UPSC CSE Prelims
External Sector Previous Year Questions (PYQs)
Showing solved Previous Year Questions for Chapter: External Sector
Topic Breakdown: Scroll →
Which of the following is issued by registered foreign portfolio investors to overseas investors who want to be part of the Indian stock market without registering themselves directly?
Detailed Explanation:
Answer: Option 4 — Participatory Note
Participatory Notes (P-Notes) are financial instruments issued by registered Foreign Portfolio Investors (FPIs) to overseas investors who wish to invest in Indian securities without directly registering with SEBI. The FPI holds the underlying Indian securities on behalf of the overseas investor, and the P-Note represents their beneficial ownership.
Why other options are incorrect:
• Certificate of Deposit is a short-term debt instrument issued by banks to mobilize deposits, not related to stock market participation.
• Commercial Paper is an unsecured short-term debt instrument issued by corporations to meet working capital needs, not for foreign portfolio investment.
• Promissory Note is a written promise to pay a specified sum of money at a future date, unrelated to stock market investment mechanisms.
📝 Short Notes: Participatory Notes (P-Notes)
- Definition: Offshore derivative instruments issued by registered FPIs to overseas investors for investing in Indian securities without direct SEBI registration.
- Regulatory Body: Securities and Exchange Board of India (SEBI) regulates P-Notes through FPI regulations.
- Advantages: Easier market access for foreign investors, reduced compliance burden, and anonymity for investors.
- Concerns: Potential for round-tripping of funds, lack of transparency regarding ultimate beneficiaries, and money laundering risks.
- SEBI Regulations: SEBI has tightened P-Note norms over time, requiring FPIs to conduct proper KYC of P-Note subscribers and restricting certain derivative structures.
- Market Impact: P-Notes constitute a significant portion of FPI investments in India, though their share has declined due to stricter regulations.
The term ‘Domestic Content Requirement’ is sometimes seen in the news with reference to -
Detailed Explanation:
Answer: Option 1 — Developing solar power production in our country
Domestic Content Requirement (DCR) is a policy mandate that requires a certain percentage of components or equipment used in a project to be manufactured domestically. In India, DCR has been prominently used in the solar power sector, where the government mandated that solar power developers use a specified percentage of domestically manufactured solar cells and modules in their projects. This policy was designed to promote indigenous solar manufacturing capabilities and reduce import dependence, though it faced challenges at the WTO due to trade obligations. The term is most commonly associated with the National Solar Mission and solar power development in India.
Which of the following best describes the term “import cover”, sometimes seen in the news?
Detailed Explanation:
Answer: Option 4 — It is the number of months of imports that could be paid for by a country's international reserves
Import cover is a key indicator of external sector stability that measures how many months of imports a nation can finance using its current foreign exchange reserves. It is calculated by dividing total foreign exchange reserves by average monthly imports. For example, if a country has $300 billion in reserves and monthly imports of $25 billion, its import cover is 12 months. A higher import cover indicates stronger ability to withstand balance of payments crises or sudden capital outflows. The Reserve Bank of India typically aims to maintain adequate import cover (generally 9-12 months) to ensure economic security. Option 1 describes import intensity relative to GDP, Option 2 refers to absolute import value, and Option 3 describes the export-import ratio, none of which capture the reserves-to-imports relationship that defines import cover.
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Consider the following statements with reference to ‘IFC Masala Bonds’ -
- The International Finance Corporation, which offers these bonds, is an arm of the World Bank.
- They are the rupee-denominated bonds and are a source of debt financing for the public and private sector.
Select the correct answer using the code given below.
Detailed Explanation:
Answer: Option 3 — Both 1 and 2
✅ Statement 1 – Correct: The International Finance Corporation (IFC) is the private sector arm of the World Bank Group, which comprises five institutions working to reduce poverty and promote sustainable development in developing countries.
✅ Statement 2 – Correct: Masala Bonds are rupee-denominated bonds issued outside India by foreign entities to raise capital in Indian rupees. They serve as a source of debt financing for both public and private sector entities, while the currency risk is borne by the investors rather than the issuer.
The problem of international liquidity is related to the non-availability of -
Detailed Explanation:
International liquidity refers to the availability of foreign exchange reserves (primarily hard currencies like the US Dollar, Euro, Yen, and Pound Sterling) that a country holds to meet its short-term international payment obligations.
The problem of international liquidity arises when there is a shortage of reserve currencies needed for import payments, debt servicing, and foreign exchange market interventions, not a lack of physical goods, precious metals, or exportable surplus.
Convertibility of rupee implies:
Detailed Explanation:
Convertibility of rupee refers to the freedom to convert Indian rupees into other currencies and vice versa without restrictions, enabling cross-border transactions.
Option 1 refers to the outdated gold standard, Option 2 describes a floating exchange rate system, and Option 4 refers to currency trading infrastructure—none of which defines convertibility itself.
With reference to Balance of Payments, which of the following constitutes/constitute the Current Account?
- Balance of trade
- Foreign assets
- Balance of invisibles
- Special Drawing Right
Select the correct answer using the code given below.
Detailed Explanation:
Current Account of the Balance of Payments (BoP) comprises two main components: Balance of Trade (visible items - exports and imports of goods) and Balance of Invisibles (invisible items - services, income, and current transfers).
