NISM Certifications · NISM-Series-XV: Research Analyst · Economic Analysis
A persistent widening of the current account deficit, financed by volatile short-term capital inflows, is most likely to make a country's currency vulnerable because:
The currency becomes vulnerable because a sudden reversal of short-term capital inflows can leave the current account deficit unfunded, putting heavy pressure on the exchange rate and causing sharp depreciation. It does not cause exports to vanish or reserves to rise endlessly.
- AExports automatically fall to zero
- BSudden reversal of capital flows can cause sharp depreciationCorrect
- CDomestic inflation must fall
- DForeign exchange reserves rise without limit
Explanation
If a deficit depends on volatile short-term flows, a sudden stop or reversal leaves a funding gap and can trigger sharp currency depreciation. The other options do not follow from such financing.
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