· Contact Admin ·

11
2 National Income
External Sector

The external sector of a country’s economy o Foreign Currency Assets (FCAs): The
includes all international economic transactions largest component of the FOREX
between residents of the country (both public Reserves
and private sector) and the rest of the world. o Gold
All economic activities that take place in foreign
o Special Drawing Rights (SDRs)
currency fall in the external sector like import,
export, capital account, foreign investment, o Reserve position of RBI with the
the Balance of Payment, etc. International Monetary Fund (IMF)
Importance of External Sector - Why Imports • FOREX reserves are used to back liabilities
and Exports Matter (meet their foreign obligations) and
Imports and exports matter because they influence monetary policy.
influence various aspects of the economy of a • India’s foreign exchange reserves touched a
country as: record high of US$ 603.694 billion, in April
GDP (Gross Domestic Product): 2022, according to the RBI data.
• GDP is a broad measure of the economy’s • The rise in FOREX reserves was mainly on
overall activity. When the GDP is estimated account of an increase in foreign currency
using the spending method, The GDP assets (dominated by the dollar), which
formula is as follows: rose to $536.768 billion, gold reserves rose
GDP=C+I+G+ (X-M) to $43.145 billion, the country’s reserve
Here position with the IMF increased to $5.086
C= Consumer spending on goods and services. billion, Special Drawing Rights (SDR) were
I = Investment spending on business capital up to $18.694 billion.
goods.
G= Government spending on public goods and
services.
X= Exports
M = Imports
• In this equation, (X-M) is net exports. When
exports exceed imports; it has a positive
effect on GDP, and when exports are less
than imports, the net export has a negative
effect.
Exchange rates
In a country where exports are higher than
imports, their forex supply is high in the country,
so it reduces the exchange rates and vice versa.
FOREX reserve
• The foreign currency assets held by a
country’s central bank are known as Foreign
Exchange Reserves (RBI).
• In the context of India, foreign exchange Fig. 11.1: FOREX Reserves in India in Previous years
reserves include:

External Sector 189

 · Contact Admin ·

• Hence, FCA > Gold > SDR > Reserve Position • The goal of a fixed exchange rate system
with IMF. is to keep the value of a currency within a
Exchange Rate certain range.
• The value of one currency expressed in • After decades of having a fixed exchange
terms of another currency is referred to as rate, most countries converted to a floating
an exchange rate. exchange rate in the early 1970s.
• For example, at present, approximately • A fixed exchange rate system may minimise
Rs. 74.68 is exchanged for US $1. Hence, instabilities in real economic activities by
the value of one US Dollar is equal to 74.68 reducing volatility and fluctuations in the
Indian rupees. (approximately, the exchange currency.
rate is in February 2022). Managed Exchange Rate System
Exchange Rate System • A managed exchange rate is a cross between
• An exchange rate system establishes fixed and floating exchange rate systems.
the way in which the exchange rate is • The native currency is governed by demand
determined, i.e., the value of the domestic and supply, subject to central bank
currency with respect to other currencies. intervention in the FOREX market, under
• There are many ways in which the country’s this exchange rate.
exchange rate is determined. • The central bank cannot fix the exchange rate,
Floating Exchange Rate System but it can affect the currency exchange rate
• The exchange rate of currencies is both directly (by buying and selling currencies)
established in the Floating or Flexible or indirectly (through monetary policy).
Exchange Rate System based on demand- • But in case of extreme fluctuations, the central
supply in the FOREX market relative to bank under managed floating exchange rate
other currencies. system intervenes in the FOREX market with
• As a result, if there is a large demand for the objective to minimise the fluctuation in
money and a low supply, the value will rise. the exchange rate of the currency.
If demand is low and supply is plentiful, the • India adopted this form in 1993.
currency price will fall. • Today, the majority of economies use
• A currency that uses a floating exchange a controlled exchange rate system to
rate is known as a floating currency. determine currency exchange rates.
• Most of the world’s currencies are floating Wider Band Exchange Rate System
and include the most widely traded • Under this, the central bank (RBI) fixes
currencies: The United States dollar, the exchange rate bands (lower and upper limit)
Swiss franc, the euro, the Japanese Yen, for the domestic currency within, which it
the pound sterling, and the Australian is permitted to fluctuate.
dollar. Crawling Peg Exchange Rate System
• Even in the case of floating currencies, • Under this central bank (RBI) fixes the
central banks frequently intervene in the exchange rate band which is periodically
markets to try to affect the value of the revised, and it is like a type of fixed exchange
currency. rate system.
Fixed Exchange Rate System • This type of fixed exchange rate system is
• The central bank of a country determines followed in China.
the exchange rate of currencies in a fixed Devaluation
or pegged exchange rate regime (RBI for • It refers to the reduction in the value of
India). the domestic currency in terms of foreign
currency.

