Indian Economy: UPSC Previous Year Questions (Prelims)

Explanation

Statement 1 is correct: Short-term foreign debt is a major vulnerability during a financial crisis. When global confidence deteriorates, investors can pull their short-term funds out of emerging markets very quickly. This sudden outflow of capital can cause a currency crisis, sharp interest rate increases, and severe economic disruption. A lower reliance on such borrowings provides greater resilience.

Statement 2 is incorrect: Opening up to more foreign banks would lead to enhanced exposure to the global economy. While foreign banks can introduce advanced practices and enhance capital availability, they also increase India’s exposure to global financial shocks. During crises these banks often prioritize their home markets, reducing support to Indian operations and exacerbating credit shortages. Greater foreign bank presence may foster interconnectedness but does not guarantee immunity, potentially heightening India’s vulnerability to external disruptions.

Statement 3 is incorrect: Capital account convertibility means no restriction on the amount one can convert into foreign currency to enable one to acquire any foreign assets and vice versa. In case of a financial crisis it can create a situation of "Capital flight" where a foreign investor can withdraw all his money at once.

Explanation

Demand deposit accounts consist of funds held in a bank account from which deposited funds can be withdrawn at any time while a term deposit account restricts access for a predetermined time(Fixed deposits accounts, Recurring deposits accounts). Current accounts and savings accounts are demand deposits. Money = total currency with the public + demand deposits of the public with banks. When you withdraw Rs. 1,00,000 in cash from your demand deposit account, you’re simply changing the form of your money. You’re not changing the total amount of money in the economy. Before the withdrawal: You have Rs. 1,00,000 in your bank account, which is part of the money supply (specifically, it’s part of the deposit component of the money supply). After the withdrawal: You have Rs. 1,00,000 in cash. This cash is also part of the money supply (specifically, it’s part of the currency in circulation component). The money has just moved from one "pocket" of the money supply to another. The overall quantity of money remains the same.

Explanation

Interest Coverage Ratio is a financial metric used to assess a company’s ability to meet its interest obligations on its debt. It’s calculated as:

Interest Coverage Ratio = Earnings Before Interest and Taxes (EBIT) / Interest Expense Statements 1 and 2 are correct: The interest coverage ratio is a debt and profitability ratio used to determine how easily a company can pay interest on its outstanding debt. Banks use the ICR to assess the current financial health of a firm. A low ICR suggests the firm may face difficulties repaying interest on its loans, posing a higher risk to lenders. ICR trends can help banks foresee emerging risks. A declining ICR signals worsening financial health, hinting at future repayment challenges.

Statement 3 is incorrect: A higher ICR implies that the firm generates sufficient earnings to cover its interest expenses comfortably, which is favorable. Conversely, a low ICR indicates a firm’s weakened ability to service its debt.

Explanation

Expansionary Monetary Policy is also known as Ac-commodative Monetary Policy has its main objective to increase the money supply in the economy through several measures such as:

Lowering interest rates.

Reducing reserve requirements for banks.

Purchasing government securities by RBI The goal of expansionary policy is to stimulate economic growth by encouraging business activities and consumer spending, while also helping reduce unemployment.

Statement 1 is incorrect: Statutory Liquidity Ratio (SLR) is the percentage of a bank’s net demand and time liabilities that must be maintained in the form of liquid assets, such as cash, gold, or government securities. Reducing the SLR allows banks to have more funds available for lending, thereby increasing the money supply in the economy. Hence RBI would cut and optimise the Statutory Liquidity Ratio.

Statement 2 is correct: Marginal Standing Facility (MSF) Rate is the rate at which banks can borrow overnight funds from the RBI against approved government securities. Increasing the MSF rate makes borrowing from the RBI more expensive for banks, which could discourage lending and contract the money supply. Thus raising the MSF rate is contrary to expansionary policy goals.

Statement 3 is incorrect: Bank Rate is the rate at which the RBI lends to commercial banks without any collateral. Repo Rate is rate at which the RBI lends to commercial banks against government securities. Lowering these rates reduces the cost of borrowing for banks, encouraging them to lend more to businesses and consumers, thereby increasing the money supply. Hence, cutting the Bank Rate and Repo Rate is consistent with an expansionary monetary policy.

Explanation

Rural co-operatives include District Central Cooperative Banks (DCCBs), State Co-operative Banks (StCBs), and Primary Agricultural Credit Societies (PACS).

Statement 1 is incorrect: Although the focus of rural cooperative lending is agriculture, the share in credit flow to the agriculture of rural cooperatives is only 12.1%, as compared to 76% of Scheduled Commercial Banks (SCBs), and 11.9% of Regional Rural Banks.

Statement 2 is correct: A District Co-operative Central Bank (DCCB) is a cooperative bank operating at the district level in various parts of India. It was established to provide banking to the rural hinterland for the agricultural sector with the branches primarily established in rural and semi-urban areas. DCCBs mobilise deposits from the public and provide credit to the public and PACS.

