Trade and External Sector

Sterilization refers to the process by which the Reserve Bank of India (RBI) neutralizes the impact of foreign exchange inflows or outflows on the domestic money supply. When there is a surge in foreign capital inflows, the RBI often buys foreign currency (like US Dollars) to prevent the Indian Rupee from appreciating excessively. This purchase injects an equivalent amount of Indian Rupees into the banking system, increasing liquidity and potentially causing inflation. To 'sterilize' or offset this effect, the RBI conducts Open Market Operations (OMO) by selling government securities in the open market to absorb the excess liquidity. Conversely, during capital outflows, the RBI sells foreign currency and buys government securities to maintain liquidity. Thus, Open Market Operations are the primary instrument used for sterilization to maintain monetary stability.

* Statement I is correct In 2021, Switzerland exported $86.7B in Gold, making it the 1st largest exporter of Gold in the world. Switzerland is consistently the world's leading gold-exporting country based on value. (Please note: The list is dynamic & keeps varying yearly)

* Statement II is not correct. The United States is way out in front as the country with the largest gold reserves in the world at 8,000 tonnes (as of 2024).

* In India, the largest resources of gold ore (primary) are located in Bihar (44%) followed by Rajasthan (25%), Karnataka (21%), West Bengal (3%), Andhra Pradesh (3% ), Jharkhand (2 %). The remaining 2% resources of ore are located in Chhattisgarh, Madhya Pradesh, Kerala, Maharashtra and Tamil Nadu. (PIB 2021)

* India is one of the largest gold importers, sourcing 800-1,000 tons annually, mainly from Switzerland, the UAE, and South Africa. Imports are driven by high domestic demand for jewelry and investment. Gold exports, primarily in jewelry, target the US, UAE, and Hong Kong, supporting India's trade through its jewelry manufacturing sector.

Statement 1 is Correct: The National IPR Policy does reiterate India's commitment to the Doha Development Agenda and the Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS Agreement). The Doha Development Agenda aimed to clarify and improve specific aspects of the TRIPS Agreement, particularly focusing on flexibilities for developing countries. India, as a developing nation, is entitled to certain flexibilities in implementing the TRIPS Agreement, such as using compulsory licensing to ensure access to affordable medicines.

Statement 2 is Correct: The Department for Promotion of Industry and Internal Trade (DPIIT) under the Ministry of Commerce and Industry is the nodal agency for the development and implementation of IPR policy in India, earlier its name was the Department of Industrial Policy and Promotion.

Hence, option C is the correct answer.

Statement 1 is correct: This is the primary objective of the Gold Monetization Scheme (GMS). The scheme encourages individuals and institutions to deposit their idle physical gold (jewellery, coins, bars) with banks. This gold is then melted, assayed, and added to the country's gold reserves, which can be lent to jewellers, thereby bringing it into the formal economy.

Statement 2 is incorrect: These schemes are focused on managing domestic gold supply and demand. They are not designed to attract Foreign Direct Investment (FDI). Policies related to FDI in the jewellery sector are separate from these schemes.

Statement 3 is correct: This is a core objective of both schemes. * The Sovereign Gold Bond (SGB) Scheme provides a financial alternative to buying physical gold. By shifting demand from physical gold to paper gold, it helps reduce the demand for gold imports. * The Gold Monetization Scheme (GMS) increases the domestic supply of recycled gold available to jewellers, thus reducing their reliance on imported gold. Both schemes aim to curb gold imports, which are a major component of India's import bill and contribute significantly to the Current Account Deficit (CAD).

The terms "amber box," "blue box," and "green box" are often associated with the agriculture sector and are commonly used in discussions related to international trade negotiations, particularly within the framework of the World Trade Organization (WTO) Agreement on Agriculture.

* Amber Box: This refers to domestic support measures considered to distort agricultural production and trade. These measures typically include price supports, production subsidies, and other forms of support that are considered trade-distorting.

* Blue Box: This category includes domestic support measures that are considered less trade-distorting compared to those in the amber box. However, they still involve certain constraints or conditions aimed at limiting their trade-distorting effects.

