A country follows a fixed exchange rate system. In a year, its autonomous payments are greater than its autonomous receipts. Which of the following correctly states the effect?
Answer & explanation
Correct answer: option 4
The correct answer is Option (4) → The BoP is in deficit; the central bank sells foreign exchange, so official reserves fall.
When autonomous payments exceed autonomous receipts, the BoP is in deficit. Under a fixed rate the central bank fills the gap by selling foreign exchange from its reserves (official reserve sale), so reserves fall.
Option (1) The BoP is in surplus, and the gap is shown under errors and omissions. — Incorrect. The BoP is in deficit; errors and omissions only cover recording mistakes.
Option (2) The BoP is in deficit, and market forces alone remove it with no change in official reserves. — Incorrect. Under a fixed rate the market is not left to adjust; the government must use reserves.
Option (3) The BoP is in surplus, and the central bank buys foreign exchange, so official reserves rise. — Incorrect. That happens when receipts are greater than payments.
Option (4) The BoP is in deficit; the central bank sells foreign exchange, so official reserves fall. — Correct. This is an official reserve sale.
NCERT (2026-27): “6.1.3 Balance of Payments Surplus and Deficit … The reserve bank sells foreign exchange when there is a deficit. This is called official reserve sale. The decrease (increase) in official reserves is called the overall balance of payments deficit (surplus). …” “Autonomous and Accommodating Transactions … The balance of payments is said to be in surplus (deficit) if autonomous receipts are greater (less) than autonomous payments. …” “6.2.3 Merits and Demerits of Flexible and Fixed Exchange Rate Systems … Often, if there is a deficit in the BoP, in a fixed exchange rate system, governments will have to intervene to take care of the gap by use of its official reserves. …” |