BoP and Convertibility MCQ Quiz - Objective Question with Answer for BoP and Convertibility - Download Free PDF

The correct answer is Both (1) and (2).

Key Points

The balance of payments (BoP)

• It records the transactions in goods, services, and assets between residents of a country with the rest of the world for a specified time period typically a year.

There are two main accounts in the BoP

The current account

• The current account records exports and imports in goods and services and transfer payments.

The capital account

• The capital account records all international purchases and sales of assets such as money, stocks, bonds, etc.

The correct answer is Amount borrowed from World Bank.

Key Points

• Amount borrowed from World Bank:
  • Borrowing, whether from the World Bank or any other source, is considered a capital receipt, not a revenue receipt.
  • Capital receipts are funds received by the government that either create a liability or reduce an asset.
  • When the government borrows money, it incurs a liability to repay that amount in the future, along with interest.
  • This inflow of funds does not arise from the regular revenue-generating activities of the government.
  • Therefore, loans and borrowings are classified under capital receipts in the government budget.

Additional Information

• GST (Goods and Services Tax):
  • GST is a major source of revenue for the government and is categorized as a revenue receipt.
  • Revenue receipts are the regular and recurring receipts of the government, which do not create a liability or reduce an asset.
  • GST is an indirect tax levied on the supply of goods and services.
  • It is a consumption-based tax and forms a significant part of the government's tax revenue.
  • The collection of GST is a regular feature and directly contributes to the government's funds for financing its various expenditures.
• Fees paid for the registration of property:
  • Fees collected by the government for services rendered, such as property registration, are considered revenue receipts.
  • These are non-tax revenue receipts, as they are payments made by individuals or entities in exchange for specific services provided by the government.
  • Property registration fees are a recurring source of income for the government.
  • They do not create any liability for the government nor do they lead to a reduction in its assets.
  • Such fees help the government finance its administrative and other routine expenses.
• Grant received by UNESCO:
  • Grants received by the government from international organizations like UNESCO are generally treated as revenue receipts.
  • These grants are typically provided for specific purposes, such as educational or cultural projects, and are not expected to be repaid.
  • They are considered non-debt creating inflows of funds.
  • While the nature and conditions of grants can vary, they usually fall under the category of revenue receipts as they supplement the government's regular income without creating a liability.
  • These grants help the government in funding specific programs and initiatives without burdening its financial resources through borrowing.

The correct answer is Both (i) and (ii).

Key Points

• Balance of Trade (BOT) is the difference between a country's exports and imports of goods in a given period.
• A positive balance of trade, known as a trade surplus, occurs when a country exports more than it imports.
• A negative balance of trade, known as a trade deficit, occurs when a country imports more than it exports.
• BOT is a significant component of a country's balance of payments (BOP).

Additional Information

• Balance of Payments (BOP)
  • BOP is a comprehensive record of all economic transactions between residents of a country and the rest of the world in a given period.
  • It includes the trade balance, capital flows, and financial transfers.
  • A positive BOP indicates a surplus, while a negative BOP indicates a deficit.
• Trade Surplus
  • A trade surplus occurs when the value of a country's exports exceeds the value of its imports.
  • A trade surplus can contribute to a stronger currency and increased foreign exchange reserves.
• Trade Deficit
  • A trade deficit occurs when the value of a country's imports exceeds the value of its exports.
  • A trade deficit can lead to increased borrowing from foreign lenders and a weaker currency.
• Economic Impact
  • The balance of trade affects a country's economic stability, inflation, and employment rates.
  • Governments may implement trade policies to correct imbalances, such as tariffs and trade agreements.

The correct answer is it is regime where a nation's currency is set by the forex market through supply and demand.

Key Points

• A floating exchange rate is a regime where the currency price of a nation is set by the forex market based on supply and demand relative to other currencies.
• It is determined by market forces of demand and supply.
• It is in contrast to a fixed exchange rate.
• In  fixed exchange a currency is pegged or held at the same value relative to another currency.

The correct answer is export of goods is less than import of goods 

Key Points

• Trade deficit is a term used to describe a situation where the value of a country’s export of goods is less than import of goods during a given period.
• It is also referred to as a negative balance of trade (BOT).
• The balance can be calculated on different categories of transactions: goods, services, goods and services.
• Trade deficits can have advantages and disadvantages depending on impacts on production, jobs, national security, and how they are financed.

