International Economics, Balance of payment, Exchange rate are important part of Economy and its syllabus. Previous Year Question (PYQ) papers are invaluable resources for aspirants preparing for competitive exams like the Union Public Service Commission (UPSC) examinations. In this article we present important PYQ on International Economics.
PYQ on International Economics
Q- With reference to the Indian economy, consider the following statements: (2022)
- An increase in Nominal Effective Exchange Rate (NEER) indicates the appreciation of rupee.
- An increase in the Real Effective Exchange Rate (REER) indicates an improvement in trade competitiveness.
- An increasing trend in domestic inflation relative to inflation in other countries is likely to cause an increasing divergence between NEER and REER.
Which of the above statements are correct?
(a) 1 and 2 only
(b) 2 and 3 only
(c) 1 and 3 only
(d) 1, 2 and 3
Answer- Option C
EXPLANATION
Statement 1 accurately describes the Nominal Effective Exchange Rate (NEER) as the weighted average of bilateral nominal exchange rates, indicating an increase in NEER signifies rupee appreciation.
Statement 2 contains an error regarding the Real Effective Exchange Rate (REER). REER is indeed the weighted average of nominal exchange rates adjusted for relative price differentials between domestic and foreign countries. An increase in REER suggests that exports become more costly and imports become cheaper, indicating a loss of trade competitiveness.
Statement 3 correctly defines the Real Effective Exchange Rate (REER) as the NEER adjusted for relative prices or costs, typically reflected in inflation differentials between the home economy and its trading partners. The statement also highlights that when NEER is adjusted for inflation in the home country, it equals REER. Moreover, it points out that higher inflation leads to a greater difference between NEER and REER.
Q- With reference to the “G20 Common Framework”, consider the following statements: (2022)
- It is an initiative endorsed by the G20 together with the Paris Club.
- It is an initiative to support Low Income Countries with unsustainable debt.
Which of the statements given above is/are correct?
(a) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2
Answer- Option C
EXPLANATION
Statement 1 accurately describes the Common Framework for debt treatment beyond the Debt Service Suspension Initiative (DSSI) as an initiative backed by both the G20 and the Paris Club.
Statement 2 correctly outlines the purpose and process of the Common Framework. It aims to provide structural support to Low-Income Countries facing unsustainable debt levels. The Common Framework operates on a case-by-case basis, initiated by eligible debtor countries. Upon request, a Creditor Committee is formed, with negotiations facilitated by the IMF and the World Bank, including their Debt Sustainability Analysis.
Q- With reference to foreign-owned e-commerce firms operating in India, which of the following statements is/are correct? (2022)
- They can sell their own goods in addition to offering their platforms as market-places.
- The degree to which they can own big sellers on their platforms is limited.
Select the correct answer using the code given below:
(a) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2
Answer- Option B
EXPLANATION
The FDI Policy in India prohibits companies with foreign direct investment (FDI) from engaging in retail trading through e-commerce platforms, particularly in the multi-brand retail sector. Multi-brand retail trading involves selling products from various brands on a single platform. Additionally, India has not permitted FDI in inventory-driven e-commerce models, akin to those utilized by companies like Walmart and Amazon in the United States. This restriction aims primarily to safeguard India’s extensive unorganized retail sector, which lacks the purchasing power to compete with large-scale retailers and offer substantial discounts. Hence, statement 1 is inaccurate.
In 2018, India revised its FDI policy pertaining to e-commerce marketplaces, introducing a regulation that categorizes any vendor responsible for more than 25% of a platform’s total sales as “controlled” by the marketplace operator. Consequently, no seller is allowed to exceed 25% of the total business on any foreign e-commerce platform. Therefore, statement 2 accurately reflects this regulatory change.
