UPSC CSE Prelims
External Sector Previous Year Questions (PYQs)
Showing solved Previous Year Questions for Chapter: External Sector
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Which of the following is/are the most significant implication(s) of obtaining Oeko-Tex certification for Eri Silk in the global textile industry?
- It allows Indian exporters to compete in high-end markets that prioritise chemical-free products.
- It confirms that Eri Silk meets international safety, environmental, and quality standards, enabling its entry into premium eco-conscious markets.
Select the answer using the code given below:
Detailed Explanation:
Statement 1 — Correct. Oeko-Tex certification proves the silk is free from harmful chemicals. This helps Indian exporters compete in high-end global markets that demand safe, chemical-free products.
Statement 2 — Correct. This certification confirms Eri Silk meets international safety, environmental, and quality standards. Combined with its GI tag and reputation as cruelty-free "peace silk" (no silkworm killed in production), it opens doors to premium eco-conscious markets like Europe and North America.
Both statements are simply two sides of the same benefit — certification = trust = market access.
Consider the following Statements :
Statement-I: Switzerland is one of the leading exporters of gold in terms of value.
Statement-II: Switzerland has the second largest gold reserves in the world.
Which one of the following is correct in respect of the above statements?
Detailed Explanation:
Answer: Option 3 — Statement-I is correct but Statement-II is incorrect
Switzerland is indeed one of the leading exporters of gold in terms of value, consistently ranking first globally due to its role as a major gold refining and trading hub. However, Switzerland does not have the second largest gold reserves in the world; the United States holds the largest gold reserves (approximately 8,000 tonnes), followed by Germany, Italy, and France—Switzerland ranks much lower.
✅ Statement-I – Correct: Switzerland is the world's leading exporter of gold by value, having exported $86.7B in gold in 2021, primarily due to its extensive gold refining industry.
❌ Statement-II – Incorrect: Switzerland does not have the second largest gold reserves; the United States has the largest reserves, followed by Germany and Italy.
📝 Short Notes: Global Gold Trade and Reserves
- Top Gold Exporters: Switzerland consistently ranks #1 in gold exports by value due to its sophisticated refining infrastructure and position as a global trading hub.
- Top Gold Reserves (2024): 1. United States (~8,000 tonnes), 2. Germany (~3,350 tonnes), 3. Italy (~2,450 tonnes), 4. France (~2,440 tonnes), 5. Russia (~2,300 tonnes).
- India's Gold Resources: Primary gold ore resources are concentrated in Bihar (44%), Rajasthan (25%), Karnataka (21%), with smaller deposits in West Bengal, Andhra Pradesh, and Jharkhand.
- India's Gold Trade: India is one of the largest gold importers (800-1,000 tonnes annually), sourcing mainly from Switzerland, UAE, and South Africa, driven by jewelry and investment demand.
- Switzerland's Role: Acts as a refining center, importing raw gold, refining it to high purity standards, and re-exporting to global markets.
Consider the following statements:
- Tight monetary policy of US Federal Reserve could lead to capital flight.
- Capital flight may increase cost of firms with existing External Commercial Borrowings (ECBs)
- Devaluation of domestic currency decreases the currency risk associated with ECBs
Which of the statements given above are correct?
Detailed Explanation:
Answer: Option 2 — 1 and 2 only
A tight monetary policy by the US Federal Reserve involves raising interest rates, which makes US assets more attractive to global investors, leading to capital flight from emerging markets. This capital outflow causes domestic currency depreciation and increases the cost of servicing External Commercial Borrowings (ECBs) for firms, as they must pay more in domestic currency to repay foreign currency-denominated debt.
✅ Statement 1 – Correct: Tight US monetary policy (higher interest rates) attracts capital to the US, causing capital flight from emerging economies like India as investors seek better returns.
✅ Statement 2 – Correct: Capital flight leads to currency depreciation, increasing the rupee cost of repaying ECBs denominated in foreign currency (like USD), thereby raising the financial burden on firms.
