Foreign Exchange, FDI & External Debt (Part – II)

Total Questions: 50

1. With reference to Foreign Direct Investment in India, which one of the following is considered its major characteristic? [I.A.S. (Pre) 2020]

Correct Answer: (b) It is a largely non-debt creating capital flow.
Solution:Foreign Direct Investments (FDI) means investment through capital instruments by a person resident outside India (a) in an Unlisted Indian Company; or (b) in ten percent or more of the post issue paid-up equity capital on a fully diluted basis of a listed Indian company. Hence, option (a) is incorrect.

FDI infuses long term sustainable capital in the economy and contributes towards technology transfer, development of strategic sectors, greater innovations, competition and employment creation amongst other benefits. So, it is considered as a major source of non-debt financial resources for the economic development. Hence, option (b) is the correct answer.

The foreign direct investment can be made in 'Capital Instrument', i.e. in equity shares, debentures, preference shares and share warrants issued by Indian company, but not in the Government securities. Hence, option (d) is incorrect.

FDI do not involve debt-servicing. Debt service is the cash that is required to cover the repayment of interest and principal on a debt for a particular period. While FDI contributes towards technology transfer, innovation, competition, skills and employment creation etc. Hence, option (c) is also incorrect.

2. Which of the following would include Foreign Direct Investment in India? [I.A.S. (Pre) 2012]

1. Subsidiaries of foreign companies in India

2. Majority foreign equity holding in Indian companies

3. Companies exclusively financed by foreign companies

4. Portfolio investment

Select the correct answer using the codes given below:

Correct Answer: (d) 1, 2 and 3 only
Solution:Foreign investment has two components, namely, Foreign Direct Investment (FDI) and Foreign Portfolio Investment (FPI). Foreign Direct Investment (FDI) is the investment through capital instruments by a person resident outside India (a) in an unlisted Indian company; or (b) in 10 percent or more of the post issue paid-up equity capital on a fully diluted basis of a listed Indian company.

Subsidiaries of for. companies in India, majority foreign holding in Indian companies and companies exclusively financed by foreign companies would include FDI in India.

Foreign Portfolio Investment (FPI) is any investment made by a person resident outside India in capital instruments where such investment is (a) less than 10 percent of the post issue paid-up capital on a fully diluted basis of a listed Indian company or (b) less than 10 percent of the paid-up value of each series of capital investments of a listed Indian company.

3. Consider the following: [I.A.S. (Pre) 2021]

1. Foreign currency convertible bonds.

2. Foreign institutional investment with certain conditions

3. Global depository receipts

4. Non-resident external deposits

Which of the above can be included in Foreign Direct Investments?

Correct Answer: (a) 1, 2 and 3
Solution:Foreign Currency Convertible Bond' (FCCB) means a bond issued under the Issue of Foreign Currency Convertible Bonds and Ordinary Shares (Through Depository Receipt Mechanism) Scheme, 1993, as amended from time to time. Since these bonds are convertible into equity shares over a period of time, therefore inward remittances received by the Indian company vide issuance of FCCBs are treated as FDI. 'Foreign Institutional Investors' (FIIs) are allowed to invest in the primary and secondary capital markets in India through the Portfolio Investment Scheme (PIS).

Under this scheme, FIIs can acquire shares/debentures of Indian companies through the stock exchanges in India. The ceiling for overall investment for Flls is 24 percent of the paid-up capital of the Indian company. Foreign Institutional Investment with certain conditions (e.g. in convertible debentures) is counted as FDI.

In case, the total holding of a portfolio investment increases to 10 percent or more of the total paid-up equity capital on a fully diluted basis, the total investment so made will be re-classified as FDI, subject to certain conditions as specified by SEBI in this regard.

'Depository Receipt' (DR) means a foreign currency denominated instrument whether listed on an international exchange or not, issued by a foreign depository in a permissible jurisdiction on the back of eligible securities

issued or transferred to that foreign depository and deposited with a domestic custodian and includes 'Global Depository Receipt' (GDR) as defined in the Companies Act, 2013. Depository Receipts such as ADR and GDR are treated as FDI.

Non-resident external deposits are not treated as FDI as they are debt creating inflows. NRIs/PIOs are allowed to invest in the primary and secondary capital markets in India through the PIS. The ceiling for investment for NRIs/PIOs is 10 percent of the paid-up capital of the Indian company.

Hence, statements 1, 2 and 3 are correct while statement 4 is incorrect.

4. As part of the liberalization programme and with a view to attract foreign exchange, the Government and the RBI have, devised two schemes known as FCNR 'A' and FCNR 'B'. [IAS (Pre) 1995]

Which of the following is/are true regarding these two schemes?

