External Sector & Financial Markets

A comprehensive set of flashcards based on key concepts from the UPSC lecture on the external sector and financial markets.

What impact might an increase in India's trade surplus with the USA have on diplomatic trade negotiations?

It may lead to protectionist demands and calls for greater market access by the US in trade talks.

How do capital inflows affect the value of a country's currency in a managed floating exchange regime?

Capital inflows appreciate the rupee unless offset by RBI’s sterilized interventions.

What happens if India’s CAD rises while capital account inflows remain stagnant?

It can widen the BoP deficit, forcing reliance on forex reserves or external borrowing.

How does high remittance inflow help reduce the current account deficit?

It adds to foreign exchange inflows under transfers, helping bridge merchandise trade deficit.

Why is balance on invisibles becoming more significant than balance on trade in India?

Services and remittances are stable and growing, cushioning the volatile goods trade.

How would pegged exchange rate affect RBI’s foreign reserve levels in crisis conditions?

It drains reserves due to currency support operations, reducing India’s forex buffer.

What shift in monetary policy focus is likely if India moves from NEER to REER targeting?

REER targeting shifts focus to inflation-adjusted competitiveness, affecting export pricing.

What structural risk arises when portfolio investment dominates capital account flows?

It increases volatility, exposing India to sudden flight of capital during global shocks.

Why does the RBI maintain a high level of forex reserves despite current account deficits?

To stabilize the rupee, meet external liabilities, and boost investor confidence.

What are the consequences of persistent BOP surplus on inflation and monetary policy?

Increased forex inflows may cause inflation, forcing RBI to absorb excess liquidity.

How are SEZs treated as foreign territory reflected in BoP accounting?

They are included in exports and imports of goods/services under the current account.

How do automatic and government routes differ in terms of FDI regulatory burden?

Automatic route has fewer bureaucratic hurdles, enabling quicker capital deployment.

Why is FDI in the software sector seen as less volatile than FPI?

FDI involves long-term ownership, while FPI is liquid and reacts to market volatility.

How does external debt affect India’s exchange rate stability during global crisis?

Rising external debt puts pressure on rupee and raises repayment burden during global tightening.

What happens if short-term debt overtakes long-term debt in India’s external debt composition?

It increases rollover risk and makes India vulnerable to short-term interest rate hikes.

Why is a rising REER considered detrimental to India’s export competitiveness?

Higher REER makes Indian goods costlier abroad, reducing global price competitiveness.

How does a flexible exchange rate regime limit the RBI’s intervention capacity?

It reduces policy effectiveness when forex markets override domestic policy intent.

Why is the difference between nominal and real exchange rate important for trade competitiveness?

It accounts for inflation differences, giving real competitiveness over mere currency value.

What risks emerge for monetary policy stability if capital account convertibility is allowed fully?

It exposes the currency to global flows, weakening monetary policy control and stability.

Why is full rupee convertibility a double-edged sword for emerging markets?

It boosts access to capital but raises risks of speculation, volatility, and capital flight.

How does the rise in US interest rates affect India’s capital flows and exchange rate?

It causes capital outflow from India and rupee depreciation as investors chase US returns.

What happens when foreign portfolio investors withdraw rapidly due to global shocks?

Rupee depreciates, forex reserves deplete, and market volatility rises significantly.

How do transfer payments like remittances differ from net factor income in the current account?

Remittances are unilateral, while factor income includes two-way earnings on capital/labor.

What risk arises from relying heavily on short-term hot money to bridge the CAD?

It heightens vulnerability to outflows, forcing policy tightening during external shocks.

How is BoP surplus different from current account surplus in terms of implications?

BoP surplus includes capital account, while current account surplus reflects trade strength.

What does an increase in SDR holdings reflect about India’s forex position?

Higher SDRs improve forex strength and IMF standing, signaling external stability.

Why are petroleum and gold top imports and a source of trade deficit for India?

They are demand-driven and import-intensive, contributing heavily to trade imbalances.

How can devaluation of the rupee boost exports but worsen external debt obligations?

Exports rise due to price competitiveness, but external repayments become costlier in rupees.

If India switches to PPI from WPI, what new sectoral inflation indicators would emerge?

PPI would include producer-side prices and may better reflect industrial inflation.

Why is REER-6 used alongside REER-40 in RBI’s policy toolkit?

REER-6 tracks major trade partners, while REER-40 offers a wider global competitiveness picture.

How do trade deficits with China and Switzerland reflect different structural issues?

With China it's structural imports; with Switzerland, it’s gold and luxury re-exports.

How does PPP-based exchange rate differ from market-based exchange rate during global crises?

PPP reflects long-term purchasing power, market rate reflects short-term capital flows.

Why is India’s position as top remittance recipient strategically important for BoP stability?

Remittances offer steady forex, reduce CAD, and signal diaspora trust in home economy.

How does CECA differ from FTA in terms of policy depth and implementation?

CECA includes services, investments, IPRs, unlike FTA which focuses mostly on goods.

What is the significance of customs union having a common external tariff policy?

It ensures external tariff uniformity, simplifying trade rules with non-member countries.

How does anti-dumping duty protect local industry and affect consumer prices?

It raises local producer competitiveness but may raise prices for consumers.

How do FTAs with UAE and Australia impact India’s current account and export preparedness?

They reduce tariff barriers, improve access, and diversify India’s trade partners.

Why is a tariff barrier easier to implement than non-tariff barriers for short-term trade protection?

Tariff is faster to implement and adjust, unlike complex regulatory non-tariff measures.

How does NEER help in assessing currency overvaluation without adjusting for inflation?

It gives nominal exchange trends but doesn’t adjust for domestic vs foreign inflation.

What distinguishes debt overhang from fiscal deficit in terms of economic stress?

Debt overhang creates repayment stress, while fiscal deficit reflects annual borrowing gap.

What are the monetary policy implications of BOP deficit caused by high imports?

It forces RBI to intervene, raise rates, or use reserves, tightening domestic liquidity.

How do T-bills fulfill both monetary policy and fiscal management objectives?

They help finance deficits and regulate liquidity through monetary transmission.

Why are CPs more attractive than CDs for large corporates despite being unsecured?

Despite higher risk, CPs offer better rates and flexible terms to high-rated firms.

How does CD buyback restriction support monetary stability in short-term market?

Buyback restriction avoids premature withdrawals, supporting cash flow forecasting.

Why is FIMMDA important in regulating OTC trading of commercial papers?

It sets trading rules, improving transparency and stability in corporate debt markets.

How do SEZs act as a cushion during trade-related external shocks?

They earn forex, diversify exports, and bypass some domestic constraints.

Why are only central governments allowed to issue T-bills, not states?

States lack legal mandate and fiscal tools to issue sovereign debt like T-bills.

How does capital account surplus offset a persistent CAD in India’s BoP structure?

It covers CAD shortfalls, balancing BoP and ensuring currency stability.

What’s the logic of imposing countervailing duty instead of direct tariff increase?

It targets subsidized imports without breaching WTO norms of MFN treatment.

How does a financial market support economic growth beyond capital allocation?

It mobilizes savings, enhances capital allocation, and improves liquidity ecosystem.

Why is the liquidity of money market instruments critical during financial crises?

They provide short-term liquidity and prevent panic during market or banking crises.