(a) Explain the impact of rise in exchange rate on national income.(b) Explain the concept of 'deficit' in balance of payments. (2024)

FAQs

How a rise in the exchange rate can cause a deficit? ›

On the other hand, an appreciating currency may lead to trade deficits as exports become more expensive for foreign buyers, potentially harming domestic industries reliant on international markets. Exchange rates also influence inflation within a country.

A change in a country's balance of payments can cause fluctuations in the exchange rate between its currency and foreign currencies. The reverse is also true when a fluctuation in relative currency strength can alter balance of payments.

1. In the goods market, a positive shock to the exchange rate of the domestic currency (an unexpected appreciation) will make exports more expensive and imports less expensive. As a result, the competition from foreign markets will decrease the demand for domestic products, decreasing domestic output and price.

The huge import bill in the current account increases demand for foreign currency, while slowdown in exports of goods reduces the inflow of foreign currency. The combined effect exerts pressure on the exchange rate to depreciate (weaken).

A balance of payments deficit means the nation imports more commodities, capital and services than it exports. It must take from other nations to pay for their imports.

A budget deficit can affect the exchange rate in different ways, depending on how the government finances it. If the government borrows from abroad, it will increase the demand for foreign currency and reduce the value of the domestic currency. This is called a depreciation.

How Does a Higher Exchange Rate Affect Trade? When a country's exchange rate increases relative to another country's, the price of its goods and services increases. Imports become cheaper. Ultimately, this can decrease that country's exports and increase imports.

It means an increasing trade deficit leads to a fall in the exchange rate of a country. Therefore, the exchange rate becomes lower due to the growing trade deficit.

An increase in imports above the value of exports (imports > exports) affects the balance of payments. This should consequently, all other things being equal, depreciate the domestic country's currency. Consumer spending is instrumental in keeping the economy afloat even in the course of deflation.

When the value of a currency changes, prices for goods traded using that currency can be affected. A currency appreciation (when the value increases over time) results in a lower effective price for imported goods; currency depreciation (when the value decreases over time) translates to higher import prices.

How does increase in income affect exchange rate? ›

Income levels: Another factor affecting exchange rate is the relative income level. Income level of the country determines the imports demanded which affects the exchange rate. If the US income level rises while the British level of income remains the same.

The Kuwaiti Dinar (KWD), recognized as the highest-valued currency globally, symbolizes Kuwait's economic strength. In Kuwait, the Indian ex-pat group has a strong presence, making the KWD to INR rate the most popular Kuwait Dinar exchange rate.

The exchange rate exerts a significant influence on the trade balance, and by extension, on the current account. An overvalued currency makes imports cheaper and exports less competitive, thereby widening the current account deficit or narrowing the surplus.

The real exchange rate is the current price businesses and consumers will pay to buy a foreign product using their home currencies. For example, if the current U.S. exchange rate between the U.S. and Britain was $138 U.S. dollars for one pound, an American consumer would need $1.38 to buy one pound worth of goods.

An exchange rate is a relative price of one currency expressed in terms of another currency (or group of currencies). For economies like Australia that actively engage in international trade, the exchange rate is an important economic variable.

The exchange rate affects the real economy most directly through changes in the demand for exports and imports. A real depreciation of the domestic currency makes exports more competitive abroad and imports less competitive domestically, thereby increasing demand for domestically produced goods.

The exchange rate of the dollar is important, as a stronger dollar makes foreign products cheaper for American consumers while making U.S. exports more expensive for foreign buyers. A growing U.S. economy also often leads to a larger deficit, since consumers have more income to buy more goods from abroad.

The Bottom Line

Trade deficits occur when a country imports more goods and services than it exports, resulting in a negative balance of trade. They can affect domestic industries, employment, and economic growth, and are influenced by factors such as exchange rates, trade policies, and global economic conditions.

When an exchange rate changes, the value of one currency will go up while the value of the other currency will go down. When the value of a currency increases, it is said to have appreciated. On the other hand, when the value of a currency decreases, it is said to have depreciated.