NISM Certifications · NISM-Series-XV: Research Analyst · Economic Analysis
A country's current account deficit widens while foreign portfolio inflows remain unchanged and the central bank does not intervene. All else equal, what is the most likely effect on the domestic currency?
The domestic currency is most likely to depreciate. A wider current account deficit raises demand for foreign currency to pay for imports relative to its supply, and with unchanged capital inflows and no central bank intervention, that excess demand weakens the domestic currency.
- ADepreciationCorrect
- BAppreciation
- CNo change, since the capital account offsets automatically
- DAppreciation, because imports rise
Explanation
A wider current account deficit means greater demand for foreign currency to pay for imports relative to supply from exports. With capital inflows unchanged and no intervention, the extra demand for foreign currency pushes the domestic currency down. Higher imports do not strengthen the currency.
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