. It does not. The rate is still market-determined; the central bank only leans against the wind — buying when the rupee is falling too fast, selling when it is rising too fast.

How it works in practice (a word-picture) …

Part (b)Concept understanding — Current Account Deficit

The Current Account Deficit: Spending More Than You Earn, But With a Country

Think of your monthly allowance. If you spend ₹2,000 but only earn ₹1,500, you have a deficit of ₹500. You cover that gap by borrowing from a friend or dipping into savings. A country does the same thing on a massive scale — that's the Current Account Deficit (CAD).

The Everyday Intuition

A country's current account is like its income-and-expenditure diary with the rest of the world. It records three main things:

Goods (exports and imports of physical items — phones, wheat, oil)
Services (IT exports, tourism, shipping)
Transfers (money sent home by workers abroad, foreign aid)

When the total money flowing out for imports, services, and transfers exceeds the money flowing in from exports, services, and transfers, you have a deficit. The country is a net borrower from the world.

Note

A deficit is not automatically "bad." It means the country is consuming or investing more than it produces — which can be fine if the borrowed money goes into productive assets (factories, roads) that generate future income.

The Precise Definition (NCERT Style)

The current account is part of the Balance of Payments (BoP) — the record of all economic transactions between residents of a country and the rest of the world.

\text{Current Account Balance} = (X - M) + (X_{\text{services}} - M_{\text{services}}) + \text{Net Transfers} + \text{Net Income}

Where:

$X$ = Exports of goods
$M$ = Imports of goods
$X_{\text{services}}$ = Exports of services (e.g., Indian IT firms selling software to the US)
$M_{\text{services}}$ = Imports of services (e.g., Indians using Netflix)
Net Transfers = Money received from abroad minus money sent abroad (e.g., remittances from Indians working in the Gulf)
Net Income = Earnings from investments abroad minus payments to foreign investors (e.g., dividends paid to a Japanese company that owns a factory in India)

If this total is negative, the country has a Current Account Deficit.

Why It Matters (The "So What?")

A CAD must be financed. How? By borrowing from abroad or selling assets to foreigners. This shows up on the other side of the BoP — the Capital Account. If a country runs a CAD of $50 billion, it must attract$ 50 billion of foreign investment (FDI, FII, loans) to balance the books.

Three things to watch:

Sustainability — A small CAD (say 2-3% of GDP) is normal for a growing economy like India. A large, persistent CAD (5%+ of GDP) signals trouble: the country is living beyond its means and may struggle to repay.
Currency pressure — To finance a CAD, the country needs foreign currency (dollars). High demand for dollars can weaken the rupee. A weaker rupee makes imports costlier (inflation) but helps exports.
The J-Curve effect — When the rupee depreciates, the trade deficit often worsens initially before improving. Why? Imports are priced in dollars and become more expensive in rupees immediately, while export volumes take time to respond. The graph of the trade balance over time looks like a "J" — dipping first, then rising. …

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Part (a): Yes — under a managed float the central bank must intervene (buying/selling foreign exchange) to prevent excessive volatility, though the rate stays largely market-determined.

Part (b): A BOT surplus covers only goods; a current account surplus covers goods + services + income + transfers, so it is the broader measure.

Part (a)

A managed floating system ("dirty float") sits between a fixed peg and a clean float: the exchange rate is set mainly by the market forces of demand and supply, but the central bank reserves the right to step in when movements become sharp and destabilising.

Do I agree that intervention is needed? Yes. Currency markets can overshoot — a speculative attack or herd behaviour can push the rate far from its fundamental value, disrupting importers, exporters and the wider economy. The central bank therefore intervenes selectively:

If the domestic currency is depreciating too fast, it sells foreign exchange from its reserves, increasing supply of foreign currency and easing the fall.
If the currency is appreciating too much (hurting exports), it buys foreign exchange, adding to reserves and moderating the rise. …

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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 67 on this concept.

