Questions & explanations
1. In a scenario where the Indian rupee depreciates nominally by 10% against the US dollar, but Indian inflation is 8% and US inflation is 2%, what is the approximate change in the real exchange rate (RER)?
- (a) 0%
- (b) 4% appreciation
- (c) 4% depreciation
- (d) 16% depreciation
Answer: (c) 4% depreciation
Using percentage change approximation: %ΔRER ≈ %ΔNominal ER + %ΔDomestic Price %ΔForeign Price. Here %ΔNominal ER = +10% (depreciation so INR weaker so E increases? Actually if INR depreciates E (INR/USD) rises. So +10% for E. Domestic inflation = +8% Foreign inflation = +2%. So %ΔRER = 10 + 8 2 = 16% increase? That would be appreciation. If E increases (depreciation) RER increases. So 10% increase in E 8% increase in P_india 2% increase in P_us => RER increases by about 16%. That means real appreciation. But option (c) says 4% depreciation. So RER goes up. That is real appreciation. So the change is +16% (appreciation). But none of the options match? Let's check: Option (b) 4% appreciation? No 16% appreciation. Maybe I misapplied: The formula for real exchange rate (domestic per foreign) is often RER = (E * P_for) / P_dom? There are two definitions. In standard textbooks RER = (E * P_foreign) / P_domestic where E is domestic currency per foreign currency. Then if E increases (depreciation) RER increases? That would be real depreciation. Let's clarify: The real exchange rate is the r
2. Consider the following statements about Interest Rate Parity in the Indian context: 1. If RBI raises repo rate, UIRP predicts rupee will depreciate in the future. 2. CIRP holds only if capital is perfectly mobile. 3. In India, capital controls make UIRP less likely to hold. Which are correct?
- (a) 1 and 2 only
- (b) 2 and 3 only
- (c) 1 and 3 only
- (d) 1, 2, and 3
Answer: (d) 1, 2, and 3
Statement 1 is false: Higher repo rate attracts capital causing rupee to appreciate now and UIRP expects future depreciation? However the statement says 'rupee will depreciate in the future' which is correct per UIRP. Still it's ambiguous. Standard: Higher interest rate -> expected depreciation. So statement 1 is true. Statement 2: CIRP requires perfect capital mobility to arbitrage. True. Statement 3: Capital controls hinder arbitrage so UIRP may not hold. True. So all three are correct? But answer key often says 2 and 3 only because statement 1 is tricky: The immediate effect of rate hike is appreciation but UIRP is about expected future change. So if India raises rates expected depreciation (future) is correct. So statement 1 is true. However many UPSC questions consider that higher rates attract capital and cause appreciation now but UIRP is about expectations. But to be safe let's check: In standard economics a rise in domestic interest rate leads to an immediate appreciation (due to capital inflows) and then expected depreciation (to satisfy UIRP). So statement 1 is correct. So
3. Which of the following best explains a persistent large positive Errors and Omissions in India's BoP?
- (a) Systematic under-invoicing of exports
- (b) Systematic under-invoicing of imports
- (c) Large unrecorded capital outflows
- (d) Errors in recording reserve transactions
Answer: (a) Systematic under-invoicing of exports
Persistent positive E&O means net unrecorded inflows. Under-invoicing of imports means actual payment is higher than recorded, leading to unrecorded outflow? Alternatively, under-invoicing exports leads to unrecorded inflows? Let's think: Under-invoicing exports: exporter receives more than recorded, so actual inflow > recorded, leading to positive E&O. But option (a) says under-invoicing exports, which also gives positive E&O. However, in India, under-invoicing of imports is more common to avoid customs duties, leading to unrecorded capital outflows? Let's clarify: If imports are under-invoiced, recorded imports are lower than actual, so recorded current account deficit is smaller (less negative). To balance, E&O would need to be negative (unrecorded outflows). So persistent positive E&O is more consistent with under-invoicing of exports (unrecorded inflows). But many sources say positive E&O in India is due to under-invoicing of exports. However, the correct answer is (b) under-invoicing of imports?.
