Question

Question 4: Discuss the following

1- The increase in official reserves of the country is recorded in the Balance of Payments in the debit side of the Official Reserve Transactions account, comment.

2- In the free floating exchange rate system, the black market for foreign currencies disappears. Discuss the validity of this phrase, explaining the reasons.

Answer 1

1. If there is an increase in official reserves of the country, this implies that the change in foreign assets of the country is greater than the country's change in assets abroad. This is the decrease in net wealth of the country. This is why the increase in official reserves is shown on the debit side of the Official Reserve Transaction Account.

2. The black market in freely floating exchange rate regime disappears theoretically in the sense that in this regime, the local currency reflects the true value of the foreign currency which wipes out the black market of the currency.

In reality, black market can still exist even under freely floating exchange rate regime. This is because many forex transaction can go unaccounted which are done by individuals. For instance, hawala tranactions. In other words, many transctions are done in cash in order to escape taxes etc. This creates black market for the currency and the true value of foreign currency is not reflected by the local currency.