External Sector: FDI, FPI & BoP — Set 5

Correct Answer: B. B. After currency depreciation, trade deficit initially worsens before improving as exports become more competitive

The J-Curve Effect describes the trade balance response to currency depreciation. Initially, after depreciation, the trade deficit worsens because import prices rise immediately (higher import costs) while export volumes take time to respond. Over time (usually 1-2 years), as exporters take advantage of improved competitiveness and export volumes rise, the trade balance improves. The initial deterioration followed by improvement traces a J-shape, hence the name.

Correct Answer: B. B. Merchandise exports (goods) and service exports

India's exports are classified into: (1) Merchandise exports — goods including engineering goods, petroleum products, gems & jewellery, chemicals, pharmaceuticals, textiles, agricultural products; (2) Service exports — software/IT, business process outsourcing, professional services, tourism, financial services. India's merchandise exports have been growing but face competitiveness challenges, while service exports (especially IT) are a major strength. Combined goods and services exports are tracked in India's BoP.

Correct Answer: B. B. Merchandise exports minus merchandise imports (goods only)

Trade Balance (or Merchandise Trade Balance) specifically refers to the difference between merchandise (goods) exports and merchandise imports. India typically has a merchandise trade deficit (imports > exports), which is partially offset by a services trade surplus. When trade balance includes both goods and services, it is called the 'Balance of Trade in Goods and Services.' The Current Account adds primary income (dividends, interest) and secondary income (remittances) to this.

Correct Answer: B. B. Rupee accounts for NRIs, fully repatriable, with interest exempt from Indian income tax

NRE (Non-Resident External) accounts are Rupee-denominated accounts maintained in India for Non-Resident Indians (NRIs). Key features: (1) Deposits in foreign currency, converted to rupees at prevailing rate; (2) Principal and interest are fully and freely repatriable; (3) Interest income is exempt from Indian income tax; (4) Can be used for investments in India (equities, mutual funds, etc.). NRE deposits provide a significant and stable inflow of foreign currency to India.

Correct Answer: B. B. Specified categories of capital transactions to be conducted freely (FDI, FPI, ECBs within limits) while others remain regulated

India has achieved partial capital account convertibility — specific categories of capital transactions are liberalized: FDI (with sectoral caps), FPI (with market limits), ECBs (with guidelines), NRI deposits (fully repatriable for NRE), and Liberalised Remittance Scheme for individuals. However, outward direct investment, external commercial borrowings, and certain portfolio transactions still have limits or require approval. Full capital account convertibility would mean no such restrictions.

Correct Answer: B. B. State-owned investment fund typically created from commodity export revenues or forex reserves

Sovereign Wealth Funds (SWFs) are state-owned investment funds or entities typically created from a country's commodity export revenues (oil, gas — e.g., Norway's GPF, UAE's ADIA) or foreign exchange reserves (China, Singapore). They invest globally in equities, bonds, real estate, and alternative assets to preserve and grow national wealth. India does not have a traditional SWF, though NIIF (National Investment and Infrastructure Fund) is sometimes considered a nascent SWF-type entity.

Correct Answer: B. B. Exchange rate, domestic cost competitiveness, infrastructure quality, trade facilitation, and market access

India's export competitiveness is determined by multiple factors: (1) Exchange rate (depreciation boosts competitiveness); (2) Domestic costs (labour, land, logistics costs relative to competitors); (3) Infrastructure quality (ports, roads, power); (4) Trade facilitation (customs efficiency, documentation); (5) Market access (FTAs, preferential agreements); (6) Product diversification and quality. India's logistics costs remain high relative to competitors like Vietnam, reducing price competitiveness.

Correct Answer: A. A. Simultaneous fiscal deficit and current account deficit

India's 'Twin Deficit' problem refers to the coexistence of (1) Fiscal Deficit (government spending exceeds government revenue) and (2) Current Account Deficit (imports exceed exports). These two deficits are linked — high fiscal deficit stimulates domestic demand which increases imports and reduces export competitiveness. When both deficits are large simultaneously, it creates macroeconomic vulnerability and pressure on the exchange rate, as both require external or internal financing.

Correct Answer: B. B. The weighted average exchange rate of rupee against a basket of currencies, adjusted for relative inflation

REER (Real Effective Exchange Rate) is the weighted average of India's exchange rate against a basket of major trading partner currencies (RBI calculates both 6-country and 36-country REER), adjusted for relative inflation rates. REER above 100 indicates an overvalued currency (reducing export competitiveness), while below 100 indicates undervaluation. REER is more useful than nominal exchange rates for assessing trade competitiveness because it accounts for inflation differentials.

Correct Answer: C. C. UAE (Comprehensive Economic Partnership Agreement — CEPA)

India signed a Comprehensive Economic Partnership Agreement (CEPA) with the UAE in February 2022, which came into force in May 2022. It was India's first FTA with a major trading partner in a decade. India also has FTAs/CEPAs with ASEAN, South Korea, Japan, Sri Lanka, and Singapore. India was negotiating FTAs with the UK, EU, and Canada. India chose not to join RCEP (Regional Comprehensive Economic Partnership) in 2019, citing concerns about trade deficits.