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

Explanation

Statement 1 is correct: Devaluation is a decrease in the value of a country’s currency relative to other currencies. It means it takes more of the domestic currency to buy one unit of a foreign currency. For example, if the exchange rate changes from 70 to 80 per dollar, the rupee has been devalued. Devaluation makes a country’s exports cheaper for foreign buyers. This can increase demand for exports, leading to higher export volumes and potentially improving the trade balance (ex-ports minus imports).

Statement 2 is incorrect: Devaluation means a decrease(not increase) in the value of the domestic currency relative to foreign currencies. It takes more of the domestic currency to buy one unit of a foreign currency.

Statement 3 is incorrect: Devaluation can potentially improve the trade balance over time by boosting exports and reducing imports, but it is not guaranteed. The trade balance may deteriorate because import costs rise immediately, while export volumes may take time to increase. This phenomenon is called the J-curve effect. If a country devalues its currency, it still has to pay higher prices for imported oil, machinery, and technology. Over time, as foreign buyers demand more of its cheaper exports, the trade balance may improve.

Explanation

Foreign Direct Investment (FDI) refers to an investment made by an entity (typically a company or individual) from one country into a business or asset in another country, with the intent of establishing a lasting interest and exerting a degree of influence over the enterprise’s management and operations. It’s not just about a financial transaction but more about substantial and enduring involvement. Foreign currency convertible bonds (FCCBs) are debt instruments issued by a company in a foreign currency, which can be converted into equity shares at a future date. Because FCCBs can be converted into equity, and thus represent a potential ownership stake so They are considered a component of FDI. Foreign Institutional Investment (FII) are investments made by foreign institutions in the financial markets of another country. In India, if an FII’s investment exceeds 10% of the post-issue paid-up equity capital of a company, it is reclassified as FD Global Depository Receipts (GDRs) are financial instruments used by companies to raise capital from international markets. They represent shares of a foreign company and are traded on international stock exchanges. Investments through GDRs are treated as FDI since they result in foreign equity participation in the issuing company. Non-Resident External (NRE) Deposits are deposits held by non-resident Indians (NRIs) in Indian banks in Indian rupees. They are primarily a means for NRIs to invest their savings in India. While they represent a flow of foreign funds into India, they are not considered FDI. They are more akin to portfolio investments or remittance as they don’t involve a direct stake in a business or substantial management influence.