Q- Which one of the following situations best reflects “Indirect Transfers” often talked about in media recently with reference to India? (2022)
(a) An Indian company investing in a foreign enterprise and paying taxes to the foreign country on the profits arising out of its investment
(b) A foreign company investing in India and paying taxes to the country of its base on the profits arising out of its investment
(c) An Indian company purchases tangible assets in a foreign country and sells such assets after their value increases and transfers the proceeds to India
(d) A foreign company transfers shares and such shares derive their substantial value from assets located in India
Answer- Option D
EXPLANATION
Indirect transfers occur when shares or assets held by foreign entities in India are transferred, rather than the direct transfer of the underlying assets within India. Amendments to the Income Tax Act (ITA) in 2012 clarified that if a company is registered or incorporated outside India, its shares will be considered as situated in India if their value is primarily derived from assets located within India. Consequently, individuals who sold such shares of foreign companies before the enactment of this amendment (before May 28, 2012) also became subject to taxation on the income generated from such sales.
Q- Consider the following statements: (2022)
- Tight monetary policy of US Federal Reserve could lead to capital flight.
- Capital flight may increase the interest cost of firms with existing External Commercial Borrowings (ECBs).
- Devaluation of domestic currency decreases the currency risk associated with ECBS.
Which of the statements given above are correct?
(a) 1 and 2 only
(b) 2 and 3 only
(c) 1 and 3 only
(d) 1, 2 and 3
Answer- Option A
EXPLANATION
Statement 1 accurately describes tight monetary policy as a measure employed by central banks like the Federal Reserve to curb overheated economic growth and combat rapid inflation. Central banks implement such policies to maintain stability in inflation, unemployment, and economic growth. When the economy overheats, central banks increase interest rates and adopt contractionary measures to slow down economic activity, potentially leading to capital flight by investors.
Statement 2 correctly highlights the consequence of capital flight, which can elevate interest costs due to reduced money supply in the system. This can particularly affect firms with external commercial borrowings, leading to higher interest expenses.
However, Statement 3 is inaccurate. Devaluation of the domestic currency doesn’t directly impact External Commercial Borrowings (ECBs) since they are denominated in foreign currency, not domestic currency. Therefore, changes in the domestic currency’s value do not affect the cost or repayment terms of ECBs.
Q- Consider the following statements: (2021)
The effect of the devaluation of a currency is that it necessarily
1. Improves the competitiveness of the domestic exports in the foreign markets
2. Increase the foreign value of the domestic currency
3. Improves the trade balance
Which of the above statements is/are
a) 1 only
b) 1 and 2
c) 3 only
d) 2 and 3
Answer- Option A
EXPLANATION
Statement 1 is correct: A decrease in the value of the rupee against the dollar makes exports more affordable for foreign customers. For instance, if the rupee depreciates against the dollar, Indian-made cars sold in America become cheaper in terms of dollars.
Statement 2 is incorrect: Devaluation of a currency leads to a decrease in the foreign value of the domestic currency.
Statement 3 is incorrect: Devaluation increases the debt burden of loans denominated in foreign currencies when translated into the domestic currency. Consequently, devaluation may not necessarily lead to an improvement in the trade balance in the long term.
Q- With reference to the international trade of India at present, which of the following statements is/are correct? (2020)
(1) India’s merchandise exports are less than its merchandise imports.
(2) India’s imports of iron and steel, chemicals, fertilisers and machinery have decreased in recent years.
(3) India’s exports of services are more than its imports of services.
(4) India suffers from an overall trade/current account deficit.
Select the correct answer using the code given below:
(a) 1 and 2 only
(b) 2 and 4 only
(c) 3 only
(d) 1, 3 and 4 only
Answer- Option D
EXPLANATION
India maintains a surplus in services trade, with a notable surplus of $6.84 billion observed in June, driven by exports totaling $16.48 billion and imports at $9.64 billion. Therefore, statement 3 is correct. According to RBI data, India’s merchandise exports during April-August 2019-20 amounted to $133 billion, while imports totaled $210 billion during the same period, illustrating a trade deficit. Hence, statement 1 is accurate. India’s trade deficit significantly narrowed to USD 6.77 billion in August 2020 from USD 13.86 billion in August 2019.
