11 October 2022

Q1. Predatory pricing policy is designed to:

1. Drive competitors out of business
2. Maximize profits
3. Encourage entrants into the market
4. Attain the least cost output

• Solution:

(A)

• Predatory Pricing – the pricing of goods or services at such a low level that other firms cannot compete and are forced to leave the market.

Q2. RBI has around $480 billion of Forex reserves. It is acquired by the RBI for which of the following reasons:

• To import essentials for economic and social security
• To gain external account security
• To deter speculations
• To enjoy favourable credit rating

Select the correct answer code:

1. 1, 2, 3
2. 1, 3, 4
3. 2, 3, 4
4. 1, 2, 3, 4

• Solution:

(D)

• India’s foreign exchange (Forex) reserves stand at around $480 billion.

It is acquired by the RBI for the following reasons:

• To defend the rupee when needed
• To gain external account security
• To enable country to globalise further
• To import essentials for economic and social security
• To deter speculations
• To enjoy favourable rating by sovereign credit rating agencies.

Q3. Phantom FDI sometimes in news is described as:

1. Investments done by high net worth individuals
2. Investments done in green field projects
3. Investments that pass through empty corporate shells d
4. None of the above

• Solution:

(C)

• About $15 trillion, or 38 per cent, of the world’s foreign direct investment (FDI) in 2017 was “phantom capital” that was tailor-made to trim tax bills of multinational corporations, and tax havens were being used to funnel these investments, according a study put out by the International Monetary Fund.
• Roughly a half of the phantom FDI — “investments that pass through empty corporate shells” with no real business activity — passes through just Luxembourg and the Netherlands.

Q4. Consider the following statements regarding ‘Treasury Bills’:

• T-bills are short term securities issued on behalf of the government by the RBI and are used in managing short term liquidity needs of the government.
• T-Bills are issued on discount to face value, while the holder gets the face value on maturity.
• T-Bills are issued by both Central government and State government in India.

Which of the above statements is/are correct:

1. 1, 2
2. 2, 3
3. 1, 2, 3
4. 1, 3

• Solution:

(A)

• T-bills are short term securities issued on behalf of the government by the RBI and are used in managing short term liquidity needs of the government.
• T-Bills are issued on discount to face value, while the holder gets the face value on maturity.
• The return on TBills is the difference between the issue price and face value.
• Thus, return on T-Bills depends upon auctions.
• When the liquidity position in the economy is tight, returns are higher and vice versa.
• Individuals, Firms, Trusts, Institutions and banks can purchase T-Bills.
• The commercial and cooperative banks use T-Bills for fulfilling their SLR requirements.
• Treasury Bills are issued only by the central government in India.
• The State governments do not issue any treasury bills.
• The secondary market of T-Bills is very active so they have a higher degree of tradability.

Q5. In an open economy without government intervention, trade deficit can be financed by:

1. Foreign institutional investment
2. Domestic consumption
3. Monetary expansion
4. All of the above

• Solution:

(A)

• Total balance of payments consists of current account (includes trade, invisibles, remittances etc) as well as capital account.
• Capital inflows like FDI, FII help bridge the trade deficit and neutralize BoP.
• High consumption expenditure will further inflate the import bill and cause trade deficit.
• And, so will monetary expansion – pushes up demand and thus imports in the short-term aggravating the BoP.

Q6. Consider the following statements about ‘Fiat Money’:

• It is a currency that a government has declared to be legal tender.
• It is backed by a physical commodity.
• Its value increases during hyperinflation.

Which of the above statements is/are incorrect:

1. 1 only
2. 2, 3
3. 1, 3
4. 1, 2, 3

• Solution:

(B)

• Fiat money is currency that a government has declared to be legal tender, but it is not backed by a physical commodity.
• The value of fiat money is derived from the relationship between supply and demand rather than the value of the material from which the money is made.
• Because fiat money is not linked to physical reserves, it risks becoming worthless due to hyperinflation.

Q7. Consider the following statements:

• The Reserve Bank of India functions as the custodian and manager of forex reserves.
• Majority of India’s foreign currency reserves are deposited in foreign central banks.
• Under the Liberalised Remittances Scheme, individuals from India are allowed to remit up to $25000 every year to another country for investment and expenditure.