CBSE 2026Set 58/1/11 markMCQ
$Q. Read the following statements : Assertion (A) and Reason (R). Choose the correct option from those given below : Assertion (A) : Unilateral Transfers are recorded in the Current Account of the Balance of Payments (BoP) of a nation. Reason (R) : Capital account records transactions which cause a change in the assets or liabilities of the country. Options : (A) Both Assertion (A) and Reason (R) are true, and Reason (R) is the correct explanation of Assertion (A). (B) Both Assertion (A) and Reason (R) are true, but Reason (R) is not the correct explanation of Assertion (A). (C) Assertion (A) is true, but Reason (R) is false. (D) Assertion (A) is false, but Reason (R) is true.$
›Reveal solutionSolution

Both the Assertion (A) and the Reason (R) are true statements regarding the Balance of Payments. However, the Reason (R) defines the Capital Account and does not explain why Unilateral Transfers are recorded in the Current Account.

The Balance of Payments (BoP) is a comprehensive record of all economic transactions between the residents of a country and the rest of the world over a specific period, typically a year. It is divided into two main accounts: the Current Account and the Capital Account. Understanding what each account records is crucial for analyzing a nation's international economic position.

Let's examine Assertion (A): Unilateral Transfers are recorded in the Current Account of the Balance of Payments (BoP) of a nation.

Unilateral transfers are one-sided transactions, meaning they involve no quid pro quo (no return payment or obligation). These include gifts, remittances (money sent by residents working abroad to their home country), grants, and donations. Since these transfers do not create any future claims or liabilities, they are considered current transactions. The Current Account records the flow of goods, services, income, and these unilateral transfers. Therefore, Assertion (A) is true.

Now, let's look at Reason (R): Capital account records transactions which cause a change in the assets or liabilities of the country.

The Capital Account records all international transactions that involve a resident country's assets or liabilities. These transactions create future claims or obligations. Examples include foreign direct investment (FDI), foreign institutional investment (FII), external commercial borrowings (ECBs), loans from international financial institutions, and changes in foreign exchange reserves. When a country borrows from abroad, its liabilities increase; when it invests abroad, its assets increase. These are capital transactions. Therefore, Reason (R) is also true. …
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CBSE 2026Set 58/2/11 markMCQ
$Q. Read the following statements carefully : Statement 1 : Under the flexible exchange rate system, a deficit / surplus in the Balance of Payments is automatically corrected. Statement 2 : Under the flexible exchange rate system, there is always a possibility of over/under valuation of currency. In the light of the above given statements, choose the correct option from the following : (A) Statement 1 is true and Statement 2 is false. (B) Statement 1 is false and Statement 2 is true. (C) Both Statements 1 and 2 are true. (D) Both Statements 1 and 2 are false.$
›Reveal solutionSolution

Under a flexible exchange rate system the BoP is automatically corrected through market-driven currency adjustments, so Statement 1 is true. But over-/under-valuation of a currency is a feature of a fixed exchange rate system, not a flexible one, so Statement 2 is false. The correct option is (A).

A flexible (floating) exchange rate system is one in which the value of the currency is determined by the market forces of demand and supply of foreign exchange, without the government or central bank fixing or defending a particular rate.

Statement 1 — automatic correction of the BoP (TRUE)

This is the celebrated advantage of flexible exchange rates. Suppose India runs a current-account deficit: it imports more than it exports, so demand for foreign currency (say dollars) exceeds its supply. In a flexible system this excess demand raises the price of the dollar in rupee terms — the rupee depreciates. A cheaper rupee makes Indian exports more competitive abroad and imports dearer at home, so over time exports rise, imports fall, and the deficit shrinks. A surplus triggers the reverse (appreciation). The price mechanism does the adjusting, so Statement 1 is true.

Note

This self-correcting property is precisely why flexible rates reduce the need for a country to hold large foreign-exchange reserves to defend a parity.