Major export destinations in 2018 included the United States, United Arab Emirates, China, Hong Kong, and Singapore. Additional details indicate a substantial increase in iron and steel product exports by over 100% in June 2020. However, the statement incorrectly attributes this increase to chemicals, which include various categories such as dyes, organic and inorganic chemicals, agro-chemicals, cosmetics, and toiletries. From April 2019 to January 2020, exports of dyes grew by 9.12% year-on-year to reach US$ 2.27 billion, while cosmetics and toiletries increased by 5.62%. Therefore, statement 2 is incorrect.
Q- With reference to Trade-Related Investment Measures (TRIMS), which of the following statements is/are correct? (2020)
(1) Quantitative restrictions on imports by foreign investors are prohibited.
(2) They apply to investment measures related to trade in both goods and services.
(3) They are not concerned with the regulation of foreign investment.
Select the correct answer using the code given below:
(a) 1 and 2 only
(b) 2 only
(c) 1 and 3 only
(d) 1, 2 and 3
Answer- Option C
EXPLANATION
Statement 1 is accurate. Trade-Related Investment Measures (TRIMS) prohibit quantitative restrictions on imports by foreign investors.
Statement 2 is incorrect. The TRIMS agreement applies to investment measures related to both trade in goods and services. It is outlined in Article 1 of the TRIMS agreement.
Statement 3 is correct. Under the TRIMS Agreement, members must notify the WTO Council for Trade in Goods of any existing TRIMs that are inconsistent with the agreement. TRIMs are regulations that restrict the preferences of domestic firms, making it easier for international firms to operate in foreign markets. However, they do not directly regulate foreign investment, which is governed by the Foreign Exchange Management Act (FEMA) and Department of Industrial Policy and Promotion (DIPP) guidelines and regulations.
Q- 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? (2019)
(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 :
(a) 1 only
(b) 1 and 2 only
(c) 3 only
(d) 1, 2 and 3
Answer- Option A
EXPLANATION
Both international creditors and debtor nations face significant challenges during a global financial crisis, often leading to defaults and the need for assistance. Therefore, India should avoid relying on short-term foreign borrowings to ensure stability and immunity from such crises.
This renders Statement A correct. However, the financial crisis tends to exacerbate the burden of Non-Performing Assets (NPAs) on banks, hindering their efficiency in NPA recovery and potentially leading to insolvency. Thus, the suggestion to open up to more foreign banks poses a substantial risk for India, rendering Statement B incorrect. Capital account convertibility entails the freedom to conduct investment transactions without constraints, including the ability to convert currency for acquiring foreign assets. However, during a financial crisis, this could prove to be a significant mistake. Therefore, Statement C is not accurate.
Q- Consider the following statements (2019)
(1) Purchasing Power Parity (PPP) exchange rates are calculated by comparing the prices of the same basket of goods and services in different countries.
(2) In terms of PPP dollars, India is the sixth-largest economy in the world.
Which of the statements given above is/are correct?
(a) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2
Answer- Option A
EXPLANATION
The Purchasing Power Parity (PPP) theory evaluates currencies of different countries by comparing a standardized “basket of goods and services.” It assesses the exchange rate between two countries by determining how much of one country’s currency is needed to purchase the same basket of goods and services as another country’s currency. This aligns with statement 1. However, in 2018, China emerged as the world’s largest economy according to PPP measurements, with the United States and India ranking second and third, respectively. Therefore, statement 2 is inaccurate.
Q- In the context of India, which of the following factors is/are contributors to reducing the risk of a currency crisis? (2019)
(1) The foreign currency earnings of India’s IT sector
(2) Increasing the government expenditure
(3) Remittances from Indians abroad
Select the correct answer using the code given below.
