UPSC STATIC QUIZ – Economy : 15 March 2024

Solution: d)

The term ‘Washington Consensus’ was coined by the US economist John Williamson (in 1989) under which he had suggested a set of policy reforms which most of the official in Washington (i.e., International Monetary Fund and World Bank) thought would be good for the crisis-driven Latin American countries of the time. The policy reforms included ten propositions:

• Fiscal policy discipline, with avoidance of large fiscal deficits relative to GDP;
• Redirection of public spending from subsidies (“especially indiscriminate subsidies”) toward broad-based provision of key pro-growth, pro-poor services like primary education, primary health care and infrastructure investment;
• Tax reform, broadening the tax base and adopting moderate marginal tax rates;
• Interest rates that are market determined and positive (but moderate) in real terms;
• Competitive exchange rates;
• Trade liberalization: liberalization of imports, with particular emphasis on elimination of quantitative restrictions (licensing, etc.); any trade protection to be provided by low and relatively uniform tariffs;
• Liberalization of inward foreign direct investment;
• Privatization of state enterprises;
• Deregulation: abolition of regulations that impede market entry or restrict competition, except for those justified on safety, environmental and consumer protection grounds, and prudential oversight of financial institutions;
• Legal security for property rights.

Solution: d)

The Balance of Payments shows a country’s transactions with the rest of the world.

The current account comprises the trade balance (which is trade in goods) and also includes the balance for trade in services.

When people refer to a balance of payments deficit they invariably mean a current account deficit. But, this is not the case as the BoP also includes the capital account, which includes FDI, FII, external long-term debt etc. A high exposure to debt can be sustained with a current account surplus.

Balance of Payments Crisis occurs when the current account deficit cannot be maintained. It means there will be a fall in foreign exchange reserves and the country can no longer attract sufficient capital flows to finance the current account deficit.  India faced the BoP crisis in 1991.

While Forex reserves can be used to meet BoP crisis situations, they do NOT form part of the BoP as such.

Solution: d)

• The real effective exchange rate (REER) compares a nation’s currency value against the weighted average of the currencies of its major trading partners.
• It is an indicator of the international competitiveness of a nation in comparison with its trade partners.
• The formula is weighted to take into account the relative importance of each trading partner to the home country.
• An increasing REER indicates that a country is losing its competitive edge.
• A nation’s nominal effective exchange rate (NEER), adjusted for inflation in the home country, equals its real effective exchange rate (REER).

Solution: b)

Statement 3 is incorrect.

India has taken some steps to promote the internationalisation of the rupee (e.g., enable external commercial borrowings in rupees), with a push to Indian banks to open Rupee Vostro accounts and measures to trade with ~18 countries in rupees instituted.

For a currency to be considered a reserve currency, the rupee needs to be fully convertible, readily usable, and available in sufficient quantities. India does not permit full capital account convertibility (i.e., allowing free movement of local financial investment assets into foreign assets and vice-versa), with significant constraints on the exchange of its currency with others — driven by past fears of capital flight (i.e., outflow of capital from India due to monetary policies/lack of growth) and exchange rate volatility, given significant current and capital account deficits.

Solution: b)

Statement 2 is incorrect.

A barrier to trade is a government-imposed restraint on the flow of international goods or services. The most common barrier to trade is a tariff—a tax on imports. Tariffs raise the price of imported goods relative to domestic goods (goods produced at home).

An import quota is a type of protectionist trade restriction that sets a physical limit on the quantity of a good that can be imported into a country in a given period of time.

FDI is related to the capital sector and overall investment policy of the nation. FDI is not considered a trade component.