Q. 245.0( 2 Votes )

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Answer :


There are different types of the exchange rate which can be followed by the country. But broadly there are two types they are fixed exchange rate and flexible exchange rate.


Devaluation is the process practised in the fixed exchange rate system. Devaluation is the process of devaluing the domestic currency purposefully by the government. This is mainly done by the government to promote the exports of the country. When the devaluation takes place, the domestic currency becomes cheaper in the international market compared other countries currency.


Depreciation is the process which happens in the flexible exchange rate system where the exchange rate is determined by the forces of demand and supply. Depreciation happens when the price of the domestic goods in the foreign market falls. The value of the domestic currency will be lower compared to foreign currency.


Even though the devaluation and depreciation are two processes with a different approach, but the effect on the economy is the same. Both have the same effect on international trade in the economy -both will increase the exports.


When domestic currency is devalued, it becomes cheaper in the international market compared to foreign currency. This will lead to the purchase of a good by other countries from the domestic country. When the all other nation purchases the commodities from the domestic country, it increases the exports of the domestic country. And also it will decrease the exports of other nation which has a high value of the currency. Hence the devaluation by the country will increase the exports of the country.


When domestic currency is depreciated due to market forces, it becomes cheaper in the international market compared to the foreign market. This will lead to the purchase of a good by other countries from the domestic country. When the all other nation purchases the commodities from the domestic country, it increases the exports of the domestic country. And also it will decrease the exports of other nation which has a high value of the currency. Hence the depreciation by the country will increase the exports of the country.


b)


Official reserve transactions are the transactions made by the Central Bank which cause changes in its official reserves of foreign exchange. It takes effect in the foreign reserve of the country. This transaction happens only when an economy withdraws from its stock of foreign exchange reserves to finance the deficit in its overall Balance of Payments.


The following are the importance of the official reserve transaction:


• Official transaction reserve helps to bring balance in the country’s balance of payment.


• Purchase of a country's own currency is a credit item in the balance of payments; whereas, the sale of the currency is a debit item.


• It helps to adjust the deficit and surplus in the balance of payments.


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