“Many Multinational Corporations (MNCs) have recently shifted their production from China to India, which has boosted the ‘Make in India’ plan.”
Assuming other factors being constant, discuss the effects of the given statement on foreign exchange rates with reference to the Indian economy.
“Many Multinational Corporations (MNCs) have recently shifted their production from China to India, which has boosted the ‘Make in India’ plan.”
Assuming other factors being constant, discuss the effects of the given statement on foreign exchange rates with reference to the Indian economy.
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Solution and Explanation
MNCs are shifting their production from China to India. This helps the Make in India plan.
We must assume other factors stay constant and find the effect on the exchange rate of the rupee.
The exchange rate is the price of one currency in terms of another. Here it is the price of foreign currency (say the dollar) in rupees.
Step 2: Effect on production and trade:
When MNCs set up plants in India, they bring in capital and technology. Domestic production of goods rises.
Part of this extra output is sold abroad, so Indian exports increase.
Higher production at home can also reduce the need to import some goods. So net exports (exports minus imports) improve.
Step 3: Effect on Balance of Payments:
More exports mean more earnings from abroad. MNC investment also brings in foreign capital.
So the Balance of Payments (BoP) position of India improves.
Step 4: Effect on the foreign exchange market:
More dollars now flow into India. The supply of foreign exchange rises.
When the supply of foreign exchange rises and demand stays the same, the price of foreign exchange falls.
A fall in the price of foreign currency means one dollar buys fewer rupees. In other words the rupee gets stronger.
Economists call this appreciation of the domestic currency. The exchange rate (rupees per dollar) falls.
Final Answer:
The shift of MNC production to India raises output and net exports and improves the BoP. Inflow of foreign exchange rises, so the Indian rupee appreciates against foreign currencies.
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