UPSC Prelims 2020 Q49: Indian Economy – External Sector & Balance Of Payments
If another global financial crisis happens in the near future, which of the following actions/policies are most likely to give some immunity to India?
1. Not depending on short-term foreign borrowings
2. Opening up to more foreign banks
3. Maintaining full capital account convertibility
Select the correct answer using the code given below:
- (a) 1 only
- (b) 1 and 2 only
- (c) 3 only
- (d) 1, 2 and 3
Answer: (a) 1 only
Explanation
What protects India in a global financial crisis?
A crisis abroad reaches India mainly through money that can leave quickly.
So anything that reduces such money gives protection.
| Action or policy | Gives immunity? | Reason |
|---|---|---|
| 1. Not depending on short-term foreign borrowings | Yes | Short-term debt must be repaid or rolled over soon; in a crisis lenders refuse, causing a run on reserves |
| 2. Opening up to more foreign banks | No | Foreign banks carry the crisis in; they cut lending here when their parent is in trouble |
| 3. Maintaining full capital account convertibility | No | It lets capital flee freely; this worsened the 1997 East Asian crisis |
Why India was less hurt in 2008:
| Buffer | Detail |
|---|---|
| Partial capital account convertibility | Limits on how fast money can leave |
| Low short-term external debt | Followed since the 1991 crisis |
| Mostly domestic banks | Little exposure to toxic foreign assets |
| Large forex reserves | A cushion for the rupee |
Only action 1 helps.
Answer: (a) 1 only.
Why each option is right or wrong
- (a) CORRECT. Avoiding short-term foreign borrowings removes the main channel of sudden outflow.
- (b) Incorrect. More foreign banks would bring more exposure to a global crisis.
- (c) Incorrect. Full capital account convertibility makes capital flight easier, not harder.
- (d) Incorrect. Actions 2 and 3 increase exposure to the global crisis.
Key point
Crisis immunity: low short-term external debt, partial capital account convertibility, strong reserves. Foreign banks and full convertibility raise exposure (East Asia, 1997).
Remember
Less short-term foreign debt = more immunity.
Common mistakes
- Seeing full convertibility as a sign of strength; in a crisis it is a risk.
- Assuming foreign banks bring stability; they transmit shocks from their home markets.
- Forgetting that India's 1991 crisis was triggered by short-term external debt.
Exam tip
Ask one question: does it let money leave faster? If yes, it reduces immunity.
Sources
- Reserve Bank of India — Report of the Committee on Fuller Capital Account Convertibility (Tarapore Committee II), 2006
- Economic Survey 2008-09 — Ch on External Sector (impact of the global financial crisis)