UPSC Civil Services Exam – Prelims 2022 – General Studies Paper I – Solved with Explanations

Question 1.
1. “Rapid Financing Instrument” and “Rapid Credit Facility” are related to the provisions of lending by which one of the following?
(a) Asian Development Bank
(b) International Monetary Fund
(c) United Nations Environment Programme Finance Initiative
(d) World Bank
1. “त्वरित वित्तीयन प्रपत्र (Rapid Financing Instrument)” और “त्वरित ऋृण सुविधा (Rapid Credit Facility)”, निम्नलिखित में किस एक के द्वारा उधार दिए जाने के उपबंधों से संबंधित हैं?
(a) एशियाई विकास बैंक
(b) अंतर्राष्ट्रीय मुद्रा कोष
(c) संयुक्त राष्ट्र पर्यावरण कार्यक्रम वित्त पहल
(d) विश्व बैंक
Answer 1.
Answer: (b)

Explanation:

The Rapid Financing Instrument (RFI) is a lending provision setup under International Monetary Fund (IMF).
The RFI provides rapid and low-access financial assistance to member countries facing an urgent balance of payments (BoP) need, without the need to have a full-fledged program in place. It can provide support to meet a broad range of urgent needs, including those arising from commodity price shocks, natural disasters, conflict and post-conflict situations, and emergencies resulting from fragility. As a single, flexible mechanism with a broad coverage, the RFI replaced the IMF’s previous policy that covered Emergency Natural Disaster Assistance (ENDA) and Emergency Post-Conflict Assistance (EPCA).

The RFI is available to all member countries, although member countries eligible for the Poverty Reduction and Growth Trust are more likely to use the similar concessional Rapid Credit Facility (RCF).The Rapid Credit Facility (RCF) is also a lending provision setup under International Monetary Fund (IMF).

The Rapid Credit Facility (RCF) provides rapid concessional financial assistance to low-income countries (LICs) facing an urgent balance of payments (BoP) need with no ex post conditionality where a full-fledged economic program is neither necessary nor feasible. The RCF was created under the Poverty Reduction and Growth Trust (PRGT) as part of a broader reform to make the Fund’s financial support more flexible and better tailored to the diverse needs of LICs, including in times of crisis.

The International Monetary Fund (IMF) is an international financial institution, headquartered in Washington, D.C., consisting of 190 countries. Its stated mission is “working to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty around the world.”

Therefore, option (b) is the correct answer.

Why and how did this question come in the exam?
These terms are related to the Sri Lanka economic crisis which has been in news in April and May 2022. Please see articles published on various days in the newspaper.

https://timesofindia.indiatimes.com/world/south-asia/ sri-lanka-requests-imf-for-rapid-financial-aid-amidst-current-economic-crisis/articleshow/90934908.cms

https://www.thehindu.com/news/international/ world-bank-to-disburse-700-million-to-crisis-hit-sri-lanka-report/article65476117.ece

Source(s):

https://www.imf.org/en/About/Factsheets/Sheets/ 2016/08/02/19/55/Rapid-Financing-Instrument

https://www.imf.org/en/About/Factsheets/Sheets/ 2016/08/02/21/08/Rapid-Credit-Facility

Q2. With reference to the Indian economy, consider the following statements:
1. An increase in Nominal Effective Exchange Rate (NEER) indicates the appreciation of rupee.
2. An increase in the Real Effective Exchange Rate (REER) indicates an improvement in trade competitiveness.
3. 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: (c)

Explanation:

The Nominal Effective Exchange Rate (NEER) and the Real Effective Exchange Rate (REER) are both indicators of a nation’s competitiveness in relation to its trading partners.

The Nominal Effective Exchange Rate (NEER) is an unadjusted weighted average rate at which one country’s currency exchanges for a basket of multiple foreign currencies. The nominal exchange rate is the amount of domestic currency needed to purchase foreign currency.

The NEER may be adjusted to compensate for the inflation rate of the home country relative to the inflation rate of its trading partners. The resulting figure is the Real Effective Exchange Rate (REER).

If a domestic currency increases against a basket of other currencies inside a floating exchange rate regime, NEER is said to appreciate. If the domestic currency falls against the basket, the NEER depreciates.

The Real Effective Exchange Rate (REER) is the weighted average of a country’s currency in relation to an index or basket of other major currencies. The weights are determined by comparing the relative trade balance of a country’s currency against that of each country in the index.

An increase in a nation’s REER is an indication that its exports are becoming more expensive and its imports are becoming cheaper. It is losing its trade competitiveness.

Therefore, statement 1 is correct and statement 2 is incorrect.

Hence, option (c) is the correct answer.

Why and how did this question come in the exam?
In January 2022, the RBI had published a report. These terms of REER and NEER were popular in the said article/report. The report was reported in various newspapers.

https://economictimes.indiatimes.com/news/economy/policy/rbis-inflation-targeting-policy-helps-improve-external-competitiveness-as-inflation-differentials-with-trading-partners-narrow/articleshow/80418729.cms

https://indianexpress.com/article/business/economy/rupees-real-value-stable-showing-better-external-competitiveness-rbi-study-7159311/

Source(s):
https://www.investopedia.com/terms/n/neer.asp

https://www.investopedia.com/terms/r/reer.asp

Q3. With reference to the Indian economy, consider the following statements:
1. If the inflation is too high, Reserve Bank of India (RBI) is likely to buy government securities.
2. If the rupee is rapidly depreciating, RBI is likely to sell dollars in the market.
3. If interest rates in the USA or European Union were to fall, that is likely to induce RBI to buy dollars.
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: (b)

Explanation:
Statement 1 is incorrect: If the inflation is too high, the Reserve Bank of India (RBI) is likely to reduce the money supply in the economy to control inflation. Thus, RBI sells the government securities so as to suck the excess money supply from the economy and to control inflation.

Statement 2 is correct: The Reserve Bank of India intervenes in the currency market to support the rupee as a weak domestic unit can increase a country’s import bill. There are a variety of methods by which RBI intervenes. It can intervene directly in the currency market by buying and selling dollars. If RBI wishes to prop up rupee value, then it can sell dollars and when it needs to bring down rupee value, it can buy dollars.

Statement 3 is correct: When the US raises its domestic interest rates, this tends to make India less attractive for the currency trade. As a result, some of the money may be expected to move out of the Indian markets and flow back to the US, therefore decreasing the value of India’s currency against the US dollar. Thus, if interest rates in the USA or European Union were to fall, the value of rupee against the dollar increases and that is likely to induce RBI to buy dollars.

Therefore, option (b) is the correct answer.

Source(s):
https://economictimes.indiatimes.com/markets/forex/so-how-can-a-rbi-rate-hike-help-stem-the-rupee-slide/articleshow/66071179.cms?from=mdr

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