(a) 1 only
(b) 1 and 3 only
(c) 2 only
(d) 1, 2 and 3
Answer- Option B
EXPLANATION
A currency crisis occurs when a nation’s currency experiences a sudden and significant decrease in value, leading to adverse effects on the economy. To stabilize the currency, central banks and governments may intervene by selling foreign currency reserves or gold, or by intervening in the foreign exchange markets. This devaluation adversely impacts the economy by causing fluctuations in exchange rates, resulting in reduced purchasing power of the currency in comparison to others. Foreign currency earnings and remittances contribute to strengthening the rupee. Therefore, Statements 1 and 3 are accurate, while Statement 2 is incorrect.
Q- Consider the following statements: (2019)
(1) Most of India’s external debt is owed by governmental entities.
(2) All of India’s external debt is denominated in US dollars.
Which of the statements given above is/are correct?
(a) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2
Answer- Option D
EXPLANATION
Commercial borrowings remained the primary component of external debt, constituting 37.4% of the total, followed by NRI deposits at 24.1% and short-term trade credit at 19.9%. Therefore, Statement 1 is incorrect.
US dollar-denominated debt retained its position as the largest component of India’s external debt, comprising 45.9% of the total, followed by the Indian rupee at 24.8%, SDR at 5.1%, yen at 4.9%, and euro at 3.1%. Thus, Statement 2 is also incorrect.
Q-Consider the following statements (2018)
(1) The quantity of imported edible oils is more than the domestic production of
edible oils in the last five years.
(2) The Government does not impose any customs duty on all the imported edible
oils a special case.
Which of two statements given above is/are correct
(a) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2
Answer- Option A
EXPLANATION
India plays a significant role in the global oilseeds industry, contributing approximately 10% to worldwide production. However, the demand for edible oils, including those extracted from oilseeds and palm oil, surpasses domestic production, leading to a reliance on imports for 60% of the requirement. Therefore, statement 1 is accurate. To protect the interests of the domestic oil crushing industry, the government imposes customs duties on edible oils. Specifically, crude sunflower seed oil and crude canola/rapeseed/mustard incur a duty of 25%, while crude soybean oil faces a 30% duty. Hence, statement 2 is incorrect.
Q- The term ‘Base Erosion and Profit Shifting’ is sometimes seen in the news in the context of (2016)
(a) mining operation by multinational companies in resource-rich but backward areas
(b) curbing of the tax evasion by multinational companies
(c) exploitation of genetic resources of a country by multinational companies
(d) lack of consideration of environmental costs in the planning and implementation of developmental projects
Answer- Option B
EXPLANATION
Base erosion and profit shifting (BEPS) refers to the tactics employed by companies to avoid taxes by exploiting inconsistencies and loopholes in tax regulations, enabling them to artificially shift profits to regions with low or no tax obligations. To address this issue, the inclusive framework involves over 135 countries and jurisdictions working together to enforce measures aimed at preventing BEPS. This collaborative effort includes the implementation of double-tax avoidance treaties and the exchange of tax-related information among member nations as strategies to counteract this practice.
Q- ‘European Stability Mechanism’, sometimes seen in the news, is an (2016)
(a) agency created by EU to deal with the impact of millions of refugees arriving from Middle East
(b) agency of EU that provides financial assistance to eurozone countries
(c) agency of EU to deal with all the bilateral and multilateral agreements on trade
(d) agency of EU to deal with the conflicts arising among the member countries
Answer- Option B
EXPLANATION
The European Stability Mechanism (ESM) was established by euro area Member States to provide aid to countries facing severe financial difficulties. Created in October 2012, it succeeded the European Financial Stability Facility (EFSF). The ESM offers financial support, typically in the form of loans, to eurozone nations or struggling banks. However, such assistance is only provided if it is deemed essential to protect the overall financial stability of the euro area and its member states.
