External Sector of Economy

11. With reference to the “G20 Common Framework”, consider the following s

With reference to the “G20 Common Framework”, consider the following statements:

  • It is an initiative endorsed by the G20 together with the Paris Club.
  • It is an initiative to support Low Income Countries with unsustainable debt.

Which of the statements given above is/are correct ?

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1 only
2 only
Both 1 and 2
Neither 1 nor 2
This question was previously asked in
UPSC IAS – 2022
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Statement 1 is correct. The G20 Common Framework for Debt Treatments beyond the DSSI was agreed upon by the G20 and the Paris Club (an informal group of official creditors, mostly high-income countries) in November 2020. It provides a structure for coordinated debt restructuring for eligible countries.
Statement 2 is correct. The Common Framework is specifically designed to help Low-Income Countries (LICs) that are eligible for the World Bank-IMF’s Debt Service Suspension Initiative (DSSI) and have unsustainable debt burdens. It aims to provide debt relief beyond temporary suspension, on a case-by-case basis, in a coordinated manner involving both official and private creditors.
The G20 Common Framework is an international initiative to address the debt vulnerability of low-income countries exacerbated by global shocks like the COVID-19 pandemic. It involves key creditors like G20 and Paris Club members.
The framework encourages comparable treatment from private creditors to ensure fair burden sharing. Implementation has faced challenges, including delays in setting up creditor committees and coordinating diverse creditor bases.

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12. With reference to the Indian economy, consider the following statement

With reference to the Indian economy, consider the following statements:

  • If the inflation is too high, Reserve Bank of India (RBI) is likely to buy government securities.
  • If the rupee is rapidly depreciating, RBI is likely to sell dollars in the market.
  • If interest rates in the USA or European Union were to fall, that is likely to induce RBI to buy dollars.

Which of the statements given above are correct ?

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1 and 2 only
2 and 3 only
1 and 3 only
1, 2 and 3
This question was previously asked in
UPSC IAS – 2022
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Statement 1 is incorrect. If inflation is too high, the Reserve Bank of India (RBI) uses monetary policy tools to reduce liquidity and curb aggregate demand. Buying government securities (Open Market Operations – OMO purchase) injects liquidity into the market. To control inflation, RBI would *sell* government securities (OMO sale) to absorb liquidity.
Statement 2 is correct. If the rupee is rapidly depreciating, it means its value is falling relative to foreign currencies (like the US dollar). This is often due to high demand for foreign currency or low supply. To counter this, RBI can intervene in the foreign exchange market by selling dollars from its foreign exchange reserves. This increases the supply of dollars, which helps to stabilize the rupee’s value or reduce the rate of depreciation.
Statement 3 is correct. If interest rates in the USA or European Union fall, financial investments in those regions may become less attractive compared to India, assuming India offers relatively better returns. This encourages foreign investors to move capital to India, increasing capital inflows (e.g., FII/FPI investments). These inflows are often denominated in foreign currency (like USD) and converted to rupees, leading to increased supply of foreign currency in the domestic market. This would put pressure on the rupee to appreciate. To prevent excessive or rapid appreciation and maintain exchange rate stability, RBI may buy dollars (and sell rupees) from the market, thereby absorbing the excess foreign currency supply.
RBI uses Open Market Operations (buying/selling government securities) to manage domestic liquidity and influence interest rates. RBI intervenes in the foreign exchange market (buying/selling foreign currency) to manage the value of the rupee and control volatility.
RBI’s monetary policy decisions are guided by the objectives of price stability while keeping in mind the objective of growth. Exchange rate management is also a crucial function to ensure external sector stability, although India follows a managed float system, not a fixed exchange rate.

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13. With reference to the Indian economy, consider the following statement

With reference to the Indian economy, consider the following statements:

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  • 1. An increase in Nominal Effective Exchange Rate (NEER) indicates the appreciation of rupee.
  • 2. An increase in the Real Effective Exchange Rate (REER) indicates an improvement in trade competitiveness.
  • 3. 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 ?

