Indian Economy: UPSC Previous Year Questions (Prelims)

Explanation

Option (a) is incorrect: While reducing the SLR can stimulate economic activity by increasing liquidity but it does not directly lead to a drastic increase in GDP growth. GDP growth is influenced by a multitude of factors, including investment levels, consumption, and government spending.

Option (b) is incorrect: The SLR reduction primarily affects domestic liquidity and does not directly influence foreign investment decisions. Foreign Institutional Investors (FIIs) are more influenced by factors such as market potential, regulatory environment, and economic stability.

Option (c) is correct: The Statutory Liquidity Ratio (SLR) cut by the RBI is likely to give more room for banks to cut rates. When the RBI reduces the SLR banks are required to keep a smaller portion of their net demand and time liabilities (NDTL) in liquid asset freeing up additional funds. This boost in liquidity allows banks to lend more to borrowers. To encourage borrowing and make use of the increased liquidity, banks may lower their lending rates, thereby making credit more accessible to consumers and businesses.

Option (d) is incorrect: It does not drastically reduce the liquidity to the banking system. Reducing the SLR increases liquidity in the banking system by freeing up funds that banks can use for lending or investment.

Explanation

The Basel III Accord is a set of international regulatory reforms developed by the Basel Committee on Banking Super-vision in response to the global financial crisis of 2008. Its main objective is to enhance the regulation, supervision, and risk management of the banking sector making banks more resilient to financial and economic shocks and reducing the risk of future crises. Key Aspects of Basel III:

Capital Requirements: It increases both the quality and quantity of capital banks must hold, helping them absorb losses and reducing the risk of insolvency. Liquidity Standards: It enforces stricter liquidity requirements to ensure that banks maintain enough liquid assets to meet short-term obligations, especially in times of financial stress, addressing the risk of liquidity crises. Leverage Ratio: The accord introduces a leverage ratio to curb excessive borrowing by banks, preventing them from becoming overleveraged. Countercyclical Capital Buffer: It requires banks to accumulate additional capital during periods of rapid credit growth, which can be used to absorb losses during economic downturns.

Explanation

Monetary policy refers to actions undertaken by the central bank (in India, the Reserve Bank of India - RBI) to manipulate the money supply, interest rates, and credit conditions to stimulate or restrain economic activity. Its primary goal is to maintain price stability (control inflation) while supporting economic growth.

Statement 1 is correct: The bank rate in India is defined as the interest rate at which the Reserve Bank of India (RBI) lends money to commercial banks for long-term loans. It serves as a tool to control the money supply in the economy and manage inflation. Changes in the bank rate influence other inter-est rates in the economy. An increase in the bank rate makes borrowing more expensive which can slow down economic activity and inflation. Decreasing the bank rate has the opposite effect.

Statement 2 is correct: Open Market Operations (OMO) involve the buying and selling of government securities by the RBI in the open market. When the RBI purchases government securities, it injects money into the economy, thereby increasing the money supply. Conversely, when the RBI sells government securities, it removes money from circulation, reducing the money supply. These actions influence interest rates and the availability of credit in the economy. Statements 3 and 4 are incorrect: Public Revenue and debt are not part of monetary policy. They are related to fiscal policy. Public debt also known as government debt represents the total amount of money the government owes to its creditors. It arises from borrowing to finance government spending. Public debt is a consequence of fiscal policy decisions. Public revenue refers to the income the government generates through taxes and other channels. Public revenue is an element of fiscal policy rather than monetary policy.

Explanation

The Fourteen Finance Commission was constituted (FFC) by the President on January 2, 2013 under chairmanship of Dr. Y. V. Reddy to give recommendations on specified aspects of Centre-State fiscal relations during 2015-2020. The Commission submitted its report to the President on December 15, 2014.

Statement 1 is correct: The Fourteenth Finance Commission has radically enhanced the share of the states in the central divisible pool from the current 32% to 42% which is the biggest ever increase in vertical tax devolution.

Statement 2 is incorrect: Unlike the thirteenth Finance Com-mission, the Fourteenth Finance Commission did not make any recommendation concerning sector specific-grants.

Explanation

Statement 1 is incorrect: The budget is prepared by the Department of Economic Affairs. The Budget Division under Department of Economic Affairs is responsible for the preparation and submission to Parliament of the Central Governments Budget other than Railways, as well as the supplementary Demands for Grants and Demands for Excess Grants. The Department of Revenue plays a key role in managing In-dia’s financial resources by overseeing tax collection and enforcing economic laws. It is responsible for collecting both direct taxes (such as income tax and wealth tax) and indirect taxes (like GST, customs duty, and excise duty). It does not prepare budget.

