(a) "Accommodating transactions are undertaken to maintain stability in the Balance of Payments Account." Just

Question 53 of 77

Q. (a) "Accommodating transactions are undertaken to maintain stability in the Balance of Payments Account." Justify the given statement with valid explanation.

(OR)

(b) "Depreciation of currency may promote exports of a nation." Defend or refute the given statement with valid arguments.

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Part (a)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) …

Part (b)Concept understanding — Currency Devaluation Depreciation

Let’s start with something you already know. Suppose you have ₹100 and you want to buy a toy that costs $2. If the exchange rate is ₹50 =$ 1, you can buy exactly one toy. Now imagine the rate changes to ₹100 = $1. Your ₹100 now buys only$ 1 — you can no longer afford the toy. The rupee has become weaker relative to the dollar. That’s the everyday feeling of a currency losing value.

What is Currency Depreciation?

Depreciation is the fall in the value of one currency in terms of another currency under a flexible (floating) exchange rate system. In this system, the market — supply and demand for currencies — decides the rate. If more people want to sell rupees and buy dollars, the rupee’s price falls. That’s depreciation.

Example: If the rate moves from ₹70/ $to ₹80/$ , the rupee has depreciated. Each dollar now costs more rupees.

Note

Depreciation happens automatically in a floating rate system. It is not a government decision — it’s a market outcome.

What is Currency Devaluation?

Devaluation is the official reduction in the value of a currency by the government or central bank under a fixed exchange rate system. Here, the government pegs the currency to another currency (say, the dollar) and then deliberately lowers that peg.

Example: If the government had fixed ₹70/ $and then announces a new fixed rate of ₹80/$ , that’s devaluation.

Watch out

Many students mix these up. Remember: Depreciation = market-driven fall (floating rate). Devaluation = government-driven fall (fixed rate). The effect is similar — your currency buys less foreign currency — but the cause is different.

Why Does It Matter? The Real Effects

1. Exports become cheaper, imports become costlier

When the rupee depreciates (or is devalued), Indian goods become cheaper for foreigners. A shirt that costs ₹500 earlier cost $10 at ₹50/$ . Now at ₹100/ $, it costs only$ 5. Foreign buyers buy more — exports rise.

But the reverse is painful. An imported laptop that cost $1000 earlier cost ₹50,000. Now it costs ₹1,00,000. Imports become expensive, hurting consumers and industries that rely on foreign raw materials.

2. Impact on the trade balance

If exports rise and imports fall, the trade deficit (exports minus imports) may shrink. But this is not guaranteed — if demand for imports is inelastic (people must buy them anyway), the import bill actually rises in rupee terms.

3. Inflation pressure

Since imported oil, machinery, and components cost more, production costs rise. Firms pass this on to consumers. This is called imported inflation.

4. Debt burden

If India has borrowed in dollars, a weaker rupee means we need more rupees to repay the same dollar debt. This increases the burden on the government and companies.

The Formula (Yes, there is one — but it’s simple)

The NCERT textbook does not give a separate formula for depreciation/devaluation itself. But the concept is tied to the exchange rate:

\text{Exchange Rate} = \frac{\text{Price of domestic currency}}{\text{Price of foreign currency}}

More commonly, we write it as:

\text{₹ per $} = \frac{\text{₹}}{\text{$}}

If this number rises, the domestic currency (₹) has depreciated or been devalued.

There is also the percentage change formula:

\text{Percentage depreciation} = \frac{\text{New rate} - \text{Old rate}}{\text{Old rate}} \times 100

Example: Rate goes from ₹70/ $to ₹80/$ .

\frac{80 - 70}{70} \times 100 = 14.3\%

The rupee has depreciated by 14.3% against the dollar.

Tip

Always check which currency is in the denominator. If the denominator currency strengthens, the numerator currency weakens. A rising ₹/$ rate means the rupee is falling.

A Diagram in Words

Draw a standard supply-and-demand graph for dollars. On the vertical axis, put “₹ per $” (the exchange rate). On the horizontal axis, put “Quantity of$ ”. …

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Part (a): Accommodating (official reserve) transactions are the balancing item — they finance the deficit or absorb the surplus left by autonomous transactions, so the BoP account balances.

Part (b): Depreciation lowers the foreign-currency price of exports, raising competitiveness and typically promoting exports if demand is elastic — the statement is defensible.

Part (a)

The Balance of Payments records all economic transactions between residents of a country and the rest of the world, split into two categories by motive.

