Foreign Exchange, FDI and External Debt (External Sector) Part-I

Total Questions: 50

11. The Capital Account Convertibility of the Indian Rupee implies: [I.A.S. (Pre) 1998]

Correct Answer: (c) that the Indian Rupee can be exchanged for any major currency for the purpose of trading financial assets
Solution:The balance of payments account, which is a statement of all transactions made between a country and the rest of the world, consists of two accounts current and capital account. While the current account deals mainly with import and export of goods and services, the capital account is made up of cross-border movement of capital by way of investments and loans.

Current account convertibility refers to the freedom to convert rupees into other internationally accepted curren- cies and vice-versa/or without any restrictions. Similarly, capital account convertibility means the freedom to conduct investment transactions without any constraints.

Typically, it would mean no restriction on the amount of rupees anyone can convert into foreign currency or vice-versa for the purpose of trading financial assets. Indian rupee is fully convertible on current account from August, 1994. As far as the capital account convertibility of rupee is concerned, India has come a long way in liberating the capital account transactions in the last three decades and currently has partial capital account convertibility.

12. Which of the following constitute Capital Account? [I.A.S. (Pre) 2013]

1. Foreign Loans

2. Foreign Direct Investment.

3. Private Remittances

4. Portfolio Investment

Select the correct answer using the codes given below:

Correct Answer: (b) 1, 2 and 4
Solution:In terms of balance of payments foreign loans, foreign direct investment and portfolio investment etc. constitute capital account while private remittances are part of current account. The current account represents a country's net income over a period of time, while the capital account records the net change of assets and liabilities during a particular year.

All possible transactions are divided into two main accounts - the Current Account and the Capital Account.

Current Account:

It refers to all transactions that are related to current consumption and it is further divided into - Trade Balance (the export and import of physical goods) and Invisibles Trade (trade in services, e.g. banking, IT, tourism, etc).
As can be seen from the table, India had a trade deficit (import>export) but a surplus in the Invisibles trade.

However, since the trade deficit was bigger than the surplus on the Invisibles trade, the overall current account of India is also in negative or deficit. This is called the Current Account Deficit (CAD).

Capital Account:

The capital account refers to those transactions which are not for current consumption, but for investment purposes. It includes net foreign investments (either foreign direct investment or foreign portfolio investments) and loans or money that countries borrow from each other.

As can be seen from the table, India had a capital account surplus of $90 billion from April-December 2021 as against a current account deficit of $26.6 billion.

13. Tarapore Committee was associated with which one of the following? [I.A.S. (Pre) 2007]

Correct Answer: (b) Fuller capital account convertibility
Solution:The first committee on capital account convertibility (CAC) under the chairmanship of S.S. Tarapore was constituted by the RBI for suggesting a roadmap on full convertibility of rupee on capital account. The committee submitted its report in May, 1997. Reserve Bank of India on 20 March, 2006 constituted a second, 6-member committee on fuller capital account convertibility (FCAC) of rupee under the chairmanship of S. S, Tarapore.

The committee submitted its report on 31 July 2006, and the report of this committee was made public by RBI on 1 September, 2006. In this report, the committee suggested 3 phases of adopting the full convertibility of rupee on capital account. It also laid down the pre-conditions: 3 percent fiscal deficit, 3 percent current account deficit and 1 percent NPA.

14. The question of fullcapital account convertibility of India was examined by the Committee known as [U.P.P.C.S. (Pre) 2007]

Correct Answer: (c) Tarapore Committee
Solution:The first committee on capital account convertibility (CAC) under the chairmanship of S.S. Tarapore was constituted by the RBI for suggesting a roadmap on full convertibility of rupee on capital account.

The committee submitted its report in May, 1997. Reserve Bank of India on 20 March, 2006 constituted a second, 6-member committee on fuller capital account convertibility (FCAC) of rupee under the chairmanship of S. S, Tarapore.

The committee submitted its report on 31 July 2006, and the report of this committee was made public by RBI on 1 September, 2006. In this report, the committee suggested 3 phases of adopting the full convertibility of rupee on capital account. It also laid down the pre-conditions: 3 percent fiscal deficit, 3 percent current account deficit and 1 percent NPA.