Statement 2 — over-/under-valuation of currency (FALSE)

Over-valuation and under-valuation describe a situation where a currency's official value differs from its equilibrium (market-clearing) value. This can happen only when someone sets the rate — i.e. under a fixed or managed exchange rate system, where the central bank pegs the currency above equilibrium (over-valued) or below it (under-valued). …
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CBSE 2026Set 58/3/11 markMCQ
$Q. Read the following statements carefully : Statement I : Trade in services includes both factor income and non-factor income transactions. Statement II : Current Account includes transactions related to goods, services and unilateral transfers. In the light of the given statements, choose the correct option from the following : (A) Statement I is true and Statement II is false. (B) Statement I is false and Statement II is true. (C) Both Statements I and II are true. (D) Both Statements I and II are false.$
›Reveal solutionSolution

Statement I is false because trade in services covers only non-factor income, while Statement II is true as the current account includes goods, services, and unilateral transfers.

To understand why, we need to step back and look at how a country’s balance of payments is structured. The balance of payments is a systematic record of all economic transactions between residents of a country and the rest of the world during a given period. It has two main accounts: the current account and the capital account.

The current account records transactions that arise from the exchange of goods, services, and unilateral transfers. Goods are tangible items like machinery or rice. Services are intangible — think of tourism, shipping, or consulting. Unilateral transfers are one-way payments, such as remittances from workers abroad or foreign aid. So Statement II is spot on: the current account does indeed include goods, services, and unilateral transfers. That part is correct.

Now, Statement I talks about “trade in services.” In the NCERT framework, trade in services is a subset of the current account. But here’s the crucial distinction: services in the current account are only those that are non-factor in nature. What does that mean? Factor income refers to earnings from factors of production — primarily labour and capital. For example, interest earned on foreign bonds or dividends from shares abroad is factor income. These are recorded under a separate head called “income” in the current account, not under “services.” Services in the trade account are strictly non-factor services — like travel, insurance, or software development.

Important

Trade in services in the current account excludes factor income. Factor income (like interest, dividends, and profits) is recorded separately under “income” in the current account, not under “services.” …

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CBSE 2026Set MARCH1 markMCQ
$Q. Which one of the following is not a component of current account of balance of payments?$
(a) Investment
(b) Trade in goods
(c) Trade in services
(d) Transfer payments
›Reveal solutionSolution

Investment is a capital-account item, not part of the current account, so the answer is (a).

…

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CBSE 2026Set ANNUAL1 markMCQ
$Q. Which of the following included in the invisible item? A) Non-factor services B) Income C) Transfers D) All of the above$
›Reveal solutionSolution

Invisibles include non-factor services, income and transfers alike, so the answer is D.

In the current account of the balance of payments, 'invisibles' are transactions that do not involve trade in physical goods. They comprise: (i) non-factor services such as shipping, banking and software; (ii) factor income such as interest, profit and dividends; and (iii) current transfers such as remittances and gifts. Since all thre …

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CBSE 2026Set ANNUAL1 markMCQ
$Q. Which of the following is an example of trade barriers? A) Subsidies B) Circular flow C) Tariffs D) Forex rate$
›Reveal solutionSolution

Tariffs are a trade barrier, so the answer is C.

Trade barriers are government-imposed restrictions on the free flow of goods between countries. A tariff is a tax levied on imported goods, which raises their price and discourages imports — a textbook trade barrier (along with quotas). Subsidies are financial assistance, the circular flow is a model of inco …

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CBSE 2026Set ANNUAL1 mark
$Q. Fill in the blank: ________ account records all international transactions of assets.$
›Reveal solutionSolution

The blank is filled by 'Capital' (capital account).

The balance of payments has two main accounts. The current account records trade in goods, services, income and transfers, while the capital account records all international transactions in assets — such as loans, investments (FDI/FII), banking capital and changes in foreign-exchange reserve …

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CBSE 2026Set ANNUAL1 mark
$Q. When does a surplus situations occur in the balance of trade?$
›Reveal solutionSolution

A balance-of-trade surplus occurs when exports of goods exceed imports of goods.

