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:

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UPSC Civil Services Exam (Prelims) GS Official Paper-I (Held On: 2020)
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  1. 1 only
  2. 1 and 2 only
  3. 3 only
  4. 1, 2 and 3

Answer (Detailed Solution Below)

Option 1 : 1 only
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Detailed Solution

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The correct answer is option 1.

Key Points

  • Not Depending on Short-Term Foreign Borrowings:
    • Short-term debts are those that need to be repaid within a short period.
    • If India avoids relying on short-term foreign borrowings, it reduces the immediate financial obligations and vulnerabilities during a global financial crisis.
    • This would provide some level of immunity as there would be less pressure to pay back foreign debts in the short term, thus insulating the economy from sudden external shocks.
    • Hence, statement 1 is correct.
  • Opening Up to More Foreign Banks:
    • During a global financial crisis, foreign banks tend to reduce lending and retreat from cross-border banking activities, including withdrawing investments and limiting new market entries.
    • Therefore, opening up more foreign banks in India does not necessarily provide immunity and could potentially increase exposure to external financial shocks.
    • Hence, statement 2 is not correct.
  • Maintaining Full Capital Account Convertibility:
    • Full capital account convertibility means that there are no restrictions on converting domestic currency into foreign currency for capital account transactions.
    • While this allows for free movement of capital, it can also lead to increased vulnerability during economic crises.
    • In adverse conditions, unrestricted capital flows may result in sudden capital flight, worsening the financial situation.
    • Hence, statement 3 is not correct.

Additional Information

  • Capital Account Convertibility:
    • This policy enables the free exchange of domestic currency with foreign currencies for capital transactions, promoting investment and financial integration.
    • However, during financial instability, it can lead to sudden outflows of capital, intensifying economic challenges.
  • Short-Term Borrowings:
    • High dependency on short-term foreign borrowings increases a country's risk during global financial turmoil, as it creates an obligation to repay loans promptly, often leading to a drain on foreign exchange reserves.
  • Foreign Banks:
    • While foreign banks contribute to economic growth and financial development, they tend to retreat during global financial crises, limiting credit and liquidity, which can negatively affect the host country's economy.
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