Question

Indian investors lend abroad. Answer the following questions:

(i) In which sub-account and on which side of the Balance of Payments Account such lending is recorded? Give reasons.

(ii) Explain the impact of these lendings on Market Exchange Rate.

Answer 1

(i) Indians lending abroad is recorded in Capital Account of BOP Account because it leads to creation of foreign exchange assets. It is recorded on the debit side because it outflow of foreign exchange.

(ii) Lending abroad increases demand for foreign exchange. Supply of foreign exchange remains unchanged, exchange rate may rise.

Detailed Answer:

(i) In Capital Account, and on debit side of BOP, the lending of Indian investors to abroad will be recorded. Indian investors lending abroad cause an outflow of foreign exchange from the country. Thus, it is recorded as negative item in the Capital Account of BOP.

(ii) Lending to abroad by Indian investors will decrease the supply of foreign currency. This would shift the supply curve from SS to S'S'. With the shift in supply curve, the new equilibrium is established at point E', where the exchange rate rises from OR to OR₁.