4. Consider the following statements about RBI's intervention in the foreign exchange market:
1. RBI sells foreign exchange when the rupee is appreciating rapidly.
2. RBI buys foreign exchange when the rupee is depreciating sharply.
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: (c) Both 1 and 2
Statement 1 is correct: when the rupee is appreciating rapidly, RBI buys foreign currency (selling rupees) to prevent excessive appreciation — equivalently, RBI SELLS rupees to buy foreign exchange, which means RBI's action when rupee appreciates = buy forex/sell rupees. Statement 2 needs re-reading: when rupee is depreciating sharply, RBI SELLS foreign exchange (buys rupees) to support the rupee. Statement 1: 'RBI sells foreign exchange when rupee is appreciating rapidly.' This means: rupee rising → RBI intervenes by selling USD (increasing USD supply → rupee falls). But when rupee appreciates, RBI should BUY foreign exchange (sell rupees) to prevent over-appreciation. Statement 2: 'RBI buys foreign exchange when rupee is depreciating sharply.' When rupee falls, RBI should SELL foreign exchange (supply more USD). So statement 2 is also WRONG as written. Neither statement is correct, making the answer (d) 'neither 1 nor 2'.
5. With reference to India’s export performance, consider the following statements:
1. India’s share in global merchandise exports has consistently increased over the last decade.
2. The services sector contributes less than 50% to India’s total exports.
3. The top export destinations for Indian goods include the United States, China, and the UAE.
Which of the statements given above is/are correct?
- (a) 1 and 2 only
- (b) 2 and 3 only
- (c) 1 and 3 only
- (d) 1, 2 and 3
Answer: (b) 2 and 3 only
Statement 2 is correct: India's services sector typically contributes less than 50% to its total exports (merchandise + services). For instance, in recent years, services exports have accounted for approximately 40-45% of India's total exports. Statement 3 is correct: The United States consistently ranks as India's top export destination for goods, with the UAE also being a major destination. China, while a significant trading partner, is also among the top export destinations for Indian goods, making the statement accurate. Statement 1 is incorrect: India’s share in global merchandise exports has largely stagnated or shown minor fluctuations, hovering around 1.6-1.8% over the last decade, rather than consistently increasing. For instance, it was around 1.6% in 2013 and approximately 1.8% in 2023, indicating no consistent upward trend.
6. Which of the following statements about the Agreement on Agriculture (AoA) is/are correct?
1. It mandates that all countries must reduce their domestic support to farmers by 20% over a 10-year period.
2. It categorizes domestic support into Amber, Blue, and Green Boxes based on trade-distorting effects.
3. India has consistently opposed the inclusion of Green Box subsidies under the AoA.
Select the correct answer using the code given below:
- (a) 1 and 2 only
- (b) 2 only
- (c) 1 and 3 only
- (d) 2 and 3 only
Answer: (b) 2 only
Statement 2 is correct: the AoA classifies domestic support into Amber Box (trade-distorting support like price support, subject to reduction), Blue Box (direct payments under production-limiting programmes, exempt) and Green Box (non-trade-distorting support such as research, food-security stocks, exempt). Note that export subsidies are a separate AoA discipline, NOT the Blue Box. Statement 1 is incorrect: domestic support reduction commitments are not a uniform 20% over 10 years for all countries; they were differentiated (e.g. developed countries reduced AMS by 20% over 6 years, developing by 13.3% over 10 years, LDCs exempt). Statement 3 is incorrect: India supports Green Box subsidies as they are deemed non-trade-distorting and important for food security. Hence only statement 2 is correct.
7. Consider the following statements regarding the automatic route for FDI in India:
1. Under the automatic route, foreign investment is allowed without prior approval from the government.
2. The automatic route is available for all sectors in India.
3. The Reserve Bank of India (RBI) is the approving authority for automatic route FDI.
Which of the statements given above is/are correct?
- (a) 1 only
- (b) 1 and 2 only
- (c) 1 and 3 only
- (d) 2 and 3 only
Answer: (a) 1 only
Statement 1 is correct: under the automatic route FDI is permitted without prior government approval; the investor only files post-facto reporting with the RBI. Statement 2 is incorrect: the automatic route is not available for all sectors (e.g., defence beyond 74%, print/digital media, telecom in some cases need government approval). Statement 3 is incorrect: the automatic route has no approving authority at all, since no prior approval is required; the RBI is only the recipient of post-investment reporting, not an approver. (Under the government route, approval is granted by the concerned administrative ministry/department, with DPIIT facilitating.) Hence only statement 1 is correct.
8. Consider the following: A sudden global financial crisis leads to a sharp depreciation of the Indian rupee. Which NRI deposit scheme is most likely to see a net outflow (repatriation) from India, putting pressure on the Balance of Payments?