Autonomous transactions ("above the line") happen for their own economic reasons — exports, imports, private investment, remittances — independent of the country's BoP position. They are the source of any surplus or deficit.
Accommodating transactions ("below the line"), also called official reserve transactions, are undertaken because of the net result of autonomous flows. They exist to finance the gap.

When autonomous receipts fall short of autonomous payments, there is a deficit; the central bank meets it by selling foreign exchange from its reserves, or by borrowing from the IMF/foreign monetary authorities. When there is a surplus, the central bank accumulates reserves. These reserve changes are the residual that forces the identity:

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

Note

Accommodating transactions do not prevent imbalances — they finance them. They keep the account balanced (stable in an accounting sense), while genuine correction of persistent deficits needs policy acting on autonomous flows. …

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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 32 on this concept.

CBSE 2026Set 58/1/11 markMCQ
$Q. Read the following statements carefully : Statement 1 : Depreciation of currency is an economic action undertaken by the government of a nation under the fixed exchange rate system. Statement 2 : Under the floating exchange Rate system, authorities actively intervene in the foreign exchange market by way of maintaining foreign exchange reserves. In the light of the given statements, choose the correct option from the following : (A) Statement 1 is true and statement 2 is false. (B) Statement 1 is false and statement 2 is true. (C) Both statements 1 and 2 are true. (D) Both statements 1 and 2 are false.$
›Reveal solutionSolution

Statement 1 confuses depreciation (market-driven) with devaluation (government action under fixed rates); Statement 2 wrongly claims active intervention defines floating systems. Both statements are false.

The question tests whether you can distinguish between two exchange-rate regimes and the vocabulary that goes with each. The key is to understand what governments do versus what markets do in fixed and floating systems.

Fixed vs Floating Exchange Rates: Who Decides?

Under a fixed exchange rate system, the government (or central bank) pegs the domestic currency to another currency or a basket of currencies at a declared rate. The authorities must intervene in the foreign exchange market—buying or selling reserves—to defend that peg whenever market forces push the rate away from the official level. If the government chooses to lower the official value of the currency, that deliberate policy action is called devaluation. Conversely, raising the official value is revaluation. Both are government decisions.

Under a floating (or flexible) exchange rate system, the currency's value is determined by market forces of demand and supply in the foreign exchange market, with no commitment by the government to maintain any particular rate. The exchange rate fluctuates freely. When the currency loses value in the market, we call it depreciation; when it gains value, appreciation. These are market outcomes, not government decisions.

Note

A managed float (or "dirty float") sits between the two extremes: the rate mostly floats, but authorities occasionally intervene to smooth volatility or nudge the rate. India, for instance, operates a managed float—the RBI does not target a fixed rate but may buy or sell dollars to prevent excessive swings.

Evaluating Statement 1

Statement 1 says: "Depreciation of currency is an economic action undertaken by the government of a nation under the fixed exchange rate system."

This mixes up terminology. Under a fixed system, if the government lowers the currency's official value, the correct term is devaluation, not depreciation. Depreciation refers to a market-driven fall in value under a floating system, where the government does not set the rate. The statement incorrectly attributes a government action (which would be devaluation) to the term "depreciation" and places it in the fixed-rate context.

Statement 1 is false.

Evaluating Statement 2 …
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CBSE 2026Set 58/2/11 markMCQ
$Q. Read the following statements - Assertion (A) and Reason (R). Choose the correct option from those given below : Assertion (A) : Increase in exchange rate implies that the price of foreign currency in terms of domestic currency has increased. Reason (R) : Balance of trade records the inflows and outflows of foreign exchange. Options : (A) Both Assertion (A) and Reason (R) are true and Reason (R) is the correct explanation of Assertion (A). (B) Both Assertion (A) and Reason (R) are true, but Reason (R) is not the correct explanation of Assertion (A). (C) Assertion (A) is true, but Reason (R) is false. (D) Assertion (A) is false, but Reason (R) is true.$
›Reveal solutionSolution
An increase in the exchange rate means foreign currency has become more expensive in terms of domestic currency. The Balance of Trade, however, only records visible goods, not all foreign exchange flows. Therefore, Assertion (A) is true, but Reason (R) is false.

Let's break down each statement to understand its meaning and truthfulness.

Understanding Assertion (A)

Assertion (A): Increase in exchange rate implies that the price of foreign currency in terms of domestic currency has increased.

The exchange rate is simply the price of one currency in terms of another. For instance, if the exchange rate is ₹80 per US dollar, it means that one US dollar costs 80 Indian rupees.

An "increase in the exchange rate" in this context typically refers to an increase in the number of units of domestic currency required to buy one unit of foreign currency.