Explanation

Non-financial debt refers to the debt owed by entities that are not part of the financial sector, such as households, businesses, and government bodies. This type of debt includes various forms of borrowing, such as housing loans, credit card balances, and government-issued instruments like Treasury bills. Housing Loans: Housing loans taken by house-holds are considered non-financial debt because they involve borrowing money for the purchase of property, which is a physical asset. These loans are typically not tied to financial assets like stocks or bonds. Credit Card Debt: The amounts owed on credit cards are also considered non-financial debt. Credit card debt is a form of borrowing, but it is not related to financial assets, rather to consumption or goods and services. Treasury Bills: Treasury bills are short-term borrowing instruments issued by the government to generate funds. Since they are issued by the government, which is outside the financial sector, they also fall under the category of non-financial debt.

Explanation

Statement 1 is correct: India has historically faced a trade deficit in merchandise trade, meaning that the value of merchandise imports exceeds the value of merchandise exports. This is primarily due to India’s reliance on imports of crude oil, gold, electronics, and machinery, which are higher in value compared to its exports of textiles, gems, jewelry, and pharmaceuticals.

Statement 2 is incorrect: India’s imports of iron and steel, chemicals, fertilisers, and machinery have not decreased in recent years. These imports have remained significant due to domestic demand and industrial requirements. For example, India imports a large quantity of fertilisers to meet agricultural needs and machinery for industrial and infrastructure development.

Statement 3 is correct: India has a surplus in services trade, meaning that the value of services exports (e.g., IT services, software, business process outsourcing) exceeds the value of services imports. The services sector is a major contributor to India’s economy and helps offset the trade deficit in merchandise trade.

Statement 4 is correct: India typically has a current account deficit, although the size of the deficit can vary from year to year. The current account includes merchandise trade, services trade, and other flows like remittances and investment income. Even though India has a surplus in services trade, the deficit in merchandise trade generally outweighs it resulting in an overall current account deficit. Table: Trade during December 2024 December 2024 (USD Billion) December 2023 (USD Billion) Merchandise Exports 38.01 38.39 Imports 59.95 57.15 Services* Exports 32.66 31.63 Imports 17.50 15.63 Total Trade (Merchandise + Services)* Exports 70.67 70.02 Imports 77.44 72.78 Trade Balance -6.78 -2.76

Explanation

Option (a) is incorrect: While Foreign Direct Investment (FDI) can involve capital instruments like equity shares, it is not limited to listed companies. FDI typically involves acquiring a significant ownership stake (usually 10% or more) in a company, giving the investor management control or influence over business operations. FDI can occur in both listed and unlisted companies and often includes investments in infrastructure, manufacturing units, or joint ventures. In contrast, investments primarily in listed companies without control are characteristic of Foreign Portfolio Investment (FPI), which is passive and doesn’t provide managerial influence.

Option (b) is correct: FDI involves equity investment, meaning investors acquire ownership or a significant interest in a company. Since it doesn’t require repayment like loans, it is considered a non-debt capital flow, contributing positively to the host country’s economy without creating debt obligations.

Option (c) is incorrect: Debt-servicing refers to making interest and principal payments on loans. FDI doesn’t involve such obligations, as it is equity-based. Debt-servicing is more relevant to External Commercial Borrowings (ECBs) or other loan-based investment

Option (d) is incorrect: The investment can be made in equities or equity linked instruments or debt instruments issued by the company. Thus, FDI isn’t directly associated with government securities.

Explanation

Statement 1 is correct: From the Second Five Year Plan(1956-61), there was determined thrust towards substitution of basic and capital goods industries. This plan focused on Rapid Industrialization with an emphasis on capital goods and heavy industries. It was based on the PC Mahalanobis Model.

Statement 2 is correct: The Fourth Plan (1969-74) provided a necessary corrective to the earlier trend which helped particularly the stronger sections in agriculture as well as in industry to enable them rapidly to enlarge and diversify the production base. It has adopted the objective of correcting the earlier trend of increased concentration of wealth and economic power and eliminating disparities in income between different regions. Thus, it targeted Growth with Stability, progressive achievement of self-reliance and income distribution.

Statement 3 is incorrect: The Fifth plan (1974-78) aimed at removal of poverty and attaining self-reliance. The financial sector became an integral part of the plan in the Ninth five -year plan(1997-2002). Note: Details on Five Year Plans are given in Q. 17 Explanation

Explanation

The Economic Cost of food grains to the FCI includes the Minimum Support Price and bonus (if any) paid to the farmers plus the procurement incidentals and distribution cost. Procurement incidentals are expenses incurred during procurement till the food grains reach the first point of godown. Distribution costs are now included in economic costs, whilst buffer carrying costs are now included in buffer subsidies.