Ramesh Singh Test : External Sector In India - 1 - UPSC MCQ

The correct answer is Option A: Trade Balance. Trade balance is the term used to describe the disparity between a country's exports and imports during a given period. It serves as a crucial indicator of the economic health of a nation, reflecting how much a country is exporting versus importing. An excess of exports over imports signifies a trade surplus, while the opposite indicates a trade deficit. Maintaining a healthy trade balance is essential for long-term economic stability and growth.

Statement-I correctly defines Trade Balance as the variance between a nation's exports and imports, serving as a crucial indicator of economic performance and global trade dynamics. It reflects how much a country is producing versus consuming from foreign sources. On the other hand, Statement-II inaccurately describes Revaluation. Revaluation is the process of increasing the value of a currency, but it is primarily aimed at maintaining a stable exchange rate or appreciating the currency's value rather than solely focusing on trade balance implications. Therefore, while Statement-I is accurate in defining Trade Balance, Statement-II provides an incorrect explanation of Revaluation.

1. Fixed Currency Regime – Exchange rates determined by market forces

This pair is incorrectly matched. In a fixed currency regime, exchange rates are fixed against a basket of major currencies (e.g., GBP, USD, JPY, DEM, FRF) and are periodically adjusted by the IMF, not determined by market forces.

2. Floating Currency Regime – UK adopted this in 1973

This pair is correctly matched. The UK adopted a floating currency regime in 1973 to gain flexibility and avoid payment crises, where exchange rates are determined by market forces (supply and demand).

3. Managed Exchange Rates – Dual exchange rate system in India since 1992-93

This pair is correctly matched. India has a managed exchange rate system with a dual exchange rate system since 1992-93, where the government intervenes to stabilize exchange rates through buying/selling currencies or monetary policy adjustments.

4. Foreign Exchange Market – Determines exchange rates under fixed currency regimes

This pair is incorrectly matched. The foreign exchange market determines exchange rates under floating or managed exchange rate systems, not under fixed currency regimes.

Thus, only two pairs are correctly matched.

1. LERMS - Liberalized Exchange Rate Management System: Correct. LERMS stands for Liberalized Exchange Rate Management System, which was introduced in India in 1992 to liberalize the exchange rate system.

2. CAD - Capital Account Deficit: Incorrect. CAD stands for Current Account Deficit, not Capital Account Deficit. The current account deficit represents the shortfall between the nation's savings and its investment.

3. CAC - Current Account Convertibility: Incorrect. CAC stands for Capital Account Convertibility, which refers to the freedom to convert local financial assets into foreign financial assets at market-determined exchange rates.

4. BOP - Balance of Payments: Correct. BOP stands for Balance of Payments, which is a summary of all economic transactions between residents of a country and the rest of the world during a specific period.

Pairs 1 and 4 are correctly matched, while pairs 2 and 3 are incorrectly matched. Thus, only two pairs are correctly matched.

The primary objective behind introducing the Liberalized Exchange Rate Management System (LERMS) in India in 1992 was to transition from a rigid fixed exchange rate system to a more flexible exchange rate regime that aligned with market forces. This shift aimed to allow market conditions to have a greater influence on the exchange rate, moving away from a system where the rate was strictly determined by authorities.

Forex reserves are primarily held by economies to stabilize currency exchange rates, manage external shocks, and ensure liquidity during times of crisis. These reserves act as a buffer to maintain stability in the currency's value and to deal with unexpected economic challenges, such as sudden changes in trade balances or capital flows. By having an adequate amount of forex reserves, a country can mitigate risks and maintain economic stability in the face of external uncertainties.

(Note: This question focuses on the key role of forex reserves in economic management and stability, requiring an understanding of their functions and significance in managing a country's economy.)

Statement-I correctly highlights the significant amount of India's forex reserves as of December 2022, underlining their importance in ensuring economic stability. The statement also accurately mentions that these reserves are sufficient to cover 93 months of imports, reflecting their critical role in safeguarding against external shocks and crises.
Statement-II provides an accurate representation of India's external debt situation in September 2022, detailing the total amount of external debt and its percentage relative to the GDP. By showcasing a prudent management approach post-reforms, this statement aligns with the data presented in the provided content.
Therefore, both statements are factually correct, and Statement-II explains the importance and implications of India's forex reserves highlighted in Statement-I. Hence, option (a) is the correct answer.

Statement 1 is correct. Depreciation of a currency makes a country's goods and services cheaper for foreign buyers, thereby increasing the competitiveness of its exports.

Statement 2 is incorrect. Devaluation refers to a deliberate action taken by a government to reduce the value of its currency relative to other currencies. It is not a market-driven process but a policy decision aimed at correcting trade imbalances or boosting exports.

Statement 3 is correct. NEER (Nominal Effective Exchange Rate) and REER (Real Effective Exchange Rate) are indices that measure the value of a currency against a basket of other currencies, weighted by trade. They are used to assess the competitiveness of a country's currency.

Therefore, the correct answer is Option C.

• Statement 1 is correct: Forex reserves indeed include foreign currencies, gold reserves, SDRs, and RTP in the IMF. These components are standard elements of a country's forex reserves.
• Statement 2 is incorrect: As of December 2022, India's forex reserves were sufficient to cover 9.3 months of imports, not 93 months. This is a significant error in the number of months covered.
• Statement 3 is correct: As of September 2022, India's external debt was indeed equivalent to 19.2% of its GDP, indicating a prudent management approach towards external debt.

Hence, the correct answer is Option C.

1. **Under a fixed currency regime, exchange rates are adjusted periodically by the International Monetary Fund (IMF).**
This statement is correct. In a fixed currency regime, exchange rates are pegged to a basket of major currencies and are periodically adjusted by the IMF to maintain stability.

2. **The United Kingdom adopted a floating currency regime in 1973 to enhance payment flexibility and avoid payment crises.**
This statement is correct. The UK moved to a floating currency regime in 1973 to gain more flexibility and avoid the issues associated with fixed exchange rates, such as payment crises.

3. **In India, the exchange rate was historically linked to the United States Dollar (USD) until 1948.**
This statement is incorrect. India's exchange rate was historically linked to the British Pound Sterling (GBP) until 1948, after which it was fixed to the USD at Rs 3.30.

Therefore, the correct statements are 1 and 2. Hence, the correct answer is Option B: 1 and 2 Only.