❌ Statement 3 – Incorrect: Devaluation of the domestic currency increases (not decreases) currency risk for ECBs, as firms need more rupees to repay the same amount of foreign currency debt.
📝 Short Notes: External Commercial Borrowings (ECBs)
- Definition: ECBs are commercial loans raised by Indian companies from foreign lenders in foreign currencies, typically for financing imports, infrastructure, or expansion projects.
- Currency Risk: Since ECBs are denominated in foreign currency (usually USD or Euro), any depreciation of the rupee increases the repayment burden in rupee terms.
- Impact of Capital Flight: When capital flows out of India (e.g., due to tight US monetary policy), the rupee depreciates, making ECB repayments more expensive for Indian firms.
- Interest Rate Differential: ECBs are attractive when foreign interest rates are lower than domestic rates, but this advantage is offset if currency depreciation occurs.
- Regulation: The Reserve Bank of India (RBI) regulates ECBs through guidelines on permissible end-uses, borrowing limits, and maturity periods to manage external debt risks.
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With reference to foreign-owned e-commerce firms operating in India, which of the following statements is/are correct ?
- They can sell their own goods in addition to offering their platforms as market-places.
- The degree to which they can own big sellers on their platforms is limited.
Which of the above statements are correct?
Detailed Explanation:
Answer: Option 2 — 2 only
This question tests the understanding of FDI regulations governing foreign e-commerce firms in India. Statement 1 is incorrect because foreign-owned e-commerce companies operating under the marketplace model are prohibited from selling their own goods. Statement 2 is correct as regulations limit their ownership and control over sellers on their platforms.
❌ Statement 1 – Incorrect: Foreign-owned e-commerce firms operating under the marketplace model cannot sell their own goods; they can only provide a platform connecting buyers and sellers. FDI in inventory-based models is prohibited.
✅ Statement 2 – Correct: Press Note 2 (2018) limits platform ownership of sellers—if more than 25% of a vendor's purchases come from the marketplace entity or its group companies, the vendor is deemed controlled by the platform, which is not allowed.
📝 Short Notes: FDI Policy in E-Commerce
| Aspect | Marketplace Model | Inventory-based Model |
|---|---|---|
| FDI Allowed | 100% FDI permitted under automatic route | FDI not permitted |
| Business Model | Acts as facilitator/platform between buyers and sellers | Owns inventory and sells directly to consumers |
| Inventory Ownership | Cannot own or control inventory | Owns and controls inventory |
| Selling Own Goods | Prohibited from selling their own goods | Can sell own goods (but FDI not allowed) |
| Control Over Vendors | Cannot control vendors; 25% purchase limit (Press Note 2, 2018) | Full control over inventory and sales |
| Examples | Amazon India, Flipkart (as marketplace) | Traditional retail e-commerce |
- Press Note 2 (2018): Tightened norms to prevent circumvention—vendors with >25% purchases from marketplace or its group companies are deemed controlled entities.
- Purpose: Protect small retailers and ensure level playing field; prevent predatory pricing and deep discounting.
- Single Vendor Restriction: Marketplace entities and their group companies cannot sell more than 25% of sales through a single vendor.
- Services Allowed: Can provide warehousing, logistics, order fulfillment, call center, and payment collection services.
With reference to the Indian economy, consider the following statements:
- An increase in Nominal Effective Exchange Rate (NEER) indicates the appreciation of rupee.
- An increase in the Real Effective Exchange Rate (REER) indicates an improvement in trade competitiveness.
- An increasing trend in domestic inflation relative to inflation in other countries is likely to cause an increasing divergence between NEER and REER.
Which of the above statements are correct?
Detailed Explanation:
Answer: Option 3 — 1 and 3 only
This question tests the understanding of exchange rate indices and their relationship with inflation and trade competitiveness. Statement 2 is incorrect because an increase in REER indicates overvaluation of the currency, which actually worsens (not improves) trade competitiveness.
✅ Statement 1 – Correct: NEER is a weighted average of a country's currency against a basket of trading partner currencies. An increase in NEER indicates that the domestic currency has appreciated relative to the basket of foreign currencies.
