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Q59 (IAS/2018) Economy › Agriculture & Rural Economy › Sustainable farming practices Official Key

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:

Result
Your answer: —  ·  Correct: C
Explanation

The correct answer is option C (3 only).

The ratio of short-term debt to forex reserves has emerged as a relevant yardstick to determine reserve adequacy[1], which suggests that managing short-term external debt is important for stability. Therefore, not depending on short-term foreign borrowings (Statement 1) would provide immunity during a financial crisis.

Regarding Statement 2, opening up to more foreign banks would actually increase vulnerability rather than provide immunity. It exposes the economy to global vulnerabilities, with risks including sudden capital flight, speculative attacks, and contagion effect—the transmission of financial crisis effects from other countries to the Indian economy[2].

For Statement 3, maintaining full capital account convertibility would similarly increase vulnerability. While there are benefits to be reaped from a more open capital account, international experience shows that this could impose tremendous pressures on the financial system, hence certain preconditions were indicated for capital account convertibility in India[3].

Therefore, only limiting short-term foreign borrowings (Statement 1) would provide immunity, making option C correct.

Sources
  1. [1] Indian Economy, Nitin Singhania .(ed 2nd 2021-22) > Chapter 17: India’s Foreign Exchange and Foreign Trade > RESERVE ADEQUACY FEW MONTHS OF IMPORTS RULE VERSUS GUIDOTTI-GREENSPAN RULE > p. 497
  2. [2] Indian Economy, Nitin Singhania .(ed 2nd 2021-22) > Chapter 17: India’s Foreign Exchange and Foreign Trade > Limitations > p. 499
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Q. If another global financial crisis happens in the near future, which of the following actions/policies are most likely to give some immun…
At a glance
Origin: Books + Current Affairs Fairness: Low / Borderline fairness Books / CA: 3.3/10 · 6.7/10
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This is a classic 'Conceptual Application' question. It moves beyond defining terms (like CAC or Short-term debt) to testing their functional implications during a crisis. The core logic is simple: Immunity = Isolation from contagion. If you understood why India survived the 2008 crisis (limited exposure), this was a sitter.

How this question is built

This question can be broken into the following sub-statements. Tap a statement sentence to jump into its detailed analysis.

Statement 1
Would minimizing India's reliance on short-term foreign borrowings increase India's resilience to a global financial crisis?
Origin: Direct from books Fairness: Straightforward Book-answerable
From standard books
Indian Economy, Nitin Singhania .(ed 2nd 2021-22) > Chapter 17: India’s Foreign Exchange and Foreign Trade > RESERVE ADEQUACY FEW MONTHS OF IMPORTS RULE VERSUS GUIDOTTI-GREENSPAN RULE > p. 497
Presence: 5/5
“RESERVE ADEQUACY: FEW MONTHS OF IMPORTS RULE VERSUS GUIDOTTI-GREENSPAN RULE • Traditionally, an adequate amount of forex reserve was determined in terms of reserves equivalent for few months of imports. However, with increasing importance of capital account transactions in BOP, this approach is now becoming less relevant.• Short-term external debt among various capital account transactions has gained prominence now under BOP.• Thus, the ratio of short-term debt to forex reserves has emerged as a relevant yardstick to determine reserve adequacy. Component-wise Indian forex reserves - explained in the previous chapter. 110000 India's Forex reserves cover of imports as on June ø 2020 was 14.8 months.”
Why this source?
  • Explicitly identifies short-term external debt as a key capital-account item and states the ratio of short-term debt to forex reserves is a relevant yardstick for reserve adequacy.
  • Implies high short-term debt relative to reserves raises vulnerability; reducing short-term borrowings would improve reserve adequacy and shock-absorption.
Indian Economy, Nitin Singhania .(ed 2nd 2021-22) > Chapter 17: India’s Foreign Exchange and Foreign Trade > Limitations > p. 499
Presence: 4/5
“• It exposes the economy to global vulnerabilities. \bullet• There remains a fear of sudden capital flight which may also lead to increase in current account deficit.\bullet Risk of speculative attacks.\bullet No ceiling on external debt may be disastrous.\bullet Zontagion effect, i.e., more chances of transmission of the effect of financial crisis occurring in a particular country to the Indian economy. As per the Tarapore Committee, there are some pre-conditions which need to be fulfilled before going for full convertibility of rupee: • 1. Reduce fiscal deficit to 3.5 per cent of GDP. • 2. Reduce public debt by setting up consolidated sinking fund. • 3.”
Why this source?
  • Links openness/external borrowings to global vulnerabilities: risk of sudden capital flight, speculative attacks and contagion from foreign crises.
  • Suggests that exposure via external liabilities can transmit global financial shocks to the domestic economy, so lowering such exposure reduces transmission risk.
Indian Economy, Nitin Singhania .(ed 2nd 2021-22) > Chapter 9: Agriculture > MASALA BOND > p. 266
Presence: 4/5
“Before the introduction of Masala Bonds, companies and financial institutions borrowed through issuing bonds in the overseas markets such as the US, the UK, Singapore, etc., in foreign currencies because of the easy availability of funds and at lower interest rates. This exposed the Indian borrowers to foreign currency exchange risks. Depreciation in rupee led to increase in their cost of capital. For example, XYZ Ltd. borrowed $1 million in 2020 when $1 equalled to ₹70. Total borrowing was ₹7 crore in rupees. Now, let's say in 2021, $1 has become ₹75 due to depreciation of rupee. XYZ Ltd. wants to repay its loan in 2021.”
Why this source?
  • Shows foreign-currency borrowing exposes borrowers to exchange-rate risk (depreciation raising repayment costs).
  • Illustrates that shifting to rupee-denominated alternatives (e.g., Masala Bonds) was motivated by reducing such external-vulnerability.
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