* Green Box: These are domestic support measures that are considered minimally or non-trade-distorting. They typically include subsidies that are tied to environmental or rural development objectives, as well as certain types of direct income support that do not distort trade significantly.

Import cover is a critical economic indicator that measures the number of months of imports a country can afford using its foreign exchange reserves. It is calculated using the formula: Import Cover = (Total Foreign Exchange Reserves) / (Average Monthly Imports). This metric assesses a country's external stability and its ability to withstand shocks to the balance of payments or sudden stops in foreign currency inflows. While other options describe the import-to-GDP ratio (Option A), total import volume (Option B), or trade balance/terms of trade (Option C), only Option D correctly identifies the relationship between reserves and import duration.

Rupee convertibility means the system where any amount of rupee can be converted into any other currency without any question asked about the purpose for which the foreign exchange is to be used.

Non-convertibility can generally be defined with reference to the transaction for which foreign exchange cannot be legally purchased (e.g., import of consumer goods etc), or transactions which are controlled and approved on a case-by-case basis (like regulated imports etc).

Statement 1 is Correct: Banaras Brocades and Sarees were granted Geographical Indication (GI) status in 2009, recognizing the unique handloom weaving traditions and historical origin in Varanasi, Uttar Pradesh.

Statement 2 is Incorrect: While Dal-Bati-Churma is a famous traditional food preparation from Rajasthan, it has not been accorded Geographical Indication (GI) status.

Statement 3 is Correct: Tirupati Laddu, the sacred prasad offered at the Tirumala Venkateswara Temple in Andhra Pradesh, was granted GI status in 2009 to protect its unique recipe and reputation from commercial imitation.

The correct answer is (C) dollars and other hard currencies

International Liquidity: This refers to a country's ability to meet its short-term external obligations (payments for imports, debt servicing, etc.) It essentially reflects the ease with which a country can access foreign currencies needed for international transactions.

Focus on Hard Currencies: While some transactions might involve other currencies, international reserves are predominantly held in major reserve currencies like the US Dollar, Euro, Japanese Yen, and British Pound. These currencies are considered "hard" because they are stable, widely traded, and liquid (easily convertible into other currencies).

Balance of Trade: This refers to the net difference between a country's exports and imports of goods. It's a key component of the current account.

Foreign Assets: This refers to assets held by a country's residents outside the country. It's not part of the current account but might be included in the capital account.

Balance of Invisibles: This captures the net income from services, such as tourism, transportation, and royalties, as well as net current transfers (e.g., foreign aid). It's another crucial component of the current account.

Special Drawing Right (SDR): This is an international reserve asset created by the International Monetary Fund (IMF). It's not directly part of the current account but might be included in the reserve assets.

Therefore, only options 1 (Balance of Trade) and 3 (Balance of Invisibles) are constituents of the Current Account in the Balance of Payments.

The Balance of Payments (BoP) is a systematic record of all economic transactions between the residents of a country and the rest of the world during a specific period, usually a year. These transactions include the export and import of goods (visible trade), services (invisible trade), and financial assets (capital transfers). According to NCERT Class 12 Macroeconomics, "residents" include individuals, business firms, and government agencies. Option A is the correct choice as it provides the most comprehensive definition of the BoP's scope. Other options are incorrect because they either focus on a single component (Option B for goods, Option D for capital) or incorrectly limit the participants to only governments (Option C).


India's foreign-exchange reserves include:

1. Foreign currency assets (FCAs): This is the largest component, consisting of deposits and holdings in major currencies like US Dollars, Euros, and Yen.

2. Gold reserves: India holds a significant amount of gold bullion as part of its foreign exchange reserves.

3. Special drawing rights (SDRs): These are international reserve assets created by the International Monetary Fund (IMF) that supplement official foreign reserves.

4. Reserve position in the IMF: This refers to India's quota or shareholding position in the IMF, which can be a source of additional foreign currency if needed.

1. Foreign Loans – These are borrowings from abroad by the government or private sector. They are capital inflows and part of the Capital Account.

2. Foreign Direct Investment (FDI) – Investment by foreign entities in domestic companies, creating a long-term interest in the economy, is part of the Capital Account.

3. Private Remittances – These are funds sent by individuals (like migrant workers) to their home country. They are part of the Current Account, not the Capital Account.