15. Devaluation of a currency means: [I.A.S. (Pre) 1994, U.P.P.C.S. (Pre) 1998, J.P.S.C. (Pre) 2006]

Correct Answer: (b) permitting the currency to seek its worth in the 10 international market
Solution:Devaluation of currency means decreasing the value of domestic currency in comparison of currencies used in inter- national market. A devaluation is an official lowering of the value of a country's currency within a fixed exchange rate system, in which a monetary authority formally sets a lower exchange rate of the national currency in relation to major international currencies.

The Indian rupee was devalued in 1949, 1966 and 1991. But in 1991, it was carried out in two steps on July 1 and July 3. Hence, it was devalued in three years but four times.

16. The Devaluation means: [U.P.P.C.S. (Pre) 1991, 1994,]

Correct Answer: (b) Decline in the value of currency with respect to other international currencies
Solution:Devaluation of currency means decreasing the value of domestic currency in comparison of currencies used in inter- national market. A devaluation is an official lowering of the value of a country's currency within a fixed exchange rate system, in which a monetary authority formally sets a lower exchange rate of the national currency in relation to major international currencies.

The Indian rupee was devalued in 1949, 1966 and 1991. But in 1991, it was carried out in two steps on July 1 and July 3. Hence, it was devalued in three years but four times.

17. In which year the rupee was devalued for the first time in [U.P.P.C.S. (Spl.) (Pre) 2008]

Correct Answer: (a) 1949
Solution:Devaluation of currency means decreasing the value of domestic currency in comparison of currencies used in inter- national market. A devaluation is an official lowering of the value of a country's currency within a fixed exchange rate system, in which a monetary authority formally sets a lower exchange rate of the national currency in relation to major international currencies.

The Indian rupee was devalued in 1949, 1966 and 1991. But in 1991, it was carried out in two steps on July 1 and July 3. Hence, it was devalued in three years but four times.

18. Rupee was devalued by what percent in July, 1991? [M.P.P.C.S. (Pre) 1992]

Correct Answer: (a) 18
Solution:The devaluation of rupee in 1991 took place in two steps. On July 1, 1991 the Finance Minister wanted to 'test the waters' before effecting any large change in the value of the rupee. Only when the markets reacted positively, a second devaluation was permitted on July 3, 1991.

The two-step downward adjustment in the value of the rupee worked out to 17.38 percent in terms of the intervention currency i.e., pound sterling and about 18.7 percent in US dollar terms. Hence, option (a) is the correct answer.

India's Exchange Rate Policy:
Past trends:

  • India has primarily followed a managed-float regime for three decades.
  • From 2010, the Reserve Bank of India (RBI) managed the rupee asymmetrically:
  • Under excess demand: Depreciated the rupee and sold foreign reserves.
  • Under excess supply: Accumulated reserves to avoid appreciation.

Post-COVID shifts:

  • Between 2022 and late 2024, the RBI temporarily adopted a fixed exchange rate-like regime to stabilize the rupee.
  • Recent sharp devaluation suggests a return to the managed-float approach, driven by:
  • Capital outflows.
  • Rising import costs amid high crude oil prices.

19. In which of the following financial years the devaluation of rupee in India took place twice? [U.P.P.C.S. (Mains) 2012]

Correct Answer: (b) 1991-92
Solution:The devaluation of rupee in 1991 took place in two steps. On July 1, 1991 the Finance Minister wanted to 'test the waters' before effecting any large change in the value of the rupee. Only when the markets reacted positively, a second devaluation was permitted on July 3, 1991.

The two-step downward adjustment in the value of the rupee worked out to 17.38 percent in terms of the intervention currency i.e., pound sterling and about 18.7 percent in US dollar terms.

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

The effect of devaluation of a currency is that it neces- sarily

1. improves the competitiveness of the domestic exports in the foreign markets

2. increases the foreign value of domestic currency

3. improves the trade balance

Which of the above statements is/are correct?

Correct Answer: (a) 1 only
Solution:Devaluation of currency means reduction in the value of currency vis-a-vis major internationally traded currencies. A key effect of devaluation is that it makes the domestic currency cheaper relative to other currencies. There are two implications of a devaluation.

First, devaluation makes the country's exports relatively less expensive and improves the competitiveness of domestic exports in foreign markets. Second, devaluation makes foreign products relatively more expensive for domestic consumers, thus discouraging imports.

This may help to increase the country's exports and decrease imports, and may therefore help to improve the trade balance. However, it will not necessarily improve trade balance as essential imports (e.g. crude oil) can be expensive. Hence, only statement 1 is correct.