❌ Statement 2 – Incorrect: An increase in REER indicates that the domestic currency is becoming overvalued in real terms (after adjusting for inflation differentials), which reduces export competitiveness and worsens trade competitiveness, not improves it.
✅ Statement 3 – Correct: When domestic inflation is higher than foreign inflation, the real value of the currency depreciates faster than the nominal value. This causes REER to decline or grow slower than NEER, creating a divergence between the two indices.
📝 Short Notes: NEER and REER
- NEER (Nominal Effective Exchange Rate): Weighted average of bilateral nominal exchange rates of home currency against a basket of foreign currencies; measures nominal appreciation/depreciation without considering inflation.
- REER (Real Effective Exchange Rate): NEER adjusted for relative price levels (inflation differentials); measures real appreciation/depreciation and actual competitiveness.
- Formula relationship: REER = NEER × (Domestic Price Index / Foreign Price Index)
- Appreciation vs Competitiveness: If REER increases → currency overvalued → exports become expensive → trade competitiveness worsens; If REER decreases → currency undervalued → exports become cheaper → trade competitiveness improves.
- Inflation Impact: Higher domestic inflation relative to trading partners causes REER to rise faster than NEER (real appreciation), reducing competitiveness.
- Policy Implication: RBI monitors both NEER and REER; a rising REER signals loss of export competitiveness and may require policy intervention.
Consider the following statements:
The effect of devaluation of a currency is that it necessarily:-
- improves the competitiveness of the domestic exports in the foreign markets.
- increases the foreign value of domestic currency.
- improves the trade balance.
Which of the above statements is/are correct?
Detailed Explanation:
Answer: Option 1 — 1 Only
Currency devaluation makes domestic goods cheaper for foreign buyers, thereby improving export competitiveness in international markets. However, it decreases (not increases) the foreign value of domestic currency and does not necessarily improve the trade balance as outcomes depend on various other factors like import dependency and global demand elasticity.
✅ Statement 1 – Correct: Devaluation reduces the price of exports in foreign currency terms, making domestic goods more competitive in foreign markets and potentially increasing export demand.
❌ Statement 2 – Incorrect: Devaluation decreases the foreign value of domestic currency, not increases it—this is the fundamental mechanism of devaluation where domestic currency becomes cheaper relative to foreign currencies.
❌ Statement 3 – Incorrect: While devaluation can improve trade balance by boosting exports, it's not guaranteed as it may also increase import costs (especially for import-dependent economies), lead to inflation, and the final impact depends on price elasticity of demand for exports and imports (Marshall-Lerner condition).
📝 Short Notes: Currency Devaluation
- Definition: Deliberate downward adjustment of a currency's value relative to foreign currencies by the government or monetary authority under a fixed/semi-fixed exchange rate regime.
- Immediate Effects: Exports become cheaper in foreign markets; imports become more expensive in domestic terms; foreign currency reserves become more valuable in domestic currency.
- Export Competitiveness: Domestic products gain price advantage in international markets, potentially increasing export volumes if demand is price-elastic.
- Marshall-Lerner Condition: Trade balance improves only if sum of price elasticities of demand for exports and imports is greater than 1; otherwise, trade deficit may worsen.
- J-Curve Effect: Initially trade balance may worsen (due to existing contracts and time lags), then improve over medium to long term as export volumes respond to price changes.
- Risks: Imported inflation (especially for raw materials and energy), potential competitive devaluations by trading partners, reduced purchasing power for foreign goods and services.
Consider the following
- Foreign Currency convertible bonds
- Foreign Institutional investment with certain conditions
- Global depository receipts
- Non-resident external deposits
Which of the above can be included in Foreign Direct Investments?
Detailed Explanation:
Answer: Option 1 — 1, 2 and 3
Foreign Direct Investment (FDI) refers to investment through capital instruments by a person resident outside India in an unlisted Indian company, or in 10% or more of the post-issue paid-up equity capital of a listed Indian company. FCCBs and GDRs are treated as FDI because they convert into equity shares. Foreign Institutional Investment exceeding the 10% threshold is also classified as FDI as per the Arvind Mayaram Committee recommendations.