The Impact of Trade Deficit

• Initially, a trade deficit can enhance the standard of living as it offers residents access to a wider variety of products.
• If a trade deficit continues for an extended period, the government may need to source more foreign exchange to bridge the gap, leading to the depreciation of the local currency.
• A significant trade deficit necessitates finding foreign investors to help reduce the import-export gap.
• A high trade deficit can lead to job outsourcing to foreign countries as more imports reduce job opportunities locally.
• The demand for imported goods can cause a decline in demand for local products, leading to factory closures and job losses.

Benefits of Trade Deficit

A trade deficit does come with some advantages, including:

• It allows a country to consume more than its production capacity.
• It helps nations to avoid any shortage in goods.
• Trade deficit provides countries with a comparative advantage, increasing global wealth.
• It can lead to increased foreign direct investment.

The correct answer is Both (1) and (2).

Key Points

The balance of payments (BoP)

• It records the transactions in goods, services, and assets between residents of a country with the rest of the world for a specified time period typically a year.

There are two main accounts in the BoP

The current account

• The current account records exports and imports in goods and services and transfer payments.

The capital account

• The capital account records all international purchases and sales of assets such as money, stocks, bonds, etc.

The correct answer is 52-56%.

India's crude and petroleum Imports - 

• India imports more than 70 or 80% of its oil requirement.
• India ranked 4th in terms of crude and petroleum consumption in the world.
• As per the economic survey 2013 data, the share of Crude and Petroleum products in total imports of India is 27-33%.
• As per the recent economic survey data, the share of Crude and Petroleum products in total imports of India at present is 52.7%. Hence option 2 is correct.

The correct Option is the Trade Balance.

The balance of exports and imports of goods is referred to as the Trade Balance.

Key Points

• The Trade Balance is the difference between the value of goods that a country or economic area exports and the value of goods imports.
• India has a negative Bilateral Trade Balance with China, Saudi Arabia, Switzerland, Iraq, and South Korea. India has the highest trade deficit with China. India has a surplus trade balance with USA, UK, Bangladesh, Nepal, and UK.
• The Balance of Payment of a country is the difference between all the money flowing into the country and the outflow of the money to the rest of the world.
• The Trade Surplus is a situation in a country when the value of goods exports is more than the value of goods imports.
• The Trade Deficit is a situation in a country when the value of goods imports is more than the value of goods exports

Important Points

• Trade Balance = Value of goods Exports -  Value of goods Imports
• Trade Surplus: Value of goods Exports >  Value of goods imports
• Trade Deficit: Value of goods Imports >  Value of goods  Exports
• Balance of Payment = Money flowing into the country - Outflow of the money to the rest of the world 

The correct answer is Special Drawing Rights (SDR) of IMF.

Key Points 

• The term ‘paper gold’ refers to the Special Drawing Rights (SDR) of IMF.
• Special Drawing Rights (SDR):
  • The SDR is neither a currency nor a claim on the IMF. Rather, it is a potential claim on the freely usable currencies of IMF members.
    • SDRs can be exchanged for these currencies.
  • The SDR serves as the unit of account of the IMF and some other international organizations.
  • The currency value of the SDR is determined by summing the values in US dollars, based on market exchange rates, of an SDR basket of currencies.
  • The SDR basket of currencies includes the US dollar, Euro, Japanese yen, pound sterling and the Chinese renminbi (included in 2016).
  • The SDR currency value is calculated daily (except on IMF holidays or whenever the IMF is closed for business) and the valuation basket is reviewed and adjusted every five years.
  • Quota (the amount contributed to the IMF) of a country is denominated in SDRs.
  • Members’ voting power is related directly to their quotas.
  • IMF makes the general SDR allocation to its members in proportion to their existing quotas in the IMF.
  • India's foreign exchange reserves also incorporate SDR other than gold reserves, foreign currency assets and Reserve Tranche in the IMF.​

Additional Information 

• International Monetary Fund (IMF):
  • The IMF was set up along with the World Bank after the Second World War to assist in the reconstruction of war-ravaged countries.
  • The two organizations were agreed to be set up at a conference in Bretton Woods in the US. Hence, they are known as the Bretton Woods twins.
  • Created in 1945, the IMF is governed by and accountable to the 190 countries that make up its near-global membership. India joined in December 1945.
  • The IMF's primary purpose is to ensure the stability of the international monetary system — the system of exchange rates and international payments that enable countries (and their citizens) to transact with each other.
  • Its mandate was updated in 2012 to include all macroeconomic and financial sector issues that bear on global stability.
  • Reports by IMF:
    • Global Financial Stability Report
    • World Economic Outlook.