The balance of trade (BOT) is the difference between the value of a country's exports of goods (merchandise) and its imports of goods. A surplus (favourable balance of trade) arises when the value of exports is greater than the value of imports, so BOT is positive. If imports exceed exports, the balance of trade is in deficit. (Note: the balance of trade …

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CBSE 2026Set ANNUAL1 markMCQ
$Q. Balance of trade equals$
(a) Exports less imports
(b) Exports of goods less imports of goods
(c) Exports of services less imports of services
(d) None of these
›Reveal solutionSolution

Balance of trade = exports of goods − imports of goods (visible items only), so the answer is (b).

The balance of trade (also called the balance of visible trade) records only the export and import of goods (visible, tangible items). It is the difference between the value of a country's exports of goods and its imports of goods. If exports of goods exceed imports of goods, there is a trade surplus; if imports exceed exports, a trade deficit. (Services are invisible ite …

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CBSE 2026Set ANNUAL1 markMCQ
$Q. The component(s) of a Balance of Payment is/are :$
(a) Current Account
(b) Capital Account
(c) Both
(i) and
(ii)
(d) None of these
(a) Current Account
(b) Capital Account
(c) Both
(i) and
(ii)
(d) None of these
›Reveal solutionSolution

BOP has both a Current Account and a Capital Account — not either one alone.

The Balance of Payments is a comprehensive statement, and it is split into: (i) the Current Account, which records trade in goods (visible items/Balance of Trade), trade in services (invisible items), and income plus unilateral transfer flows (interest, profit, dividends, remittances, gifts); and (ii) the Capital Account, which records transactions involving assets and liabilities — foreign direct investment, portfolio investment, external borrowing/lending, and changes in the country's foreign exchange reserves. Both accounts toge …

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CBSE 2026Set ANNUAL1 markMCQ
$Q. Read the following statements and choose the correct answer from the given alternatives: Statement 1: Balance of Trade records invisible items only. Statement 2: Balance of Payments records visible items, invisible items, unilateral transfers and capital transfers.$
(a) Both the Statements are true
(b) Both the Statements are false
(c) Statement 1 is true and Statement 2 is false
(d) Statement 2 is true and Statement 1 is false
›Reveal solutionSolution
Balance of Trade (BoT) records only visible/merchandise trade; the Balance of Payments (BoP) is the wider account covering visible items, invisible items, unilateral transfers, and capital transfers. So Statement 1 is false and Statement 2 is true.

Balance of Trade (BoT) = Value of exports of goods − Value of imports of goods. It records only visible items — physical merchandise that can be seen and recorded at customs (e.g. machinery, textiles, oil). It does not record invisible items (services, etc.) — so Statement 1, which claims BoT "records invisible items only," is factually the opposite of the truth and is false.

Balance of Payments (BoP), by contrast, is a comprehensive record of all economic transactions of a country with the rest of the world during a year. It covers:

Visible items (merchandise trade — the Current Account's trade balance)

Invisible items (services like shipping, insurance, tourism; income like interest/dividends; and transfers) …
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CBSE 2026Set ANNUAL1 markMCQ
$Q. Gifts and donations from abroad are recorded in the$
(a) credit side of Current Account of BOP
(b) debit side of Current Account of BOP
(c) credit side of Capital Account of BOP
(d) debit side of Capital Account of BOP
›Reveal solutionSolution

Gifts/donations received from abroad are unilateral transfers, which form part of the Current Account; since money flows IN, they are entered on the credit side.

The Current Account of the Balance of Payments records transactions in visible items (merchandise trade), invisible items (services, income), and unilateral transfers — one-sided transactions where one country gives something to another with no corresponding good, service, or asset received in return (e.g. gifts, donations, remittances, foreign aid grants).

…

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Q.(a) "The central bank needs to intervene under the managed floating system." Do you agree with the given statement? Support your answer with valid reasons.

Part (a)

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