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1 and 2 only
2 and 3 only
1 and 3 only
1, 2 and 3
This question was previously asked in
UPSC IAS – 2022
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Statement 1 is correct. Nominal Effective Exchange Rate (NEER) is a weighted average of bilateral nominal exchange rates of the domestic currency against the currencies of its trading partners. An increase in NEER means that, on average, the domestic currency is appreciating against the currencies of its trading partners.
Statement 2 is incorrect. Real Effective Exchange Rate (REER) is NEER adjusted for the inflation differential between the domestic economy and its trading partners. REER = NEER * (Domestic Price Index / Foreign Price Index). An increase in REER means that the domestic country’s goods and services are becoming relatively more expensive compared to those of its trading partners. This makes exports less competitive and imports more attractive, thus indicating a *decrease* (or worsening) in trade competitiveness.
Statement 3 is correct. The formula for REER shows its relationship with NEER and inflation differentials. REER = NEER * (Domestic Price Index / Foreign Price Index). If domestic inflation increases significantly relative to foreign inflation, the term (Domestic Price Index / Foreign Price Index) increases. This will cause the REER to rise relative to the NEER. For instance, if NEER remains constant, an increase in domestic inflation relative to foreign inflation will cause REER to increase, creating a divergence. Similarly, if NEER depreciates, but domestic inflation is much higher, REER might depreciate less or even appreciate, again creating divergence.
NEER reflects the nominal value of a currency against a basket, while REER reflects the real value (purchasing power) against a basket, adjusted for relative inflation. REER is a key indicator of a country’s external competitiveness.
Policymakers monitor both NEER and REER to understand the impact of exchange rate movements on trade and the economy. A higher REER often signals a potential challenge for export growth due to reduced competitiveness.

14. Consider the following statements : Tight monetary policy of US Fede

Consider the following statements :

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  • Tight monetary policy of US Federal Reserve could lead to capital flight.
  • Capital flight may increase the interest 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 ?

1 and 2 only
2 and 3 only
1 and 3 only
1, 2 and 3
This question was previously asked in
UPSC IAS – 2022
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Statement 1 is correct: A tight monetary policy by the US Federal Reserve (raising interest rates) makes dollar-denominated assets more attractive, potentially leading to capital flowing out of other countries (capital flight) as investors seek higher returns or safer assets in the US. Statement 2 is correct: Capital flight often leads to depreciation of the domestic currency. Firms with existing External Commercial Borrowings (ECBs) denominated in foreign currency (like USD) will have to pay more local currency to service the same amount of foreign currency interest payments and principal repayments. While the *interest rate* on the ECB might not change, the *cost* of that interest payment in local currency terms increases, effectively increasing the interest cost burden for the firm. Statement 3 is incorrect: Devaluation (or depreciation) of the domestic currency *increases* the currency risk associated with ECBs denominated in a foreign currency. The weaker the domestic currency, the more expensive it becomes to repay the foreign currency debt.
Tightening monetary policy in a major economy like the US can trigger capital movements globally, impacting exchange rates and the cost of foreign debt for entities in other countries.
External Commercial Borrowings (ECBs) are loans raised by eligible resident entities from recognized non-resident entities and should conform to parameters such as minimum maturity, permitted and non-permitted end-uses, maximum all-in-cost ceiling, etc. Currency risk on unhedged ECBs is a significant concern, especially during periods of exchange rate volatility.

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15. Consider the following statements: The effect of devaluation of a curr

Consider the following statements: The effect of devaluation of a currency is that it necessarily

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  • 1. improves the competitiveness of the domestic exports in the foreign markets
  • 2. increases the foreign value of domestic currency
  • 3. improves the trade balance

Which of the above statements is/are correct?

