External Sector of India: UPSC Previous Year Questions (Indian Economy)

Explanation

Foreign Direct Investment (FDI) refers to an investment made by an individual or entity from one country into business interests located in another country, with the intent of establishing a lasting interest. This typically involves acquiring a significant degree of influence or control over the foreign company’s operations. In the context of India, FDI includes:

Subsidiaries of Foreign Companies in India are companies incorporated in India that are wholly or majority-owned by foreign parent companies. Majority Foreign Equity Holding in Indian Companies occurs when foreign investors hold more than 50% equity in an Indian company, granting them significant control over its operations. Companies Exclusively Financed by Foreign Companies are entities in India that receive all their capital from foreign investors or parent companies, leading to substantial foreign control. On the other hand, Portfolio Investment refers to investments in a country’s financial assets, such as stocks and bonds, without the intent of controlling or managing the companies. Such investments are typically short-term and speculative in nature. Therefore, Portfolio Investment is not considered a form of FDI.

Explanation

Statement 1 is incorrect: The World Bank does not determine currency exchange rates; these are influenced by market forces and economic indicators. The World Bank is important to the source of financial and technical assistance to developing countries around the world.

Statement 2 is correct: A major factor influencing a currency’s value is the demand for the goods and services that a country offers. If there’s high global demand for a country’s ex-ports, there will be a higher demand for its currency to purchase those exports. This increased demand will generally push the currency’s value up. On the contrary if demand for a country’s goods and services is low, demand for its currency will be low, putting downward pressure on its value.

Statement 3 is correct: Political stability fosters investor confidence, attracting foreign investment and strengthening the currency. Political instability can lead to capital flight and currency depreciation.

Statement 4 is incorrect: While the economic potential of a country (e.g., growth prospects, productivity, and innovation) can influence long-term currency trends, it is not a direct factor in the day-to-day determination of exchange rates.