Q- The problem of international liquidity is related to the non-availability of (2016)
(a) goods and services
(b) gold and silver
(c) dollars and other hard currencies
(d) exportable surplus
Answer- Option C
EXPLANATION
International liquidity pertains to the transactions arising from international trade in goods and services. It encompasses all the resources accessible to the monetary authorities of nations to address deficits in their balance of payments. These resources vary from readily available assets to those that require extensive negotiation to access. Gold and universally accepted foreign currencies serve as the principal mediums of international liquidity for settling international transactions. The challenge of international liquidity primarily affects developing nations.
Q- The terms ‘Agreement on Agriculture’, ‘Agreement on the Application of Sanitary and Phytosanitary Measures’ and ‘Peace Clause’ appear in the news frequently in the context of the affairs of the (2015)
(a) Food and Agriculture Organization
(b) United Nations Framework Conference on Climate Change
(c) World Trade Organization
(d) United Nations Environment Programme
Answer- Option C
EXPLANATION
The terms ‘Agreement on Agriculture’, ‘Agreement on the Application of Sanitary and Phytosanitary Measures’ (SPS Agreement), and ‘Peace Clause’ are frequently mentioned in discussions related to the World Trade Organization (WTO). The WTO is the primary global organization responsible for regulating trade rules among nations. Established on January 1, 1995, with its headquarters in Geneva, Switzerland, it emerged from the Uruguay Round negotiations (1986-94), boasting a membership of 164 nations representing approximately 98% of global trade. The WTO’s foundational agreements, often referred to as the Final Act of the Uruguay Round, were signed in Marrakesh, Morocco, on April 15, 1994, superseding the General Agreement on Tariffs and Trade (GATT).
The Agreement on Agriculture, which came into effect on January 1, 1995, aims to establish a fair and market-oriented agricultural trading system. It entails commitments to reduce support and protection in the realms of domestic support, export subsidies, and market access, while incorporating considerations for non-trade concerns such as food security and environmental protection. Additionally, it provides special and differential treatment for developing countries, including enhancements in opportunities and terms of access for agricultural exports of particular interest to these nations.
Q- There has been a persistent deficit budget year after year. Which of the following actions can be taken by the government to reduce the deficit? (2015)
(1) Reducing revenue expenditure
(2) Introducing new welfare schemes
(3) Rationalizing subsidies
(4) Expanding industries
Select the correct answer using the code given below.
(a) 1 and 3 only
(b) 2 and 3 only
(c) 1 only
(d) 1,2,3 and 4
Answer- Option A
EXPLANATION
A budget deficit arises when government expenditures exceed its revenues. Decreasing revenue expenditure and streamlining subsidies can mitigate the deficit, as stated in statements 1 and 3.
Increasing taxes is another method to reduce the deficit, as higher taxes generate more revenue for the government. However, introducing new welfare schemes would exacerbate the budget deficit, contrary to statement 2. Similarly, expanding industries in the short term would not contribute to government tax revenues, thus leading to an increase in the budget deficit, contradicting statement 4.
Q- A decrease in tax to GDP ratio of a country indicates which of the following? (2016)
(1) Slowing economic growth rate
(2) Less equitable distribution of national income
Select the correct answer using the code given below.
(a) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2
Answer- Option A
EXPLANATION
The tax-to-GDP ratio serves as a metric to assess a country’s tax revenue in proportion to its gross domestic product (GDP). It reflects the effectiveness of a nation’s taxation system in utilizing economic resources. Developed countries generally exhibit higher tax-to-GDP ratios compared to developing nations. A low tax-to-GDP ratio indicates sluggish economic growth, while a higher ratio signifies robust tax buoyancy within the economy. This ratio is indicative of the government’s ability to finance its expenditures. A lower tax-to-GDP ratio may compel the government to strive to meet its fiscal deficit targets.