1 only
1 and 2
3 only
2 and 3
This question was previously asked in
UPSC IAS – 2021
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Devaluation of a currency means reducing its value relative to other currencies.
1. Improves the competitiveness of domestic exports: When a currency is devalued, foreign buyers need less of their currency to buy goods from the devaluing country. This makes the domestic country’s exports cheaper in foreign markets, thus increasing their price competitiveness. This statement is generally true, assuming other factors like quality and supply capacity remain constant and demand is price-sensitive.
2. Increases the foreign value of domestic currency: This is incorrect. Devaluation by definition means the domestic currency is now worth *less* in terms of foreign currencies.
3. Improves the trade balance: Devaluation makes exports cheaper and imports more expensive. The *aim* is to increase exports and decrease imports, thereby improving the trade balance (reducing deficit or increasing surplus). However, this outcome is not *necessary*. The effect depends on factors like the price elasticity of demand for exports and imports (Marshall-Lerner condition), the time lag for these effects to materialize (J-curve effect), supply side constraints, and potential retaliatory measures by trade partners. Therefore, it does not *necessarily* improve the trade balance.
Only statement 1 is a necessary and direct consequence of devaluation in terms of price competitiveness.
Devaluation makes exports cheaper and imports more expensive in terms of domestic currency, directly impacting price competitiveness of exports. The impact on the trade balance is not guaranteed and depends on various economic factors.
The J-curve effect describes how a country’s trade balance may initially worsen following a devaluation or depreciation (because higher import prices outweigh increased export volumes) before eventually improving as trade volumes adjust.

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16. Consider the following : 1. Foreign currency convertible bonds 2. F

Consider the following :

  • 1. Foreign currency convertible bonds
  • 2. Foreign institutional investment with certain conditions
  • 3. Global depository receipts
  • 4. Non-resident external deposits

Which of the above can be included in Foreign Direct Investments?

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1, 2 and 3
3 only
2 and 4
1 and 4
This question was previously asked in
UPSC IAS – 2021
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Foreign Direct Investment (FDI) refers to investment made by a firm or individual in one country into business interests located in another country. FDI involves a degree of management control or significant influence over the foreign enterprise. According to international standards and Indian regulations (like the classification by RBI/DPIIT), an investment is typically classified as FDI if a foreign investor acquires 10% or more of the equity shares of an Indian company. Based on this definition:
1. Foreign currency convertible bonds (FCCBs): While primarily debt instruments, they are convertible into equity. If converted, and the resulting equity holding is 10% or more, the investment originating from the FCCB can be classified as FDI.
2. Foreign institutional investment with certain conditions: Foreign Portfolio Investment (FPI), previously FII, is typically for portfolio diversification with less than 10% equity holding. However, if an FII/FPI invests with “certain conditions” implying the acquisition of 10% or more of the equity shares of an Indian company, it is reclassified and included under FDI.
3. Global depository receipts (GDRs): Similar to FCCBs, GDRs represent underlying equity shares of an Indian company listed abroad. If a foreign investor acquires GDRs leading to a 10% or more equity holding in the underlying Indian company, this investment can be treated as FDI.
4. Non-resident external deposits (NRE deposits): These are bank deposits held by non-resident Indians. They are financial liabilities of the banking system and do not represent equity investment or control in Indian companies. Therefore, they are not considered FDI.
Given the potential for 1, 2, and 3 to meet the FDI threshold based on the underlying equity acquisition and intent, they can be included in FDI under specific conditions, whereas 4 cannot.
FDI is primarily distinguished by the level of equity investment (typically >=10%) and the intent to gain control or significant influence, irrespective of the specific instrument used (equity shares, convertible instruments, etc.).
India’s foreign investment framework differentiates between FDI and FPI based primarily on the 10% equity holding threshold. FDI also includes reinvested earnings of foreign companies operating in India and inter-company debt between related entities.

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17. “Gold Tranche” (Reserve Tranche) refers to

“Gold Tranche” (Reserve Tranche) refers to

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a loan system of the World Bank
one of the operations of a Central Bank
a credit system granted by WTO to its members
a credit system granted by IMF to its members
This question was previously asked in
UPSC IAS – 2020
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“Gold Tranche” or “Reserve Tranche” is a term used in the context of the International Monetary Fund (IMF). It refers to the portion of a member country’s quota in the IMF that can be drawn upon at any time without any conditions or economic policy reforms being required. It is essentially a reserve asset or credit line that a member country holds with the IMF, denominated in Special Drawing Rights (SDRs). This system allows member countries to access funds in times of balance of payments needs.
– Gold Tranche or Reserve Tranche is associated with the IMF.
– It represents an unconditional drawing right for member countries.
– It is part of a country’s quota contribution to the IMF.
Each member country contributes a quota to the IMF, paid partly in reserve assets (like SDRs or major currencies) and partly in the country’s own currency. The portion paid in reserve assets plus any borrowing by the IMF from the member country constitutes the reserve tranche position. A country can draw on its reserve tranche at any time it represents that it has a balance of payments need, without having to agree to conditionality.

