Q.(a) State any two factors responsible for inflow of foreign currency.

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:

1. Goods (exports and imports of physical items — phones, wheat, oil)
2. Services (IT exports, tourism, shipping)
3. 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.

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.

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:

1. 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.

2. 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.

3. 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. …

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.

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.

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:

More commonly, we write it as:

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

There is also the percentage change formula:

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

The rupee has depreciated by 14.3% against the dollar.

A Diagram in Words

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