Which of the above statements is/are incorrect:

1. 1, 2
2. 1, 3
3. 2, 3
4. 2 only

• Solution:

(C)

• The Reserve Bank functions as the custodian and manager of forex reserves, and operates within the overall policy framework agreed upon with the government.
• The RBI allocates the dollars for specific purposes.
• For example, under the Liberalised Remittances Scheme, individuals are allowed to remit up to $250,000 every year.
• The RBI uses its forex kitty for the orderly movement of the rupee.
• It sells the dollar when the rupee weakens and buys the dollar when the rupee strengthens.
• Of late, the RBI has been buying dollars from the market to shore up the forex reserves.
• When the RBI mops up dollars, it releases an equal amount in rupees.
• This excess liquidity is sterilised through issue of bonds and securities and LAF operations.
• The RBI Act, 1934 provides the overarching legal framework for deployment of reserves in different foreign currency assets and gold within the broad parameters of currencies, instruments, issuers and counterparties.
• As much as 64 per cent of the foreign currency reserves are held in securities like Treasury bills of foreign countries, mainly the US, 28 per cent is deposited in foreign central banks and 7.4 per cent is also deposited in commercial banks abroad, according to the RBI data.
• The return on India’s forex reserves kept in foreign central banks and commercial banks is negligible.
• While the RBI has not divulged the return on forex investment, analysts say it could be around one per cent, or even less than that, considering the fall in interest rates in the US and Euro zone.
• There was a demand from some quarters that forex reserves should be used for infrastructure development in the country.
• However, the RBI had opposed the plan.
• Another issue is the high ratio of volatile flows (portfolio flows and short-term debt) to reserves which is around 80 per cent.
• This money can exit at a fast pace.

Q8. Consider the following statements regarding Financial Sector Regulatory Appointment Search Committee (FSRASC):

• FSRASC recommends names for the appointment of RBI Governor and chairman of SEBI.
• FSRASC is headed by Finance Secretary.

Which of the above statements is/are correct:

1. 1 only
2. 2 only
3. Both 1 and 2
4. Neither 1 nor 2

• Solution:

(A)

• As per the procedure for the appointment of regulator heads, the candidates will be shortlisted by the Financial Sector Regulatory Appointments Search Committee (FSRASC) headed by the Cabinet Secretary.
• The shortlisted candidates are interviewed by a panel comprising Economic Affairs Secretary and three external members having domain knowledge.
• Based on the interaction, FSRASC recommends name to the Appointments Committee of the Cabinet headed by Prime Minister Narendra Modi for approval.

Q9. Under ‘Import substitution’:

• Government protects the domestic industries from foreign competition
• Exports are discouraged since they reduce domestic consumption and thus production.

Which of the above statements is/are correct:

1. 1 only
2. 2 only
3. Both 1 and 2
4. Neither 1 nor 2

• Solution:

(A)

• This policy of Import substitution is aimed at replacing or substituting imports with domestic production.
• For e.g. in India, the government protected the domestic industries from foreign competition, so that the same goods that are now imported can be produced domestically.
• Protection from imports can take two forms: tariffs and quotas.
• The best example would be ‘Make In India’ rather than ‘Import to India’.
• Firms that used to export goods and services like mobile phones would manufacture in India itself after FDI.
• This would reduce imports and build domestic manufacturing base.

Q10. A closed economy is likely to have which of the following characteristics:

1. Fiscal deficit would be zero.
2. The central bank does not control money supply.
3. The government does not have a right to print currency.
4. Balance of Payments is zero.

• Solution:

(D)

• A closed economy is self-sufficient, meaning that no imports are brought in and no exports are sent out.
• The goal is to provide consumers with everything that they need from within the economy’s borders.
• A closed economy is the opposite of an open economy, in which a country will conduct trade with outside regions.
• So, if no capital or goods/services are imported, exported, the BoP will be zero.
• In this case, the fiscal deficit need not be zero since a developing country may adopt expansionary fiscal policy to tackle poverty and unemployment.