Consider our example:

Initial exchange rate: ₹80 per US dollar

Increased exchange rate: ₹82 per US dollar

In this scenario, to buy one US dollar, you now need to pay ₹82 instead of ₹80. This means the foreign currency (US dollar) has become more expensive in terms of the domestic currency (Indian rupee). Conversely, the domestic currency has depreciated.

Therefore, Assertion (A) is True.

Understanding Reason (R)

Reason (R): Balance of trade records the inflows and outflows of foreign exchange.

The Balance of Trade (BOT) is a component of the Current Account of the Balance of Payments. It specifically records the difference between a country's exports and imports of visible goods (merchandise).

Exports of goods: Lead to an inflow of foreign exchange.

Imports of goods: Lead to an outflow of foreign exchange.

While the Balance of Trade does involve inflows and outflows of foreign exchange related to goods, it does not record all inflows and outflows of foreign exchange. The broader concept that records all economic transactions between residents of a country and the rest of the world, including visible trade, invisible trade (services), income, transfers, and capital transactions, is the Balance of Payments (BOP). …
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CBSE 2026Set 58/3/11 markMCQ
$Q. Under the fixed exchange rate system, if the government decreases the value of domestic currency with respect to a foreign currency, it is known as __________ of currency. (Choose the correct option to fill in the blank) Options : (A) Devaluation (B) Depreciation (C) Appreciation (D) Revaluation$
›Reveal solutionSolution
Under a fixed exchange rate system, a deliberate reduction in the value of a domestic currency by the government is termed devaluation.

To understand the correct term, we first need to distinguish between the two primary types of exchange rate systems: fixed and flexible (or floating). The mechanism by which a currency's value changes depends critically on which system is in place.

Under a fixed exchange rate system, the government or the central bank officially sets and maintains the exchange rate at a specific level against a foreign currency or a basket of currencies. To maintain this fixed rate, the central bank must intervene in the foreign exchange market by buying or selling foreign currency. If market forces push the domestic currency's value down, the central bank sells foreign currency to buy domestic currency, increasing demand for the domestic currency and supporting its value. Conversely, if market forces push the domestic currency's value up, the central bank buys foreign currency by selling domestic currency, increasing the supply of domestic currency and preventing its appreciation.

When the government or central bank deliberately decides to decrease the official value of its domestic currency relative to a foreign currency under this fixed system, this action is known as devaluation. This is a policy decision, often undertaken to make exports cheaper and imports more expensive, thereby improving the trade balance.

Note

Devaluation is a policy tool used by governments to adjust their currency's value in a fixed exchange rate regime.

In contrast, under a flexible exchange rate system, the value of a currency is determined purely by the forces of demand and supply in the foreign exchange market, without direct intervention from the government or central bank.

If the value of the domestic currency falls due to market forces (e.g., increased supply of domestic currency or decreased demand for it), it is called depreciation.

If the value of the domestic currency rises due to market forces (e.g., decreased supply of domestic currency or increased demand for it), it is called appreciation.

Similarly, if the government or central bank deliberately decides to increase the official value of its domestic currency relative to a foreign currency under a fixed exchange rate system, this action is known as revaluation. …
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CBSE 2026Set MARCH1 mark
$Q. What is appreciation of domestic currency?$
›Reveal solutionSolution

Appreciation of the domestic currency means a rise in its value against foreign currency, so fewer domestic units buy one unit of foreign currency.

Under a floating exchange rate system, the value of the domestic currency is determined by demand and supply in the foreign exchange market. Appreciation occurs when the domestic currency gains value, so that one unit of foreign currency (say a dollar) can now be bought with fewer units of domestic currency. For example, if the rate moves from Rs. 80 = 1 dollar to Rs. 75 = 1 dollar, the rupee has appreciated. Appreci …

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CBSE 2026Set ANNUAL1 markMCQ
$Q. When exchange rate in terms of domestic currency rises$
(a) Exports become cheaper
(b) Imports become cheaper
(c) Exports become costlier
(d) No effect on imports
›Reveal solutionSolution

When the exchange rate in terms of domestic currency rises (the domestic currency depreciates), exports become cheaper for foreigners, so the answer is (a).

The exchange rate 'in terms of domestic currency' means the amount of domestic currency needed to buy one unit of foreign currency (for example, rupees per dollar). When this rate rises, it takes more domestic currency to buy foreign currency, i.e. the domestic currency has depreciated (and the foreign currency has become dearer). As a result, foreigners now need less of their own currency …

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CBSE 2026Set ANNUAL1 mark
$Q. Fill in the blank: The process of making domestic currency cheaper by some government actions is called ________.$
›Reveal solutionSolution

Making the domestic currency cheaper by government action is devaluation.