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18. If another global financial crisis happens in the near future, which o

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 ?

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  • 1. Not depending on short-term foreign borrowings
  • 2. Opening up to more foreign banks
  • 3. Maintaining full capital account convertibility

Select the correct answer using the code given below :

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1 only
1 and 2 only
3 only
1, 2 and 3
This question was previously asked in
UPSC IAS – 2020
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Statement 1 is correct: Short-term foreign borrowings are highly volatile and can be withdrawn rapidly during a global financial crisis. An economy that depends less on such borrowings is less vulnerable to sudden capital flight, which can trigger liquidity problems and currency depreciation.
Reducing reliance on volatile short-term foreign debt enhances an economy’s resilience against external financial shocks.
Statement 2 is incorrect: While opening up to foreign banks can bring benefits like increased competition and technology, it can also introduce risks of contagion from their home countries during a global crisis. Their presence does not necessarily provide immunity; it can potentially increase exposure. Statement 3 is incorrect: Maintaining full capital account convertibility allows unrestricted movement of capital in and out of the country. While beneficial in normal times, it makes the economy highly susceptible to massive capital outflows (sudden stops) during a global financial crisis, significantly increasing vulnerability rather than providing immunity.

19. With reference to Trade-Related Investment Measures (TRIMS), which of

With reference to Trade-Related Investment Measures (TRIMS), which of the following statements is/are correct ?

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  • 1. Quantitative restrictions on imports by foreign investors are prohibited.
  • 2. They apply to investment measures related to trade in both goods and services.
  • 3. They are not concerned with the regulation of foreign investment.

Select the correct answer using the code given below :

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1 and 2 only
2 only
1 and 3 only
1, 2 and 3
This question was previously asked in
UPSC IAS – 2020
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The official answer key for UPSC Prelims 2020 indicates that Statement 1 and Statement 2 are considered correct.
Statement 1: The TRIMS Agreement prohibits investment measures that are inconsistent with GATT Article III (National Treatment) and Article XI (Elimination of Quantitative Restrictions). Measures requiring enterprises to limit their imports to an amount related to the foreign exchange earnings they generate, or to the volume or value of products they export, are examples of quantitative restrictions on imports and are thus prohibited under TRIMS for foreign investors. So, statement 1 is correct.
Statement 2: According to the official key, this statement is considered correct. However, standard interpretation of the WTO TRIMS Agreement is that it applies specifically to trade-related investment measures concerning trade in **goods**, not services. Measures related to trade in services are covered under the General Agreement on Trade in Services (GATS). There might be a specific context or interpretation under which UPSC considers TRIMS relevant to investment measures touching upon both goods and services sectors, but the primary and explicit scope is goods.
Statement 3: TRIMS is fundamentally concerned with regulating certain aspects of foreign investment, specifically those measures that distort or restrict trade in goods. Therefore, the statement that they are *not* concerned with the regulation of foreign investment is incorrect.
The TRIMS Agreement requires WTO members to notify the Council for Trade in Goods of all investment measures that are incompatible with TRIMS and to eliminate them within a specified period (typically two years for developed countries, five for developing countries, and seven for least-developed countries). The illustrative list of prohibited TRIMS includes requirements for local content, trade balancing, foreign exchange balancing, and export restrictions.

20. The term ‘West Texas Intermediate’, sometimes found in news, refers to

The term ‘West Texas Intermediate’, sometimes found in news, refers to a grade of

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Crude oil
Bullion
Rare earth elements
Uranium
This question was previously asked in
UPSC IAS – 2020
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The term ‘West Texas Intermediate’ (WTI) is a well-known benchmark in the global commodities market.
– WTI refers to a grade of crude oil produced in Texas and Southern Oklahoma, USA. It is a major benchmark for oil pricing, particularly in North America. Other common benchmarks include Brent Crude (for European and global markets) and Dubai/Oman (for Middle Eastern/Asian markets).
Commodity benchmarks like WTI and Brent are important because they serve as reference prices for a vast volume of oil trades worldwide and influence energy prices globally.

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