Economic Awareness - Sectors of Indian Economy
Which of the following best describes the impact of a persistent Current Account deficit on a country's foreign exchange reserves?
Which of the following best describes the impact of a persistent Current Account deficit on a country's foreign exchange reserves?
hard Q10 of 15
Step-by-Step Solution
Step 1: Understand Current Account deficit and reserves
A persistent Current Account deficit means the country imports more than it exports, leading to net outflow of foreign currency.Step 2: Analyze financing methods
If the deficit is not fully financed by capital inflows, the country may use foreign exchange reserves to cover the gap, causing reserves to decrease.Step 3: Evaluate options
Foreign exchange reserves may decrease if deficit is financed by reserve drawdown correctly states that reserves may decrease if deficits are financed by reserve drawdown. Foreign exchange reserves increase due to capital inflows is incorrect because capital inflows may increase reserves but not always. Foreign exchange reserves remain unaffected is incorrect as reserves are affected by BoP imbalances. Foreign exchange reserves increase due to trade surplus is incorrect because trade surplus increases reserves, not deficit.Final Answer:
Foreign exchange reserves may decrease if deficit is financed by reserve drawdown → Option CQuick Check:
Foreign exchange reserves may = correct ✅
Quick Trick: Deficit financing affects reserves if capital inflows insufficient.
Common Mistakes:
MISTAKES- Assuming reserves always increase with deficits.
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