4. Portfolio Investment – Investments in stocks, bonds, and other financial assets by foreigners in the domestic market are capital inflows, part of the Capital Account.

Statement 1 is Incorrect: Share of agriculture in GDP has actually decreased since 1991, as the service sector has grown significantly.

Statement 2 is Correct: Share of India's exports in world trade has increased. India has become a more integrated part of the global economy, with a larger export footprint.

Statement 3 is Correct: FDI inflows have increased considerably. The liberalisation measures made India a more attractive destination for foreign investment.

Statement 4 is Correct: India's foreign exchange reserves have also increased enormously. This reflects India's improved ability to generate foreign currency and manage its external finances.

Therefore, the correct answer is 2, 3, and 4 only. Hence, option B is the correct answer.

Statement 1 is correct: Foreign currency earnings - The IT sector generates foreign exchange through exports of services. This increases the supply of foreign currency reserves, making it easier to defend the rupee's value in the foreign exchange market during times of stress.

Statement 2 is incorrect: While government spending can stimulate economic growth, it can also lead to a higher budget deficit. If the deficit is financed by excessive borrowing, it can put pressure on the currency if investors lose confidence in the government's ability to repay its debts.

Statement 3 is correct: Remittances from abroad - When Indians working abroad send money back home, it adds to the inflow of foreign currency. This strengthens the country's foreign exchange reserves and provides a buffer against external shocks.

Therefore, the correct code is 1 and 3 only.

To stop the slide of the Rupee (depreciation), the RBI/Government needs to increase the inflow of foreign currency (USD) or decrease the outflow.

Option (a), (b), and (c) are likely measures: They either increase the supply of dollars in the Indian market or reduce the demand for dollars, which helps stabilize the Rupee.

Option (d) is NOT a likely measure: An expansionary monetary policy usually involves lowering interest rates. When interest rates fall, the "carry trade" becomes less attractive to foreign investors, leading to capital flight. This increases the supply of Rupee in the market and decreases its value further. To stop a slide, the RBI typically follows a contractionary (dear money) policy to attract capital and curb inflation.

Option A is incorrect. Foreign Direct Investment (FDI) typically involves investment in unlisted companies or companies that involve a direct ownership stake, not just investments through capital instruments in listed companies.

Option B is correct. FDI is considered a non-debt creating capital flow because it involves equity investments that do not require repayment, unlike loans or debt instruments. This type of investment brings in long-term capital and management expertise, which helps in the development of industries in the host country.

Option C is incorrect. FDI does not involve debt-servicing. Unlike loans or bonds, FDI involves ownership stakes, and thus, there is no obligation to pay interest or principal repayments.

Option D is incorrect. The investment in Government securities by foreign institutional investors (FIIs) is considered foreign portfolio investment (FPI), not FDI. FDI focuses on acquiring a substantial ownership stake in a company, whereas FPI involves short-term investments in financial assets.


Hence, option B is the correct answer.

Not depending on short-term foreign borrowings: This reduces exposure to capital flight. During a crisis, foreign investors may pull their money out of emerging markets like India, leading to rupee depreciation and financial instability. By limiting short-term foreign borrowings, India can lessen the impact of such capital flight.

Opening up to more foreign banks: While this might seem beneficial, it can also increase reliance on foreign capital. During a crisis, foreign banks might be more likely to restrict credit, negatively impacting the Indian economy.

Maintaining full capital account convertibility: This allows for the free movement of capital in and out of the country. While it can be beneficial in normal times, it can also exacerbate capital flight during a crisis.

Therefore, the most prudent strategy is to reduce dependence on short-term foreign borrowings to minimize the vulnerability caused by potential capital flight.

Hence, only statement 1 is correct. Hence, option A is the correct answer.

Statement 1 is correct. When a country devalues its currency, it becomes cheaper for foreign buyers to purchase the country's exports. This can lead to increased demand for exports, making domestic producers more competitive in the international market.

Statement 2 is incorrect. Devaluation actually decreases the foreign value of the domestic currency. The whole point is to make the domestic currency less expensive relative to foreign currencies.