✅ Statement 1 – Correct: Foreign Currency Convertible Bonds (FCCBs) are debt instruments convertible into equity shares and are treated as FDI under India's FDI policy framework.
✅ Statement 2 – Correct: Foreign Institutional Investment (FII) with certain conditions, specifically when it exceeds 10% of equity capital, is classified as FDI as recommended by the Arvind Mayaram Committee.
✅ Statement 3 – Correct: Global Depository Receipts (GDRs) represent equity shares of Indian companies in foreign markets and are classified as FDI instruments.
❌ Statement 4 – Incorrect: Non-Resident External (NRE) deposits are banking capital maintained by NRIs in Indian banks and are classified as external debt, not as FDI in productive enterprises.
📝 Short Notes: Foreign Direct Investment (FDI) Classification
| Instrument/Category | Classification | Key Features |
|---|---|---|
| Foreign Currency Convertible Bonds (FCCBs) | FDI | Debt instruments convertible into equity shares; raise capital from foreign markets |
| Global Depository Receipts (GDRs) | FDI | Represent equity shares of Indian companies traded in foreign markets |
| American Depository Receipts (ADRs) | FDI | Similar to GDRs but specifically traded in US markets |
| FII/FPI (below 10%) | Portfolio Investment | Short-term investment in securities without controlling interest |
| FII/FPI (above 10%) | FDI | As per Arvind Mayaram Committee; reflects controlling interest |
| NRE Deposits | Banking Capital/External Debt | Bank accounts of NRIs; not investment in productive enterprises |
- FDI Definition: Investment in unlisted company or 10%+ equity in listed company by non-resident entities
- 10% Threshold: Critical benchmark distinguishing FDI from portfolio investment
- Equity Linkage: Instruments convertible to or representing equity shares qualify as FDI
- Banking Capital vs FDI: NRE/NRO deposits are banking transactions, not productive investments
If another global financial crisis happens in the near future, which of the following actions/policies are most likely to give some immunity to India?
- Not depending on short-term foreign borrowings
- Opening up to more foreign banks
- Maintaining full capital account convertibility
Select the correct answer using the code given below:
Detailed Explanation:
Answer: Option 1 — 1 only
During a global financial crisis, India's primary shield against external shocks is reducing dependence on short-term foreign borrowings, which minimizes vulnerability to sudden capital flight and currency instability. The other two measures would actually increase systemic risk rather than provide immunity.
✅ Statement 1 – Correct: Limiting short-term foreign borrowings reduces exposure to capital flight; when foreign investors withdraw funds during a crisis, economies with lower short-term external debt face less rupee depreciation and financial instability.
❌ Statement 2 – Incorrect: Opening up to more foreign banks increases reliance on foreign capital and credit; during a crisis, foreign banks typically restrict lending, amplifying credit contraction and economic damage in the host economy.
❌ Statement 3 – Incorrect: Full capital account convertibility permits unrestricted outflow of foreign capital; this accelerates capital flight during crises, causing sharp currency depreciation and financial sector stress, making the economy more vulnerable rather than immune.
📝 Short Notes: Capital Account Management and Financial Stability
- Capital Account Convertibility: Allows free movement of capital across borders. India has partial convertibility on the capital account, maintaining restrictions on short-term speculative flows to manage systemic risk.
- Short-term Foreign Debt Risk: Creates currency mismatch and rollover risk; during crises, maturity mismatches force rapid repayment, depleting foreign reserves and destabilizing the exchange rate.
- Foreign Direct Investment vs. Foreign Portfolio Investment: FDI (long-term, stable) is preferred over FPI (short-term, volatile); foreign banks' presence increases FPI dependency and pro-cyclical credit behavior during downturns.
- Debt Sustainability Framework: Countries with lower short-term external debt as a percentage of foreign reserves and lower debt-to-GDP ratios demonstrate greater resilience to external shocks.
