UPSC Prelims 2012 · Question 79 of 98
UPSC Prelims 2012 question on Exchange Rate Determinants
- ExamUPSC CSE
- Year2012
- PaperGeneral Studies Paper I
- SubjectIndian Economy
- TopicExternal Sector of India
- DifficultyHard
- TypeStatement
Consider the following statements:
The price of any currency in international market is decided by the
1. World Bank
2. Demand for goods/services provided by the country concerned
3. Stability of the government of the concerned country
4. Economic potential of the country in question.
Which of the statements given above are correct?
Show answer
Answer: B. 2 and 3 only
Verdict
Correct Answer: 2 and 3 only
Analysis
The price of a currency in the international market is mainly decided by demand and supply.
Demand for a country’s goods and services, and confidence in its political stability, directly affect demand for its currency.
Statement by statement
1. World Bank — Incorrect
The World Bank does not decide the price of currencies.
It provides loans and technical assistance to countries, but exchange rates are determined mainly by market forces and central bank policy.
2. Demand for goods and services of the country concerned — Correct
If foreign buyers demand more goods and services from a country, they need that country’s currency to make payments.
This increases demand for the currency and can raise its value.
3. Stability of the government of the concerned country — Correct
Political stability increases investor confidence.
It can attract foreign investment, increasing demand for the currency. Political instability may cause capital flight and currency depreciation.
4. Economic potential of the country in question — Incorrect
Economic potential may influence long-term investor perception, but it is not a direct determinant of the day-to-day price of currency.
Actual demand, trade flows, capital flows, inflation, interest rates and stability matter more directly.
Extra UPSC info
* Exchange rate means the price of one currency in terms of another currency.
* In a floating exchange rate system, currency value is determined by demand and supply.
* In a fixed exchange rate system, the central bank maintains the currency at a fixed value.
* India follows a managed float system, where the RBI may intervene to reduce excessive volatility.
* Appreciation means rise in currency value due to market forces.
* Depreciation means fall in currency value due to market forces.
* Devaluation is a deliberate reduction in currency value by the government or central bank under a fixed exchange rate system.
How to crack it
Currency value is not decided by the World Bank or vague future potential, but mainly by demand for the country’s goods and services and confidence created by political stability.