Foreign Assets are part of the Capital Account/Financial Account, representing investment flows and changes in ownership of international assets. Special Drawing Rights (SDR) are IMF reserve assets recorded under Reserve Assets in the BoP, not in the Current Account.
Which one of the following groups of items are included in India’s foreign-exchange reserves?
Detailed Explanation:
India's foreign-exchange reserves consist of four components: Foreign Currency Assets (FCAs), Gold holdings by the RBI, Special Drawing Rights (SDRs) from the IMF, and Reserve Tranche Position (RTP) in the IMF.
Loans from foreign countries, World Bank, or other institutions are external debts/liabilities, not part of foreign-exchange reserves which represent assets held by RBI that can be readily deployed.
Which of the following constitute Capital Account?
- Foreign Loans
- Foreign Direct Investment
- Private Remittances
- Portfolio Investment
Select the correct answer using the codes given below.
Detailed Explanation:
1. Foreign Loans – Capital Account: Borrowings from abroad by government or private sector represent capital inflows and are recorded in the Capital Account.
2. Foreign Direct Investment (FDI) – Capital Account: Long-term investments by foreign entities in domestic companies creating lasting interest are part of the Capital Account.
3. Private Remittances – Current Account: Funds sent by individuals (e.g., migrant workers) to their home country are transfer payments recorded in the Current Account, not Capital Account.
4. Portfolio Investment – Capital Account: Investments in stocks, bonds, and financial securities by foreigners are short-term capital flows part of the Capital Account.
Correct Answer: Option 2 (1, 2 and 4 only) – Private Remittances fall under Current Account.
The balance of payments of a country is a systematic record of
Detailed Explanation:
Balance of Payments (BoP) is a systematic record of all economic transactions between residents of a country and the rest of the world during a specific period (usually a year).
It includes trade in goods (visible trade), trade in services (invisible trade), income flows, current transfers, and capital and financial account transactions—making it comprehensive, not limited to just imports/exports of goods or only government transactions.
Economic growth in country X will necessarily have to occur if
Detailed Explanation:
Capital formation is the only factor among the given options that necessarily leads to economic growth within a country.
✅ Statement 3 – Correct: Capital formation in X (investment in physical capital like machinery, infrastructure, and human capital) directly increases the productive capacity of the economy, making growth inevitable.
❌ Statement 1 – Incorrect: Technical progress in the world economy does not guarantee growth in country X unless X adopts and implements those technologies.
❌ Statement 2 – Incorrect: Population growth in X alone does not ensure economic growth; it may even lower per capita income if not accompanied by proportionate increase in production.
❌ Statement 4 – Incorrect: Growth in world trade volume benefits country X only if it actively participates and increases its share; mere global trade expansion is insufficient.
The balance of payments of a country is a systematic record of
Detailed Explanation:
✅ Statement 1 – Correct: Balance of Payments (BoP) is a systematic record of all economic transactions between residents of a country and the rest of the world during a given period, typically a year, including goods, services, capital flows, and transfers.
❌ Statement 2 – Incorrect: This describes only the Balance of Trade (visible trade), not the comprehensive BoP which includes services, income, and capital accounts.
❌ Statement 3 – Incorrect: BoP covers transactions by all residents (individuals, firms, banks, government), not just government-to-government transactions.
❌ Statement 4 – Incorrect: Capital movements form only the capital account component of BoP; it also includes the current account (trade, services, income, transfers) and errors & omissions.
Consider the following statements: The price of any currency in the international market is decided by the
- World Bank
- demand for goods/services provided by the country concerned
- stability of the government of the concerned country
- economic potential of the country in question
Which of the statements given above are correct?
Detailed Explanation:
❌ Statement 1 – Incorrect: The World Bank provides loans for development projects; it does not decide or set currency prices in international markets. Currency prices are determined by market forces (demand and supply).
✅ Statement 2 – Correct: High demand for exports (goods/services) requires foreign buyers to purchase the country's currency, increasing its value in foreign exchange markets. This is a Current Account factor.
✅ Statement 3 – Correct: Political stability attracts FDI and FPI (Capital Account flows). Government instability causes capital flight, increasing currency supply and reducing its price.
❌ Statement 4 – Incorrect: While economic potential influences long-term investment sentiment, it is not a direct determinant of daily currency prices compared to immediate trade demand and political stability.
Which of the following would include Foreign Direct Investment in India?
- Subsidiaries of companies in India
- Majority of foreign equity holding in Indian companies
- Companies exclusively financed by foreign companies
- Portfolio investment
Select the correct answer using the codes given below:
Detailed Explanation:
✅ Statement 1 – Correct: Subsidiaries established by foreign companies in India represent FDI as they involve lasting interest and management control.
✅ Statement 2 – Correct: Majority foreign equity holding (typically 10% or more) in Indian companies constitutes FDI as it enables effective voice in management.
✅ Statement 3 – Correct: Wholly Owned Subsidiaries (WOS) that are exclusively financed by foreign entities are a direct form of FDI with 100% foreign ownership.
❌ Statement 4 – Incorrect: Portfolio investment (FPI) involves purchase of securities without management control, distinguished from FDI which requires long-term interest and control.
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