Read the following statements carefully : Statement I : Trade in services includes both factor income and non-

Question 75 of 77

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.

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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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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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