Devaluation is the deliberate lowering of the official value (exchange rate) of the domestic currency by the government under a fixed exchange-rate system, making the domestic currency cheaper in terms of foreign currencies. It makes exports cheaper and imports dearer, helping to correct a balance-of-payments deficit. (Under a flexible system, …

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CBSE 2026Set ANNUAL1 markMCQ
$Q. Read the following Assertion (A) and Reason (R). Choose the correct alternative given below: Assertion (A): Devaluation of Indian rupee implies that more rupees are required to buy a dollar. Reason (R): Devaluation of domestic currency makes foreign goods more expensive.$
(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 statements are true in isolation, but Reason (R) explains an effect of devaluation, not why devaluation means more rupees are needed per dollar — that part is simply definitional.

Assertion (A): Devaluation is a deliberate, official reduction in the value of the domestic currency against foreign currencies under a fixed/pegged exchange rate system. If the rupee is devalued, by definition fewer dollars can now be bought for the same number of rupees — equivalently, more rupees are required to buy one dollar. This is true, and it is essentially the definition of devaluation.

Reason (R): When the rupee is devalued, imported goods (priced in foreign currency) now cost more in rupee terms, so foreign goods indeed become more expensive for Indian buyers. This is also true — it is a genuine consequence of devaluation (and is precisely why devaluation is used to discourage imports and encourage exports).

…

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CBSE 2025Set 58/6/11 markMCQ
$Q. Read the following statements - Assertion (A) and Reason (R) carefully. Choose the correct option from those given below : Assertion (A) : Other things remaining constant, devaluation of domestic currency may lead to rise in National Income of the nation. Reason (R) : Devaluation of domestic currency refers to reduction in the value of domestic currency by the government with respect to foreign currency under the fixed exchange rate system. Options : (A) Both Assertion (A) and Reason (R) are true and Reason (R) is the correct explanation of Assertion (A). (B) Both Assertion (A) and Reason (R) are true, but Reason (R) is not the correct explanation of Assertion (A). (C) Assertion (A) is true, but Reason (R) is false. (D) Assertion (A) is false, but Reason (R) is true.$
›Reveal solutionSolution

The assertion is true: devaluation can boost national income via net exports. The reason is also true: devaluation is a deliberate reduction in currency value under fixed exchange rates. But the reason merely defines devaluation — it does not explain why national income rises. So both are true, but (R) is not the correct explanation of (A). The correct option is (B).

Let’s unpack this step by step.

1. Understand the Assertion (A) first.

The claim is: Other things remaining constant, devaluation of domestic currency may lead to a rise in National Income.

Why would that happen? When a country devalues its currency, its exports become cheaper for foreign buyers, and imports become more expensive for domestic residents. This tends to increase export revenue and reduce import spending — so net exports (X – M) rise. Since National Income (Y) = C + I + G + (X – M), a rise in net exports directly increases aggregate demand and thus output and income. So the assertion is economically sound — it’s a standard argument from international trade theory.

Watch out

A common mistake is to think devaluation always raises income. It can, but only if the Marshall-Lerner condition holds (sum of price elasticities of exports and imports > 1). The assertion says “may lead to”, which is cautious and correct.

2. Now examine the Reason (R).

It says: Devaluation of domestic currency refers to reduction in the value of domestic currency by the government with respect to foreign currency under the fixed exchange rate system.

This is a textbook definition. Under a fixed exchange rate regime, the government or central bank sets the currency’s value. If it deliberately lowers that value, that’s devaluation. (Under floating rates, a similar fall is called depreciation, not devaluation.) So (R) is factually correct.

3. The key question: Does (R) explain (A)? …
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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 markMCQ
$Q. Which of the following is an incorrect pair of country and its currency? (A) Japan - Yen (B) India - Rupee (C) Britain - Leera (D) United State of America - Dollar$
›Reveal solutionSolution
Britain's currency is the Pound Sterling, not the Lira, so the incorrect pair is (C).

In the RBSE/CBSE Class-12 open-economy chapter, international transactions involve exchanging national currencies. Checking each pair:

(A) Japan – Yen — correct.

(B) India – Rupee — correct. …
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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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Q.(a) "Accommodating transactions are undertaken to maintain stability in the Balance of Payments Account." Justify the given statement with valid explanation.

Part (a)

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