The correct answer is all import and export transactions of a country during a given period of time, normally a year.

Key Points

• The balance of payments (BOP) of a country is the record of all economic transactions between the residents of a country and the rest of the world in a particular period (over a quarter of a year or more commonly over a year).
  • Balance of Payment (BoP) of a country can be defined as a systematic statement of all economic transactions of a country with the rest of the world during a specific period usually one year.
  • It indicates whether the country has a surplus or a deficit in trade.
    • When exports exceed imports, there is a trade surplus and when imports exceed exports there is a trade deficit.
• Hence option 1 is correct.

​​Additional Information 

• Components of BoP:
  • For preparing BoP accounts, economic transactions between a country and the rest of the world are grouped under - Current account, Capital account, and Errors and Omissions. It also shows changes in Foreign Exchange Reserves.
  • Current Account: It shows the export and import of visible (also called merchandise or goods - represent trade balance) and invisible (also called non-merchandise).
    • Invisibles include services, transfers, and income.
  • Capital Account: It confers capital expenditure and income for a country.
    • It gives a summary of the net flow of both private and public investment into an economy.
    • External Commercial Borrowing (ECB), Foreign Direct Investment, Foreign Portfolio Investment, etc form a part of the capital account.
  • Errors and Omissions: Sometimes the balance of payment does not balance. This imbalance is shown in the BoP as errors and omissions. It reflects the country’s inability to record all international transactions accurately.
  • Changes in Foreign Exchange Reserves: Movements in the reserves comprise changes in the foreign currency assets held by the Reserve Bank of India (RBI) and also in Special Drawing Rights (SDR) balances.
  • Overall the BoP account can be a surplus or a deficit. If there is a deficit then it can be bridged by taking money from the Foreign Exchange (Forex) Account.
    • If the reserves in the forex account are falling short then this scenario is referred to as the BoP crisis.​

The correct answer is greater than unity.Key Points

• Devaluation is the reduction in the value of a country's currency relative to other currencies.
• The elasticity of demand refers to the responsiveness of demand for a good or service to a change in its price.
• When the sum of elasticity of demand for exports and imports is greater than unity, a devaluation can improve the balance of payments.
• This is because a devaluation makes exports cheaper and imports more expensive, which can increase the demand for exports and reduce the demand for imports, thereby improving the balance of payments.
• When the sum of elasticity of demand for exports and imports is less than unity or equal to unity, devaluation may not be effective in improving the balance of payments.

Additional Information

• If the sum of elasticity of demand for exports and imports is less than unity, devaluation may not lead to a significant increase in demand for exports or decrease in demand for imports.
• If the sum of elasticity of demand for exports and imports is equal to unity, devaluation may lead to a proportionate increase in demand for exports and decrease in demand for imports, but may not necessarily improve the balance of payments. 
• If the sum of elasticity of demand for exports and imports is zero, devaluation will not have any effect on the demand for exports or imports, and hence will not improve the balance of payments.

The correct answer is When imports are greater than exports

Key Points

• The problem of an unfavourable balance of payment arises when the value of imports exceeds the value of exports in a country.
• This means that the country is spending more money on buying goods and services from abroad than it is earning from selling goods and services to other countries.
• It is also known as the balance of payment deficit.
• Some possible causes of unfavourable balance of payments are high inflation, trade restrictions by other countries, and low competitiveness.

 Additional Information

Balance of payment deficit

• A balance of payment deficit is a situation in which the payments a country makes are more than the payments it receives.
• Essentially, more money leaves the country than is brought into it, and the country suffers a decrease in its supply of money.
• It is also known as a balance of payment gap.
• A balance of payment deficit can arise if a country imports more capital, goods, and services than it exports.
• This deficit can be balanced by utilizing the country’s foreign exchange reserves to meet the balance of payment shortfall.
• If the deficit continues for a long time, it can lead to inflation and a lower standard of living.

The correct answer is It is the number of months of imports that could be paid for by a country's international reserves.

Key Points

• Import cover:
  • It measures the number of months of imports that could be paid for by a country's international reserves.
  • It is an important indicator of the stability of the currency and a minimum of eight to ten months of import cover is essential for the stability of a currency.
  • Import cover avoids a BoP crisis by taking early preventive action.

The correct answer is 1 and 3.