With reference to Foreign Direct Investment in India, which one of the following is considered its major characteristic?
Detailed Explanation:
Answer: Option 2 — It is a largely non-debt creating capital flow.
Foreign Direct Investment (FDI) is characterized as a non-debt creating capital flow because it involves equity investments and long-term stakes in enterprises, which do not require repayment like loans or bonds. Unlike debt financing, FDI brings permanent capital, technology, and management expertise without creating obligations for interest payments or principal repayment.
❌ Option 1 – Incorrect: FDI typically involves direct ownership stakes in unlisted or private companies, not merely investments through capital instruments in listed companies (which is more characteristic of FPI).
✅ Option 2 – Correct: FDI is a non-debt creating capital flow as it involves equity participation without repayment obligations, making it a stable and long-term source of foreign capital.
❌ Option 3 – Incorrect: FDI does not involve debt-servicing since it represents equity ownership rather than borrowed capital that requires interest or principal repayment.
❌ Option 4 – Incorrect: Investment by foreign institutional investors in Government securities is classified as Foreign Portfolio Investment (FPI), not FDI, as it involves short-term financial investments without control or management participation.
📝 Short Notes: Foreign Direct Investment (FDI) vs Foreign Portfolio Investment (FPI)
| Parameter | Foreign Direct Investment (FDI) | Foreign Portfolio Investment (FPI) |
|---|---|---|
| Nature | Equity participation with control/management | Investment in financial assets without control |
| Duration | Long-term investment | Short-term investment |
| Debt Creation | Non-debt creating capital flow | Non-debt creating but volatile |
| Investment Mode | Greenfield projects, M&A, equity stakes | Stocks, bonds, government securities |
| Stability | More stable and permanent | Volatile, prone to quick exit |
| Example | Setting up manufacturing plant, acquiring company shares for control | FIIs investing in stock market or G-secs |
With reference to the international trade of India at present, which of the following statements is/are correct?
- India’s merchandise exports are less than its merchandise imports.
- India’s imports of iron and steel, chemicals, fertilisers and machinery have decreased in recent years.
- India’s exports of services are more than its imports of services.
- India suffers from an overall trade/current account deficit.
Select the correct answer using the code given below:
Detailed Explanation:
Answer: Option 4 — 1, 3 and 4 only
India consistently runs a merchandise trade deficit (imports exceed exports) and an overall current account deficit, while maintaining a services trade surplus. Statement 2 is incorrect as imports of iron and steel, chemicals, fertilizers, and machinery have actually increased in recent years, not decreased.
✅ Statement 1 – Correct: India's merchandise imports consistently exceed merchandise exports, creating a substantial trade deficit.
❌ Statement 2 – Incorrect: Imports of iron and steel, chemicals, fertilizers, and industrial machinery have registered positive growth rates, not decreased.
✅ Statement 3 – Correct: India maintains a services trade surplus, with service exports significantly exceeding service imports.
✅ Statement 4 – Correct: India suffers from an overall current account deficit (CAD), which was 2.1% of GDP in 2018-19 and 1.5% in H1 of 2019-20.
📝 Short Notes: India's Balance of Payments Structure
- Merchandise Trade: India runs a persistent merchandise trade deficit, with major imports including petroleum, gold, electronics, machinery, and chemicals.
- Services Trade: India enjoys a services trade surplus driven by IT-BPO exports, software services, business services, and remittances.
- Current Account Components: CAD = (Merchandise Trade Balance) + (Services Trade Balance) + (Primary Income) + (Secondary Income/Transfers).
- Major Export Items: Petroleum products, gems & jewelry, pharmaceuticals, engineering goods, textiles, and chemicals.
- Major Import Items: Crude oil & petroleum products, gold, electronic goods, machinery, coal, chemicals, and fertilizers.
- CAD Management: India finances CAD through foreign direct investment (FDI), foreign portfolio investment (FPI), and external commercial borrowings (ECB).
- Historical Trend: The services surplus partially offsets the merchandise deficit, but India typically maintains a moderate CAD of 1-3% of GDP.