Statement 2 is correct: Consolidated Fund of India (Article 266) is a fund to which all receipts are credited and all payments are debited. No money out of this fund can be appropriated (issued or drawn) except in accordance with parliamentary law.

Statement 3 is incorrect: Provident fund deposits, savings bank deposits, remittances etc are credited to the Public Account. The Public Account is operated by the executive action i.e. payment from this account can be made without Parliamentary appropriation.

Explanation

A tax-to-GDP ratio is a gauge of a nation’s tax revenue relative to the size of its economy as measured by gross domestic product (GDP).

Statement 1 is correct: A decrease in the tax-to-GDP ratio may indicate that the government is collecting less tax revenue relative to the size of the economy. This can happen due to slowing economic growth, which reduces corporate profits, incomes, and consumption, leading to lower tax collections. However, this is not always the case, as tax policy changes (like tax cuts) can also reduce the ratio without reflecting economic slowdown.

Statement 2 is incorrect: A decrease in the tax-to-GDP ratio does not necessarily indicate less equitable distribution of na-tional income. While lower tax revenue relative to the size of the economy could result from tax cuts, evasion, or shifts toward in-direct taxes, these factors do not directly determine income in-equality. The impact on equity depends on the structure of the tax system and government policies--if the decline stems from broad-based tax cuts benefiting all income groups, it may not affect income distribution significantly. However, if it results from reduced taxation on the wealthy or increased reliance on regressive indirect taxes, it could exacerbate inequality. Thus, a falling tax-to-GDP ratio alone is not a definitive indicator of less equitable income distribution.

Explanation

The mentioned agreements and terms are related to global trade regulations under the World Trade Organization (WTO):

Agreement on Agriculture (AoA) is a WTO agreement that sets international rules for agricultural trade, subsidies, and market access. It aims to reduce trade barriers and promote fair competition in agriculture. Agreement on the Application of Sanitary and Phytosanitary (SPS) Measures: It establishes rules for food safety and animal and plant health standards in global trade. It ensures that countries do not use health measures as a disguised trade barrier. Peace Clause: It was introduced under the WTO’s Agreement on Agriculture. It temporarily protected agricultural subsidies from legal challenges under WTO rules. It was a major issue in India’s food security concerns at WTO negotiations.

Explanation

Statement 1 is incorrect: The rate of growth of Real Gross Domestic Product (GDP) in India has not steadily increased over the last decade (2005-2015). Instead, it has experienced fluctuations due to various factors such as global economic conditions, domestic policy changes, and structural reforms. For example: India experienced high GDP growth rates during the mid-2000s (around 9% in 2007-2008). The growth rate declined significantly during the global financial crisis of 2008-2009. Post-2010, growth rates recovered but remained volatile, with a slowdown in recent years due to factors like demonetization (2016) and the introduction of the Goods and Services Tax (GST) in 2017.

Statement 2 is correct: Gross domestic product at market prices is the sum of added values of all activities which produce goods and services, plus taxes and minus subsidies on products. When measured in nominal terms (i.e., at current market prices without adjusting for inflation), India’s GDP in rupees has shown a consistent upward trend over the past decade. This steady increase reflects the overall expansion of the economy in nominal terms.

Explanation

Statement 1 is correct: Budget deficit is used to define a status of financial health in which expenditures exceed revenue. Revenue Expenditure is the part of government spending that does not result in the production of assets such as Salaries, wages, pensions, subsidies, and interest payments etc. Reducing Revenue Expenditure involves cutting down on the government’s routine expenses, such as salaries, subsidies, and administrative costs. By streamlining operations and eliminating wasteful spending, the government can lower its revenue expenditure and reduce the budget deficit.

Statement 3 is correct: Rationalizing Subsidies entails reviewing and possibly reducing subsidies that are inefficient or benefit higher-income groups disproportionately. By targeting subsidies more effectively, the government can decrease un-necessary spending, aiding in deficit reduction. Statements 2 and 4 are incorrect:

Introducing New Welfare Schemes without corresponding revenue sources can increase government expenditure, potentially widening the budget deficit. Therefore, this action may not contribute to deficit reduction. Promoting industrial expansion can boost economic growth and over time increase government revenues through higher tax collections. However, the effects of such measures are typically long-term and may not provide immediate relief to a budget deficit.

Explanation

Convertibility of a currency means that it can be freely exchanged for other currencies and vice versa with-out restrictions. It essentially means that there are no limitations on the flow of the currency in and out of the coun-try. When a currency is convertible, individuals, businesses, and investors can easily convert it to other currencies to make payments abroad, invest in foreign assets, or engage in other inter-national transactions. Similarly, they can convert foreign currencies back into the domestic currency. India has current account convertibility, meaning that there are generally no restrictions on converting rupees for trade-related purposes. There are some regulations on capital account transactions, although these have been progressively liberalized over time.