1. Under scheme 'A' RBI bears exchange rate fluctuations.

2. Under scheme 'B' other banks are to meet out the difference in exchange rate fluctuations.

3. Both the schemes stand withdrawn now.

4. Only scheme 'A' has been withdrawn.

Codes:

Correct Answer: (d) 1, 2 and 4
Solution:All statements are correct except statement 3. Scheme FCNR (A) was launched in 1975 to encourage NRI deposits. The RBI guaranteed the exchange rate prevalent at the time of a deposit to eliminate risk to depositors. It was withdrawn in 1993. FCNR (B) was started in place of FCNR (A) on 15 May, 1993. At present, FCNR account stands for Foreign Currency Non-Resident Bank (B) Account.

It is a kind of fixed deposit account opened for depositing income earned overseas. The account is held in foreign currency. An FCNR-B account allows NRIs to invest foreign currency in term deposits in India and earn tax-free interest. They can benefit from higher interest rates in India while holding their deposits in a foreign currency, thus protecting them agains exchange rate fluctuations.

5. Global capital flows to developing countries increased significantly during the nineties. In view of the East Asian financial crisis and Latin American experience, which type of inflow is good for the host country? [I.A.S. (Pre) 2002]

Correct Answer: (b) Foreign Direct Investment
Solution:Excess Portfolio Investment by the foreigners was the main reason of crisis in East Asian and Latin American countries. Such investments are highly volatile and as opposite to it Foreign Direct Investment (FDI) is stable in nature. FDI plays an effective role in the development of country. FDI is most effective and useful source of foreign capital in hosting country.

FDI accelerates growth process mainly due to superior technology transfers and greater competition that generally accompany FDI. FDI also improves export competitiveness of the country, FDI reflects seriousness and commitment on part of foreign investors since FDI causes high initial setup cost and higher exit costs in terms of difficulty in selling stake in the firm. Thus, foreign direct investor stay invested for long-term in the country and so help to improve growth prospects of the host country.

6. Both Foreign Direct Investment (FDI) and Foreign Institutional Investor (FII) are related to investment in a country. Which one of the following statements best represents an important difference between the two? [I.A.S. (Pre). 2011]

Correct Answer: (b) FII helps in increasing capital availability in general, while FDI only targets specific sectors
Solution:Foreign Direct Investment is stable in nature as compared to investments by Foreign Institutional Investor (FII). FDI is helpful in bringing better Management skills and Technology transfer whereas FII brings only capital. FII functions primarily in secondary market. Thus option (a), (c) and (d) are incorrect. FIIs are conducive for increase in availability of foreign capital at comprehensive level, even though they are short-termed and buoyant by nature, while FDI only targets specific sectors. Hence, option (b) is the correct answer.

7. Which of the following is not an example of foreign direct investment? [Uttarakhand P.C.S. (Pre) 2021]

Correct Answer: (c) The purchase of bonds or stocks issued by Pharma Company overseas
Solution:Among the given options, the purchase of bonds or stocks issued by Pharma Company overseas is not an example of foreign direct investment (FDI), while the other three are examples of FDI.

Foreign Direct Investment (FDI) refers to the investment made by a company or individual of one country into business interests located in another country. This investment typically involves acquiring a significant stake in a company or setting up new business operations such as subsidiaries, joint ventures, or branches.

FDI is different from foreign portfolio investment (FPI) because it involves a long-term interest in the company's management and operations, rather than just trading shares or securities.

8. Participatory Notes (PNs) are associated with which one of the following? [I.A.S. (Pre) 2007]

Correct Answer: (b) Foreign Institutional Investors
Solution:A Participatory Note (P-note or PN) is an instrument issued by a registered Foreign Institution Investor (FII) to an over- seas investor who wishes to invest in Indian stock markets without registering themselves with the market regulator SEBI. These notes are a unique Indian invention started in 2000 by SEBI to enable foreign corporates and high networth investors enter the Indian market without having to go through the process of registering as FII.

9. Which of the following is issued by registered foreign portfolio investors to overseas investors who want to be part of Indian stock market without registering themselves directly? [I.A.S. (Pre) 2019]

Correct Answer: (d) Participatory Note
Solution:P-Notes or Participatory Notes are Overseas Derivative Instruments that have Indian Stocks as their underlying assets. They allow foreign investors to buy stocks listed on Indian exchanges without being registered. P-Notes are issued by foreign portfolio investors (FPIs) registered with SEBI, to overseas investors who want to be part of the Indian stock market without registering themselves directly.

The instrument gained popularity as FIls, to avoid the formalities of registering and to remain anonymous, started betting on stocks through this route.

10. Limit of investment for outstanding corporate bond for Foreign Portfolio Investment in Union Budget 2020-21 has been extended upto: [U.P. P.C.S. (Pre) 2020]

Correct Answer: (d) 15%
Solution:Limit of investment in outstanding corporate bonds for Foreign Portfolio Investment (FPI) in Union Budget 2020-21 had been extended upto 15% from the previous upto 9%. The limits for FPI investment in corporate bonds shall remain unchanged at 15% of outstanding stock of securities for FY 2023-24 and 2024-25. The limits for FPI investment in Government securities (G-secs) and State Development Loans (SDLs) are at 6% and 2% respectively.