question_answer

(a) In which sub 'account and on which side of balance of payments account will foreign investments in Indian be recorded' Give reasons.

(b) What will be the effect of foreign investment in India on exchange rate? Explain.

 

Answer:

(a) Foreign investments in India will be recorded in the capital account on the credit side of Balance of Payments accounts. It is recorded as the positive item in the capital account of BOP because foreign investments is an inflow of foreign currency into our country.

(b) Foreign investment in India will increase the supply of foreign currency in our country. This increase in supply is reflected as shift in the supply curve. With the shift, new equilibrium point is established, where exchange rate falls and thus the demand and supply of foreign currency rises and exchange rate falls. This will continue till the equilibrium is reached.

As can be seen in the above diagram that the supply curve of foreign exchange is SS. As the foreign investment in India increases, the supply curve of foreign exchange shifts to rightward and now the new supply curve is S'S'. This shift in supply curve from SS to S'S' changes the equilibrium from E to \[{{E}_{1}}\] where the exchange rate falls from OR to \[O{{R}_{1}}\] and demand and supply quantity of foreign exchange rises from OQ to \[O{{Q}_{1}}\]. Hence the new equilibrium gets established at \[O{{R}_{1}}\] exchange rate and \[O{{Q}_{1}}\] quantity of foreign exchange.