Question 18 from UPSC CSE 2020 - ECONOMICS

Question

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:

IASCODEX · Accepted Answer

Correct Option: A. 1 only

Strategy: During a global financial crisis, minimizing exposure to volatile international financial flows is crucial. Avoiding reliance on short-term foreign borrowings limits vulnerability, as these funds are often withdrawn suddenly in crises. Conversely, opening up to more foreign banks or adopting full capital account convertibility would heighten exposure and risk, diminishing a country's financial immunity.

Key Info: **Short-term foreign borrowings** refer to loans or credit obtained from abroad that must be repaid in a short span, typically less than one year. Heavy reliance on such borrowings creates a risk of sudden capital outflows during global uncertainty or panic, leading to a currency or liquidity crisis, as seen in the 1997 East Asian crisis.

**Full capital account convertibility** means allowing unrestricted movement of capital in and out of a country. While it can attract more investment in boom times, it makes the economy highly vulnerable to capital flight in periods of turmoil, which can destabilize currency and financial markets. India currently maintains restrictions on capital account convertibility to shield itself from such risks.

**Opening up to more foreign banks** signifies greater integration with global financial intermediaries, increasing a country's dependence on external financial systems and exposing it to risks transmitted from abroad during crises.

Regulatory cautiousness in these areas has historically helped India remain more resilient during global shocks, such as the 2008 financial crisis. The RBI, India's central bank, regularly assesses these factors, maintaining controls to manage systemic risk.

IASCODEX · Answer

Option B: 1 and 2 only

IASCODEX · Answer

Option C: 3 only

IASCODEX · Answer

Option D: 1, 2, and 3