Topic: Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment.
Q5. Discuss the significance of capital account inflows in addressing external sector imbalances. Evaluate the risks associated with their use as a policy instrument. (10 M)
Difficulty Level: Medium
Reference: IE
Why the question
Recent policy measures by the Government and RBI, including steps to attract foreign capital inflows and strengthen the Balance of Payments position, have revived the debate on the role of capital account flows in external sector management.
Key Demand of the question
The question requires discussing how capital account inflows help address external sector imbalances and support macroeconomic stability. It also requires evaluating the risks and vulnerabilities associated with relying on such inflows as a policy instrument.
Structure of the Answer:
Introduction
Briefly define capital account inflows and highlight their significance in financing external sector requirements in an open economy.
Body
- Significance in addressing external sector imbalances: Explain how capital inflows help finance deficits, strengthen reserves and support exchange rate stability.
- Risks associated with their use as a policy instrument: Discuss concerns relating to volatility, external dependence, exchange rate distortions and vulnerability to global shocks.
Conclusion
Emphasise that while capital inflows can provide short-term external sector support, long-term stability requires strong domestic fundamentals and sustainable sources of external earnings.