Among the following, which one is the largest exporter of rice in the world in the last five years?
Detailed Explanation:
Answer: Option 2 — India
India has consistently been the world's largest exporter of rice since 2012, maintaining its dominant position in the global rice export market. During the five-year period preceding 2019, India accounted for approximately 30% of total global rice exports, far ahead of competitors like Thailand and Vietnam. While China is the world's largest rice producer, it is primarily a consumer and net importer, whereas India has a substantial exportable surplus that it ships to international markets.
📝 Short Notes: Global Rice Trade
- India's Dominance: India has been the world's largest rice exporter since 2012, with exports valued at approximately US$7.4 billion in 2018.
- Export Share: India accounts for about 30-35% of global rice exports, exporting varieties like Basmati and non-Basmati rice to over 150 countries.
- Major Competitors: Thailand (historically the largest exporter until 2012), Vietnam, Pakistan, and the United States are other significant rice exporters.
- China's Position: Despite being the world's largest rice producer, China is a net importer due to high domestic consumption and focuses on self-sufficiency.
- Key Export Destinations: India's major rice export markets include African countries, Middle East nations, Bangladesh, Nepal, and European countries.
- Basmati Advantage: India enjoys a monopoly in premium Basmati rice exports along with Pakistan, commanding premium prices in international markets.
Consider the following statements:
- Most of India’s external debt is owed by governmental entities.
- All of India’s external debt is denominated in US dollars.
Which of the statements given above is/are correct?
Detailed Explanation:
Answer: Option 4 — Neither 1 nor 2
Both statements about India's external debt are incorrect. Most of India's external debt is owed by non-governmental entities (commercial borrowings, NRI deposits, and trade credit account for the majority), while government debt constitutes a smaller portion. Additionally, India's external debt is denominated in multiple currencies, with US dollar being the largest but not the only component.
❌ Statement 1 – Incorrect: Non-governmental debt (US$ 416.7 billion) far exceeds governmental debt (US$ 104.5 billion), making most external debt non-governmental in nature.
❌ Statement 2 – Incorrect: While US dollar-denominated debt is the largest component (45.9%), India's external debt is also denominated in Indian rupee (24.8%), SDR (5.1%), Japanese yen (4.9%), euro (3.1%), and other currencies.
📝 Short Notes: India's External Debt
| Component | Details |
|---|---|
| Definition | Total debt owed by India to foreign creditors (private banks, foreign governments, IMF, World Bank, etc.) |
| By Debtor Type | Non-Government Debt: ~80% (US$ 416.7 billion) Government Debt: ~20% (US$ 104.5 billion) |
| By Components | Commercial Borrowings: 37.4% NRI Deposits: 24.1% Short-term Trade Credit: 19.9% Others: Balance |
| Currency Composition | US Dollar: 45.9% Indian Rupee: 24.8% SDR: 5.1% Japanese Yen: 4.9% Euro: 3.1% Others: Balance |
| Key Debtors | Union Government, State Governments, Corporations, Indian Citizens |
Among the agricultural commodities imported by India, which one of the following accounts for the highest imports in terms of value in the last five years?
Detailed Explanation:
Answer: Option 4 — Vegetable oils
India imports approximately 70% of its edible oil requirements, making vegetable oils the highest agricultural commodity import by value over the last five years. The imports include palm oil, soybean oil, and sunflower oil, collectively accounting for billions of dollars annually. This heavy dependence is due to limited domestic production capacity and rising consumption patterns.
📝 Short Notes: India's Agricultural Imports
- Vegetable Oils: India is the world's largest importer of vegetable oils, importing about 14-15 million tonnes annually, accounting for nearly 70% of domestic consumption.
- Main imported oils: Palm oil (from Indonesia and Malaysia), soybean oil (from Argentina and Brazil), and sunflower oil (from Ukraine and Russia).
- Pulses: India is also a major importer of pulses (lentils, peas, chickpeas), importing 2-3 million tonnes annually, primarily from Canada, Myanmar, and Australia.
