UPSC Prelims 2002 Q70: Indian Economy – External Sector & Balance Of Payments
Global capital flows to developing countries increased significantly during the nineties. In
view of the East Asian financial crisis and the Latin American experience, which type of inflow is
considered safest for the host country?
- (a) Commercial loans
- (b) Foreign Direct Investment
- (c) Foreign Portfolio Investment
- (d) External Commercial Borrowings
Answer: (b) Foreign Direct Investment
Explanation
Safest type of capital inflow for a host country
| Inflow | Risk to the host country |
|---|---|
| Foreign Direct Investment | Safest — long-term, tied to real assets, not easily withdrawn |
| Foreign Portfolio Investment | Volatile hot money; can leave at once |
| Commercial loans | Create debt and repayment burden |
| External Commercial Borrowings | Debt with fixed repayments, risky in crises |
The East Asian crisis (1997) and the Latin American experience showed that short-term portfolio flows and debt can reverse suddenly. Foreign Direct Investment is long-term, brings management and technology, and does not create a fixed repayment burden, so it is the safest inflow.
Answer: (b) Foreign Direct Investment.
Why each option is right or wrong
- (a) Incorrect. Commercial loans add debt and need repayment.
- (b) CORRECT. FDI is stable and non-debt creating.
- (c) Incorrect. Portfolio flows can reverse suddenly.
- (d) Incorrect. ECBs add to external debt.
Key point
Order of stability: FDI, then long-term loans, then portfolio inflows, then short-term debt.
Remember
FDI is the safest capital flow.
Common mistakes
- Choosing portfolio investment because it brings dollars quickly.
- Treating External Commercial Borrowings as equity-like capital, when they are debt.
- Ignoring the East Asian lesson in the stem.
Exam tip
Equity-like, long-term and non-debt: FDI.
Sources
- Economic Survey 2001-02
- Ramesh Singh — Indian Economy