Test: FDI & FPI - UGC NET MCQ

Foreign Direct Investment (FDI) involves investing in foreign businesses or assets. This form of investment typically includes activities like establishing manufacturing plants, acquiring companies or property, or setting up various business operations in a foreign nation. FDI is crucial for economic growth and globalization as it facilitates the flow of capital, technology, and expertise across borders.

Governments actively seek to attract foreign investment to improve the nation's balance of payments. This influx of foreign capital not only enhances the country's financial standing but also fosters economic growth through various means like job creation, technology transfer, and increased competitiveness. Enhancing the balance of payments is crucial for countries to maintain stability in their international financial dealings and support sustainable economic development.

Foreign Direct Investment (FDI) has played a crucial role in creating millions of jobs in India, particularly in labor-intensive manufacturing and service sectors. This influx of foreign investment has helped to reduce unemployment rates and stimulate economic growth in the country. By introducing new businesses and expanding existing ones, FDI has significantly contributed to job creation, thereby improving the overall employment scenario in India.

The Department for Promotion of Industry and Internal Trade (DPIIT) in India is primarily responsible for formulating India's FDI policy. This policy, which is published annually, outlines the guidelines and regulations governing foreign direct investments in the country. By setting the FDI policy, the DPIIT plays a crucial role in shaping the investment landscape and attracting foreign capital into various sectors of the Indian economy.

• Assertion (A) is true. Foreign Direct Investment indeed plays a vital role in boosting a country's economic competitiveness by introducing advanced technology and management practices.
• Reason (R) is also true. FDI often brings in sophisticated technology and managerial skills to the host country, which can significantly enhance its economic landscape.
• The Reason is the correct explanation of the Assertion because the infusion of advanced technology and managerial expertise through FDI directly contributes to the economic competitiveness of the host country.

Assertion: The assertion is false as portfolio investors, including foreign portfolio investors, typically do not actively participate in the management decisions of the companies they invest in. They are considered passive owners of financial assets.

Reason: The reason is also false. Foreign portfolio investors do not primarily focus on gaining control and influencing the operations of the companies they invest in. Their involvement is limited to financial returns.

Explanation: The assertion and reason are both false. Foreign portfolio investors do not engage in active management decisions and do not aim to control the companies they invest in. Instead, they focus on financial returns through investments in stocks, bonds, and other financial assets.

• Assertion (A) Evaluation: Economic growth prospects do indeed hold considerable sway over foreign portfolio investments. Greater growth potential in a country typically results in heightened investor interest.
• Reason (R) Evaluation: It is true that countries with enhanced growth opportunities tend to lure in more investors due to the perceived potential for profitable returns.
• Explanation: The Reason correctly explains the Assertion as economic growth prospects serve as a fundamental driver for foreign portfolio investments. The higher the growth opportunities, the more attractive the investment destination becomes, thus making Option A the correct answer.

• Assertion (A) is true. Infrastructure development is indeed one of the benefits that come with Foreign Direct Investment, as multinational corporations often invest in building various infrastructure projects in host countries.
• Reason (R) is true. Multinational corporations frequently invest in infrastructure projects like roads, power facilities, and telecommunications, which can significantly contribute to the overall development of the host nation's infrastructure.
• The Reason is the correct explanation of the Assertion because the investment in infrastructure by multinational corporations is a direct result of Foreign Direct Investment and plays a crucial role in the development of the host country.

Tight monetary Policy

• Tight monetary policy refers to the actions that a central bank takes to limit inflation and an overheating economy. Tight monetary policy is commonly called contractionary monetary policy.
• Tight monetary policy, or contractionary monetary policy, typically occurs when a central bank wants to keep inflation under control.
• If there has been too much spending and borrowing by consumers and businesses, the economy can become overheated and that could considerably raise the price level of goods and services.
• Inflation is the rise in the price level of items, such as groceries or clothes, over time.
• To minimize or slow down inflation, a central bank could make it more expensive for consumers to spend money and businesses to borrow money by raising interest rates. This is a form of contractionary monetary policy—it restricts, or contracts, spending.

Capital Flight

• In economics, capital flight is a phenomenon characterized by large outflows of assets and/or capital from a country due to some events, resulting in negative economic consequences to that country.
• Capital Flight will be induced due to the tight monetary policy of the US federal reserve.

Tight Monetary policy and Its Fallout.

• The US Federal Reserve is facing a tough job of walking the tightrope between controlling the red-hot inflation and supporting growth.
• The situation has become more challenging in the backdrop of volatile crude and geopolitical tensions casting a dome of uncertainty.
• The Fed policymakers aim to make borrowing more expensive so that consumers and businesses hold making investments, thereby cooling off demand and hopefully the prices.

• Higher interest rates in the US usually lead to foreign investors pulling their money from emerging markets like India back to the US for safer, and more secure returns leading to capital flight. Hence statement 1 is correct.

• Foreign institutional investors have already sold over Rs 2 lakh crore worth of Indian equities since October 2021.

• Further capital flight will put pressure on the RBI to hike interest rates or lead to rupee depreciation against the dollar, which again would lead to imported inflation for India.

• Capital flight may increase the interest cost of firms with existing External Commercial borrowing (ECBs) as the capital flight would lead to depreciation in the value of the currency and create supply-side restraints for borrowers. Hence statement 2 is correct.

• Devaluation of domestic currency will inadvertently increase the currency risk associated with ECBs and will result in higher interest costs for borrowers, Hence statement 3 is incorrect. Hence statement 3 is incorrect.

• Foreign Ownership Limits: These limits are a common feature of foreign portfolio investment regulations. Countries may set caps on the ownership percentage of a company by foreign entities to safeguard national interests.
• Currency Controls: These controls are put in place by governments to manage the flow of money across borders. They can have a direct impact on foreign portfolio investments by affecting the ease with which investors can move funds in and out of a country.

Thus, both statements are correct as foreign ownership limits and currency controls are significant considerations for foreign portfolio investors.