Question

(a) In which sub-account and on which side of balance of payments account will foreign investments in India be recorded? Given reasons.
(b) What will be the effect of foreign investments in India on exchange rate? Explain.

Answer 1

(a) In Capital account, and on credit side of BOP, foreign investments in India will be recorded. Foreign investment refers to the investment in the assets of a foreign country. By investing, the government or any resident of domestic country owns the control over the asset of the foreign country. Foreign Investment cause an inflow of foreign exchange into the country. Thus, it is recorded as positive items in the Capital Account of BOP.

(b) Foreign investments in India will increase the supply of foreign currency. This would shift the supply curve from $SS$ to $S^{\prime }S$. With the shift in supply curve, the new equilibrium is established at point E, where the exchange rate falls from $OR$ to $O{R}_1$ and the demand and supply of foreign currency rises to $Q{Q}_1$.