190 External Sector

 · Contact Admin ·

Fig. 11.2: Foreign Exchange Rates

• This monetary policy instrument is used by • The Foreign Exchange Market determines
countries with a fixed exchange rate. foreign exchange rates for every
• RBI devalued Indian rupee three times in currency.
1949, 1966 and 1991. • Central banks, commercial banks, brokers,
Revaluation exporters and importers, immigrants,
• It refers to an increase in the exchange rate investors, and tourists all participate in
of domestic currency by the central bank. foreign exchange markets.
Foreign Exchange Market • The floating exchange rate system and
Managed exchange rate system used this
• The Foreign Exchange Market (commonly
institutional framework for determining the
known as FOREX) is a market for buying
exchange rate of the currency.
and selling different currencies.

External Sector 191

 · Contact Admin ·

Fig. 11.3: Functions of Foreign Exchange Market

Depreciation • It discourages imports by raising the cost

• It refers to a reduction in the exchange rate of imports, making domestic customers
of a currency due to a change in its demand less likely to buy them, and bolstering
and supply in the FOREX market. domestic firms even more.
• A flexible exchange rate system or a • It helps in reducing the trade deficit and
managed floating exchange rate system current account deficit (CAD).
both experience depreciation. • It promotes inward foreign remittances and
foreign tourism.
• For example, if in the previous month 1$ =
Rs. 40 now 1$ = Rs. 50, hence the rupee Negative impact
loses its value in front of a dollar. • It creates inflation as it increases FOREX
Impact of Depreciation/Devaluation reserve, which increases the money supply
Positive impact: and aggregate demand.
• It may adversely affect economic growth
• It promotes export as it reduces the cost of
as it creates cost-push inflation due to an
a country’s exports, rendering them more
increase in the prices of inflated commodities
competitive in the global market.
in terms of domestic currencies.

192 External Sector

 · Contact Admin ·

• It increases the burden of external debt in Exchange Rate in India

terms of domestic currencies. • Because of the opening of the economy as
• It deteriorates terms of trade (it measures part of broader macroeconomic reforms
the purchasing power of export of a country and liberalisation from the early 1990s,
in terms of quantity of imports). India’s exchange rate policy has changed
Reasons for Rupee Depreciation in Recent Years significantly over time.
• Supply of the Rupee increased, and demand
for the Rupee decreased, leading to a
demand-supply mismatch.
• An increase in crude oil prices increased
total import cost. India is the third-largest
crude oil importing country in the world.
• High Trade Deficit and High Current Account
Deficit (CAD).
• The protectionist policy was adopted by the
major economies.
Fig. 11.4: Exchange Rate $ to Rs
• A hike in the FED rates (as was observed
twice in 2018), strengthens the US Dollar, • Exchange rate policy has changed from
which in turn leads to a depreciation of the a par value system to a basket-peg and
Indian currency. then to a controlled floating exchange rate
Government/RBI Measures to Check regime in the post-independence period.
Depreciation of Rupee? • Due to the dollar crisis of the 1960s, the
• Restriction of Imports. Bretton Woods System came to an end in
• Contractionary monetary policy. 1971, and the rupee was linked to the pound
sterling.
• Liberalisation of Foreign Investment Policy.
• It was required to address the drawbacks
• Sale of the dollar in the FOREX market by RBI.
of a single currency peg while still ensuring
• The interest rate on NRI deposits increased exchange rate stability. Thus, in September
by RBI. 1975, the rupee was pegged to a basket of
Roles of RBI in Maintaining the Stability of the currencies which continued till the early
Rupee 1990s.
• RBI acts as a regulator of foreign exchange i.e. • With the initiation of economic reforms, India
o It manages the forex reserves of India moved to a floating currency regime that
o It maintains the value of rupees outside involved the dual exchange rate system (one
the country official and the other market-determined).
o It aids foreign trade payments • The dual exchange rate system was replaced
Appreciation: by a unified exchange rate system in March
• It refers to the increase in the value of a 1993.
currency due to a change in its demand and Effective Exchange Rate
supply in the FOREX market. • The weighted value of a basket of foreign
• Appreciation occurs in a managed floating currencies is used to calculate the effective
exchange rate system or in a flexible exchange rate, which compares the value
exchange rate system. of the domestic currency to the weighted
• For example, if in the previous month 1$ = value of a basket of foreign currencies. The
Rs. 65 now 1$ = Rs. 50, hence rupee gains weights reflect the foreign countries’ share
its value in front of a dollar. in the domestic country’s trade.