- Fresh Fruits: Imports include apples, dates, and exotic fruits, but the value is significantly lower than vegetable oils.
- Spices: India is traditionally a net exporter of spices, though some premium varieties are imported in small quantities.
- Import Implications: High vegetable oil imports strain foreign exchange reserves and make India vulnerable to global price fluctuations and supply disruptions.
Which one of the following is not the most likely measure the Government/RBI takes to stop the slide of Indian rupee?
Detailed Explanation:
Answer: Option 4 — Following an expansionary monetary policy
An expansionary monetary policy involves lowering interest rates and increasing money supply, which makes the rupee less attractive to foreign investors and encourages capital outflow. This increases the supply of rupees in the forex market, leading to further depreciation rather than stabilizing it. To stop rupee depreciation, the RBI typically adopts a contractionary monetary policy (raising interest rates) to attract foreign capital inflows and support the currency.
✅ Option 1 – Likely measure: Curbing non-essential imports reduces dollar outflow while promoting exports increases dollar inflow, both supporting the rupee.
✅ Option 2 – Likely measure: Masala Bonds (rupee-denominated bonds issued abroad) attract foreign investment without creating dollar repayment obligations, supporting the rupee.
✅ Option 3 – Likely measure: Easing external commercial borrowing norms encourages dollar inflows from foreign lenders, increasing forex reserves and supporting the rupee.
❌ Option 4 – NOT a likely measure: Expansionary monetary policy weakens the currency by reducing returns on rupee assets and encouraging capital flight.
📝 Short Notes: Measures to Control Rupee Depreciation
| Type of Measure | Specific Actions | Impact on Rupee |
|---|---|---|
| Trade Measures | • Curb non-essential imports • Promote exports • Impose import duties |
Reduces dollar outflow and increases inflow |
| Capital Inflow Measures | • Masala Bonds • Ease FDI/FPI norms • Sovereign bonds |
Increases foreign investment without dollar liability |
| Monetary Policy | • Raise interest rates (contractionary) • Reduce liquidity |
Attracts foreign capital through higher returns |
| Forex Management | • RBI sells dollars from reserves • Forward rate management • Swap arrangements |
Directly increases dollar supply in market |
| External Borrowing | • Ease ECB norms • NRI deposit schemes • Bilateral currency swaps |
Increases dollar availability |
In the context of India, which of the following factors is/are contributor/contributors to reducing the risk of a currency crisis?
- The foreign currency earnings of India’s IT sector
- Increasing the government expenditure
- Remittances from Indians abroad
Select the correct answer using the code given below.
Detailed Explanation:
Answer: Option 2 — 1 and 3 only
A currency crisis occurs when a country faces rapid depletion of foreign exchange reserves, making it unable to meet its international payment obligations. Factors that increase foreign currency inflows help build reserves and reduce such risks.
✅ Statement 1 – Correct: India's IT sector earns substantial foreign exchange through service exports, directly strengthening forex reserves and providing a cushion against currency volatility.
❌ Statement 2 – Incorrect: Increasing government expenditure, especially if financed through borrowing, can widen fiscal deficits and potentially weaken investor confidence, thereby increasing rather than reducing currency crisis risk.
✅ Statement 3 – Correct: Remittances from Indians working abroad constitute a steady inflow of foreign currency, which bolsters forex reserves and acts as a buffer against external shocks.
📝 Short Notes: Factors Reducing Currency Crisis Risk
- Foreign Exchange Reserves: Act as a cushion to meet import bills and external debt obligations during times of stress.
- Current Account Balance: Export earnings (goods and services) and remittances improve the current account, reducing dependency on foreign capital.
- IT & Service Exports: India's IT sector is a major net foreign exchange earner, contributing significantly to invisible receipts.
- Remittances: India is the largest recipient of remittances globally, providing a stable source of foreign currency inflows.
- Fiscal Discipline: Excessive government expenditure leading to high fiscal deficits can trigger capital outflows and currency depreciation if financed unsustainably.
- Capital Controls: Prudent management of capital flows helps prevent sudden stops and reversals that trigger currency crises.
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