FAQs - General Concepts

What are foreign exchange reserves?

Foreign-exchange reserves are assets held by central banks (RBI) and monetary authorities like IMF, majorly in different reserve currencies (in India it’s majorly in USD). It also adds gold reserves, special drawing rights (SDRs), and International Monetary Fund (IMF) reserve positions.

What is Balance of Payments (BoP)?

BoP is an accounting record of all the monetary transactions between a country and the rest of the world. It summarizes the international transactions for a specific period – quarter and/or annual. It consists of two principal parts – the current account and the capital account.

What is meant by Current account deficit (CAD)?

In macro-economic national accounting terms, the current account deficit of a country is a mirror image of the difference between domestic savings and domestic investments. If domestic savings exceed domestic investments, a surplus on the current account will result.

On the other hand, if the domestic savings are insufficient to finance domestic investments, a deficit on the current account will result, which would need to be financed either by way of external borrowings or by drawing down on reserves.

What is capital account convertibility?

Capital account convertibility means that the home currency can be freely converted into foreign currencies for acquisition of capital assets abroad. The rupee is currently not freely convertible on the capital account.

What is Asian Clearing Union (ACU)?

The Asian Clearing Union (ACU) was established with its headquarters at Tehran, Iran, on December 9, 1974 at the initiative of the United Nations Economic and Social Commission for Asia and Pacific (ESCAP), for promoting regional co-operation. The main objective of the clearing union is to facilitate payments among member countries for eligible transactions on a multilateral basis, thereby economizing on the use of foreign exchange reserves and transfer costs, as well as promoting trade among the participating countries. The Central Banks and the Monetary Authorities of Bangladesh, Bhutan, India, Iran, Maldives, Myanmar, Nepal, Pakistan and Sri Lanka are currently the members of the ACU. The Asian Monetary Units (AMUs) is the common unit of account of ACU and is denominated as ‘ACU Dollar’ and ‘ACU Euro’, which is equivalent in value to one US Dollar and one Euro respectively.

What are REER and NEER?

Real Effective Exchange Rate (REER) is defined as a weighted average of nominal exchange rates adjusted for relative price differential between the domestic and foreign countries, relates to the purchasing power parity (PPP) hypothesis.

Nominal Effective Exchange Rate (NEER) is the weighted average of bilateral nominal exchange rates of the home currency in terms of foreign currencies. The RBI on a monthly basis has been publishing 6-currency and 36-currency REER and NEER indices based on the Wholesale price index (WPI). Starting April 2014, it also publishes the 6-currency and 36-currency REER and NEER indices based on the Consumer price index (CPI).

What is meant by the impossible trinity?

‘Impossible Trinity’ implies that we cannot have all the three, namely- a fixed exchange rate, an independent monetary policy and free capital movement at the same time. It was first proposed by the economist Robert Mundell. It can be understood with the help of the diagram below.