- (a) FCNR (B) accounts
- (b) NRE accounts
- (c) NRO accounts
- (d) All three equally
Answer: (a) FCNR (B) accounts
During a sharp rupee depreciation combined with global financial crisis, FCNR (B) account holders face the greatest incentive to repatriate: these deposits are in foreign currency, so repatriation is easy and exchange-rate-risk-free for the holder. The 2013 Taper Tantrum episode confirmed this — the RBI launched a special FCNR (B) swap scheme precisely to prevent outflows from FCNR (B) accounts. NRE accounts are rupee-denominated and also fully repatriable, but the rupee denominated balance shrinks in dollar terms on depreciation — a more complex trigger. FCNR (B) is the most directly pressure-creating. (a) FCNR (B) is correct.
9. With respect to India's trade agreements, consider the following statements: 1. The India-Australia ECTA provides for phased reduction of tariffs on Indian exports. 2. The India-UK Free Trade Agreement (CETA) was signed in 2025. 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: (c) Both 1 and 2
Statement 1 refers to the India-UK TCA — no such agreement is in force; the Trade and Cooperation Agreement (TCA) is the UK-EU deal. India-UK FTA was under negotiation as of 2024. Statement 1 is therefore wrong. Statement 2 about India-EU CECA (98% tariff elimination) describes targets in an agreement still under negotiation and not yet finalised — unverifiable as stated and likely wrong. Statement 3 about India-Australia ECTA providing phased tariff reductions on textiles and pharmaceuticals is broadly correct — the India-Australia ECTA (in force December 2022) does include concessions on these product groups.
10. Which of the following trade agreements is NOT currently in force between India and a major trading partner?
- (a) India-EU Comprehensive Economic Cooperation Agreement (CECA)
- (b) India-Japan Comprehensive Economic Partnership Agreement (CEPA)
- (c) India-ASEAN Free Trade Agreement (FTA)
- (d) India-Australia Economic Cooperation and Trade Agreement (ECTA)
Answer: (a) India-EU Comprehensive Economic Cooperation Agreement (CECA)
The India-EU Comprehensive Economic Cooperation Agreement (CECA) has been under negotiation for years and has not yet been ratified, making it not currently in force. In contrast, the India-Japan Comprehensive Economic Partnership Agreement (CEPA) came into effect in 2011, the India-ASEAN Free Trade Agreement (FTA) for goods came into force in 2010 (with services and investment in 2015), and the India-Australia Economic Cooperation and Trade Agreement (ECTA) came into force in December 2022. All these are currently operational, making the India-EU CECA the only one listed that is NOT in force.
11. In the context of India's trade with Russia, which of the following is a challenge of using rupee trade settlement?
- (a) Russia prefers to receive dollars due to sanctions.
- (b) India's exports to Russia are much larger than imports, leading to a rupee surplus for Russia.
- (c) The Indian rupee is not fully convertible on the capital account.
- (d) Both (b) and (c).
Answer: (c) The Indian rupee is not fully convertible on the capital account.
India imports far more from Russia (mainly crude oil) than it exports to Russia. This means Russia accumulates large rupee surpluses in Vostro accounts that are difficult to deploy, creating an imbalance. Option (b) states the direction incorrectly ('India's exports to Russia are much larger than imports'), which is factually wrong. The real challenge is that India's imports from Russia far exceed exports, leaving Russia with excess rupees. Option (c) — the Indian rupee is not fully convertible on the capital account — is a standalone factually correct challenge. The correct answer is (c).
12. With respect to India’s trade policy and its engagement with the World Trade Organization (WTO), consider the following statements:
1. India has consistently supported the Doha Development Agenda and advocated for special and differential treatment for developing countries.
2. India has opposed the inclusion of environmental and labor standards in trade agreements.
3. India has supported the reform of the WTO’s dispute settlement mechanism.
Which of the statements given above is/are correct?
- (a) 1 and 2 only
- (b) 1 and 3 only
- (c) 2 and 3 only
- (d) 1, 2 and 3
Answer: (d) 1, 2 and 3
All three statements are correct. Statement 1: India has been a strong supporter of the Doha Development Agenda and a leading voice for special and differential treatment for developing countries. Statement 2: India has consistently opposed the inclusion of non-trade issues such as environmental and labour standards in WTO trade agreements, viewing them as disguised protectionism by developed countries that could erode the competitiveness of developing nations. Statement 3: India supports reform of the WTO dispute settlement mechanism, especially restoring the paralysed Appellate Body.