Deficit Financing: International Journal Of Accounting Research

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Question:

Describe about the Deficit Financing: International Journal of Accounting Research?

Answer:

Introduction

Exchanged rate is the rate at which one currency is exchanged with some other currency. The value of exchange rate is influenced by various factors such as inflation, balance of trade, public finance, interest rate, etc. Every country tries to keep a control on its home currency so as to prevent its value from depreciating. Gross Domestic Product refers to the monetary value of final good and services produced within the domestic territory of the country.

Country Analysis

1. The GDP of India in the year 2013 was 1876.80 billion US dollars.

India is the second largest populated country. It accounts for around 17.5 per cent of total world’s population. The population of India was marked to be around 1,276,401,849 in the year 2014. (Patnaik, 2013)

The GDP growth rate of India from 1951-2014 is marked to be around 5.83 per cent. (Pandey, 2012)

The graph of Balance of trade of India for past 5 years is:

Value of BOT in Millions of US Dollar

The graph of Inflation rate of India for past 5 years is:

Inflation Value in %

2. Lower Inflation rate increases or exerts an upward pressure on the country’s currency value, as the total purchasing power of that country increases. Thus the inflation rate of India is comparatively low in 2014 as compared to last four years which thus increases its currency value.

More is the demand for foreign currency lesser is the value of home currency. Deficit Financing decreases the value of home currency. Since the value of balance of trade is deficit, and it keeps on increasing over the last five years, it exerts a downward pressure on the exchange rate of the Indian currency.  (A.Sunday, 2013)

Exchange Rate Overview

2(a)

Graph showing the 5 year historical exchange rate between the US dollar (USD) and Indian currency.

Dollar/INR

2(b)

On Jan 28, 2015, 1 US dollar = 0.01630258 rupee.

2(c )

Let us take the bid/ask price for a particular day i.e. 44.075/44.125

Therefore, spread percentage= {(44.125-44.075)/44.125}*100 = 0.11%

2(d)

As per our above findings, we draw this interpretation that the rate of exchange of rupee with US dollar in a decreasing trend. No, it does not match with our initial expectation. We expected our home currency value to be on an increasing trend rather to be on the decreasing trend.  (Nagendran, 2008)

Country Influence On Exchange Rate

3(a)

A country should intervene in its exchange rate mechanism due to the following reasons:

• To control the depreciating exchange rate: a country may intervene in its exchange rate mechanism to prevent its currency from depreciating. This can be done by buying local currency through using some of the country’s foreign exchange reserve.

• To control the level of inflation: Higher the level of inflation of a country, lower is the value of currency of that particular country. Thus a country may intervene to control the level of inflation in order to control its currency from depreciating.(JAYACHANDRAN, 2013)

• To control negative balance of trade: Negative balance of trade increases the demand for foreign currency and reduces the value of the home currency. A country may intervene in its exchange rate mechanism to control the deficit balance of payment and to generate surplus by increasing the level of export and reducing the level of import.(Mirchandani, 2012)

3(b)

The primary mechanisms that governments have to undergo in order to influence their currency’s exchange rate are as follows:

• Change in Bank Rate: Government in order to manage the exchange rate mechanism keeps a control on the bank borrowing and lending rate. Government through its apex bank increases the bank rate when the level of inflation is increased in the country. As the higher inflation level puts a downward pressure on the country’s exchange rate.

• Export Promotion: The value of exchange rate can be increased by increasing the level of export. Government reduces various export duties so as to encourage exports. Government also gives cash assistance and subsidies to exporters to stimulate the level of export. Various facilities like quality control, provision of market information and arranging exhibitions of exportable goods in foreign countries are also given to promote exports.(Pettinger, 2012)

• Production of import substitutes: Steps are taken up by the government to encourage the production of import substitutes. This will help to save the amount of foreign exchange in the short run by replacing the use of imports by these import substitutes.

• Fiscal Policy: It aimed at reducing the total government expenditure which helps in the exchange rate mechanism. An increase in direct taxes will reduce the disposable income of the people. This will lead to a reduction of consumption and a decrease of imports. A cut in government expenditure will have the same effect of reducing the demand for imported goods. (Neely, 2004)

3(c ) India intervenes in its exchange rate mechanism. Some of the measures or steps taken to manage the exchange rate are as follows:

• Since independence central bank of India has been changing its bank rate several times till now. Central bank increases the bank rate when inflation increases in the country. Again when downward tendencies are observed, central bank attempts to bring the economy of our country to stable condition.(Mittal, 2012)

• Fiscal policy has been introduced by the Indian government to cut the level of government total expenditure and to manage the exchange rate mechanism effectively.

• Measure such as buying and selling of securities in open market has been adopted by Indian government in order to effectively manage the exchange rate of Indian currency.

• Indian government is tapping more into foreign market by expanding the level of export and reducing the level of import. It helps to increase the value of Indian currency in foreign market.(Rishipal, 2012)

Conclusion

Every country should adopt all necessary measures in order to control the deficit financing and an increase in the rate of inflation so as to prevent their value of currency from depreciating. All necessary fiscal and monetary measures should be adopted and new reform measures should be introduced in order to effectively manage the exchange rate mechanism.

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