Q- Convertibility of rupee implies (2015)
(a) being able to convert rupee notes into gold
(b) allowing the value of the rupee to be fixed by market forces
(c) freely permitting the conversion of rupee to other currencies and vice versa
(d) developing an international market for currencies in India
Answer- Option C
EXPLANATION
Rupee convertibility denotes the unrestricted ability to exchange the Indian currency with other major currencies and reciprocally. The Indian Rupee serves as the official monetary unit of the Republic of India. Initially introduced by Sher Shah Suri, the first Indian rupee came into circulation, while the Bank of Hindustan issued the inaugural paper currency note. The issuance and oversight of currency-related regulations are managed by the Reserve Bank of India. Symbolizing India’s global presence in financial transactions and economic influence, the symbol of the Indian Rupee embodies the nation’s identity.
Q- With reference to Balance of Payments, which of the following constitutes/constitute the Current Account? (2014)
(1) Balance of trade
(2) Foreign assets
(3) Balance of invisibles
(4) Special Drawing Rights
Select the correct answer using the code given below.
(a) 1 only
(b) 2 and 3
(c) 1 and 3
(d) 1, 2 and 4
Answer- Option C
EXPLANATION
The balance of payments serves as a comprehensive record documenting all financial transactions conducted between a country’s residents and those of other nations. A deficit in the balance of payments signifies that a nation’s imports surpass its exports. Comprising two primary components, the balance of payments encompasses the current account and the capital account. The current account encompasses transactions related to trade in goods and services, including invisible items and transfer payments. On the other hand, the capital account entails various international transactions involving assets such as foreign direct investment, foreign portfolio investment, external commercial borrowings, and special drawing rights (SDR), encompassing purchases and sales of monetary assets, stocks, bonds, and the like.
Q- The balance of payments of a country is a systematic record of (2013)
(a) all import and transactions of a during a given period normally a year
(b) goods exported from a country during a year
(c) economic transaction between the government of one country to another
(d) capital movements from one country to another
Answer- Option A
EXPLANATION
The balance of payments (BOP) reflects all economic transactions between a country’s residents and the rest of the world over a defined period, typically a year or a quarter. It serves as a comprehensive record of a nation’s economic interactions globally. A country’s BOP reveals whether it has a trade surplus or deficit, with a surplus occurring when exports surpass imports, and a deficit occurring when imports exceed exports.
Q- Which of the following constitute Capital Account? (2013)
(1) Foreign Loans
(2) Foreign Direct Investment
(3) Private Remittances
(4) Portfolio Investment
Select the correct answer using the codes given below.
(a) 1, 2 and 3
(b) 1, 2 and 4
(c) 2, 3 and 4
(d) 1, 3 and 4
Answer- Option B
EXPLANATION
The capital account reflects alterations in a nation’s ownership of physical or financial assets, encompassing transactions such as Foreign Direct Investment, Portfolio Investment, foreign loans, and changes in the reserve account. Thus, statements 1, 2, and 4 are accurate. However, private remittances fall within the Current account, not the Capital account, rendering statement 3 inaccurate. Therefore, option 2 is the correct choice.
Q- Which one of the following groups of items is included in India’s foreign-exchange reserves? (2013)
(a) Foreign-currency assets, Special Drawing Rights (SDRs) and loans from foreign countries
(b) Foreign-currency assets, gold holdings of the RBI and SDRs
(c) Foreign-currency assets, loans from the World Bank and SDRs
(d) Foreign-currency assets, gold holdings of the RBI and loans from the World Bank
Answer- Option B
EXPLANATION
India’s foreign exchange reserves comprise foreign currency assets (FCA), gold reserves, Special Drawing Rights (SDRs), and reserve positions with the IMF. These reserves, usually held in US dollars, serve several purposes: they offer support to a nation’s currency during periods of devaluation, attract foreign investment, aid in meeting foreign obligations and liabilities, stabilize the market by supplying foreign currency, and enhance the country’s reputation in international circles.