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NISM Certifications · NISM-Series-XV: Research Analyst · Economic Analysis

An economy's current account deficit is 2% of GDP, while net capital and financial account inflows are 3% of GDP. Ignoring errors and omissions, what is the likely impact on foreign exchange reserves and the rupee, other things equal?

Reserves rise by 1% of GDP, supporting the rupee. Capital and financial inflows of 3% of GDP exceed the current account deficit of 2%, so the overall balance of payments shows a 1% surplus that accumulates as foreign exchange reserves.

  1. AReserves fall by 2% of GDP and rupee depreciates
  2. BReserves rise by 1% of GDP, supporting the rupeeCorrect
  3. CReserves rise by 5% of GDP
  4. DReserves are unchanged as the accounts offset exactly

Explanation

Balance of payments must balance: change in reserves = capital inflows minus current account deficit = 3% - 2% = +1% of GDP. Surplus adds to reserves and supports the rupee. Adding the two figures (5%) is a sign error, and the accounts do not exactly offset.

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