Question : If a country experiences an increase in its foreign exchange reserves, it indicates:
Option 1: A surplus in the current account
Option 2: A deficit in the current account
Option 3: A surplus in the capital account
Option 4: A deficit in the capital account
Correct Answer: A surplus in the current account
Solution : The correct answer is (a) A surplus in the current account.
Foreign exchange reserves are the foreign currency assets held by a country's central bank. An increase in foreign exchange reserves suggests that the country is receiving more foreign currency inflows than it is using for its current account transactions.
The current account of the balance of payments records the transactions related to the trade in goods, services, income flows, and unilateral transfers. A surplus in the current account means that a country's exports of goods and services, as well as income received from abroad, exceed its imports and income payments to foreign entities.
Therefore, an increase in foreign exchange reserves generally indicates a surplus in the current account.