Statement 3 is also incorrect. While improved export competitiveness can lead to a better trade balance (more exports, fewer imports), it's not a guaranteed outcome. Other factors like import prices, global demand, and domestic production costs can also influence the trade balance. Devaluation can also lead to increased import costs if the country relies on imported raw materials.

Therefore, the correct code is 1 only.

Foreign Direct Investment (FDI) refers to the investment through capital instruments by a person resident outside India in an unlisted Indian company, or in 10% or more of the post-issue paid-up equity capital of a listed Indian company.

* Statements 1 and 3 are correct: Foreign Currency Convertible Bonds (FCCBs) and Global Depository Receipts (GDRs) are instruments used by Indian companies to raise capital from foreign markets. Under the FDI policy of the Government of India, investments made through these instruments are treated as part of the FDI framework because they represent or convert into equity shares of the company. * Statement 2 is correct: While Foreign Institutional Investment (FII) is generally categorized as Portfolio Investment, the Arvind Mayaram Committee recommended that any investment by a foreign investor/FII/FPI that exceeds 10% of the equity of an Indian company should be treated as FDI. Thus, with the condition of reaching the 10% threshold, FII is included in FDI. * Statement 4 is incorrect: Non-Resident External (NRE) deposits are bank accounts maintained by NRIs in Indian banks. These are classified as 'Banking Capital' or 'External Debt' (if repatriable) and are not considered as Foreign Direct Investment in a productive enterprise.

Statement 1 is correct: The Federal Reserve's monetary policy decisions, particularly regarding interest rates, can impact global capital flows. If the Fed raises interest rates, it can make US investments more attractive, potentially leading to some outflow of capital from India. This could affect demand for Indian government bonds and influence their yield.

Statement 2 is correct: The RBI's monetary policy plays a crucial role in influencing Indian government bond yields. The RBI's actions like setting repo rates, open market operations, and cash reserve ratio (CRR) can affect the overall liquidity in the banking system. Higher liquidity can lead to lower yields, and vice versa.

Statement 3 is correct: Inflation expectations and short-term interest rates are important factors for investors when considering the return on government bonds. Higher inflation expectations can lead investors to demand higher yields to compensate for the potential erosion of purchasing power. Similarly, short-term interest rates can act as a benchmark for bond yields.

Therefore, all three factors significantly influence the yields of Indian government bonds.

Tight monetary policy is an action taken by a central bank, such as the Federal Reserve, to curb overheated economic growth. Central banks employ tight monetary policy when an economy is experiencing rapid acceleration or when inflation, which pertains to overall prices, is escalating too swiftly.

Statement 1 is correct. A tight monetary policy by the US Federal Reserve means higher interest rates in the US. This attracts global investors to shift their capital towards US assets for better returns. As a result, there can be capital flight from emerging markets like India to the US.

Statement 2 is correct. When capital flows out, the domestic currency tends to depreciate, and global interest rates rise. Firms that have borrowed in foreign currencies through External Commercial Borrowings (ECBs) will now face higher repayment costs in rupee terms. Thus, their cost of servicing these loans increases, raising their overall financial burden.

Statement 3 is incorrect. Devaluation of the domestic currency actually increases the currency risk associated with ECBs. Since these loans are denominated in foreign currency (like USD), a weaker rupee means firms have to pay more in rupees to repay the same amount of foreign debt. Therefore, devaluation heightens, not reduces, currency risk.

NOTE: The given question was dropped by UPSC from the Official Answer Key.

* Statement 1 is correct. The nominal Effective Exchange Rate (NEER) is a measure of the value of a country's currency against a basket of other currencies weighted by their importance in trade. If NEER increases, it means that the value of the currency has increased relative to the currencies in the basket, indicating appreciation.

* Statement 2 is incorrect. The Real Effective Exchange Rate (REER) takes into account both nominal exchange rates and relative price levels (inflation) between countries. An increase in REER means that the country's currency is overvalued relative to its trading partners, which can reduce trade competitiveness.

* Statement 3 is correct. If domestic inflation is higher than inflation in other countries, the real value of the domestic currency decreases faster than the nominal value, causing a divergence between NEER and REER.

Therefore, the correct statements are 1 and 3.