External Sector 193

 · Contact Admin ·

• It measures the strength of domestic • The current account is a key indicator of a

currency with respect to currencies of country’s economic health.
major trading partners. • A positive current account balance (current
o These are of two types: Nominal account surplus) shows that a country is a
Effective Exchange Rate (NEER) net lender to the rest of the world, resulting
o Real Effective Exchange Rate (REER) in an increase in the country’s net foreign
• Nominal Effective Exchange Rate (NEER) assets.
and Real Effective Exchange Rate • A negative current account balance (deficit)
(REER) are utilised to gauge the external shows that a country is a net borrower
competitiveness of an economy. from the rest of the world, lowering its net
Nominal Effective Exchange Rate (NEER) foreign assets.
• The weighted average of bilateral nominal • The current account represents the net
exchange rates of the home currency in income of the country.
terms of foreign currencies is known as the • The current account deficit is shown either
nominal effective exchange rate (NEER). numerically by showing the total monetary
• It is the domestic currency’s exchange amount of the deficit, or in the percentage of
rate in relation to the basket currencies the GDP of the economy for the concerned
(36 currencies), weighted by the basket year.
country’s share of the domestic country’s • The main components of the current
trade. account are:
• The nominal exchange rate determines o Trade-in goods (visible balance)
how much domestic money is required to o Trade-in services (invisible balance)
purchase foreign currency. o Investment incomes: It includes
Real Effective Exchange Rate (REER) dividends, interest, and remittances.
• The purchasing power parity (PPP) theory o Net transfers: It includes International
states that the real effective exchange rate aid etc.
(REER) is a weighted average of nominal Current Account Deficit (CAD)
exchange rates adjusted for relative price • The difference between the inbound and
differentials (inflation rate) between home outward flow of money as a result of the
and foreign countries. trade of goods and services, as well as
• The REER considers the relative inflation the transfer of money from domestically
levels in two economies and thus incorporates owned factors of production overseas, is
the concept of purchasing power parity. calculated as the current account deficit.
• An increase in REER shows that exports are • CAD includes the trade deficit along with
becoming more expensive while imports some other important factors like net
are becoming cheaper, indicating a loss in income and transfer payments.
trade competitiveness. • Lowering the Current Account Deficit (CAD)
Current Account implies a reduction in the country’s external
• The current account measures the overall debt, making the domestic economic policy
inflow and outflow of products, services, more independent of external influences.
transfer payments, and investment incomes • Foreign Direct Investment (FDI) provides a
of a country’s transactions with the rest of more stable source of financing for the CAD
the world. as compared to external borrowings.
• Because goods and services are typically • Crude oil and gold imports are the key
consumed in the present period, it is called causes of India’s high CAD.
a current account.

194 External Sector

 · Contact Admin ·

• The Current Account Deficit can be reduced • It summarises both private and public
by increasing exports and decreasing non- investment flows into a given economy.
essential imports like gold, mobile phones, Capital Account = Foreign Direct investment
and electronics. + Foreign Portfolio Investment + External
• India’s Current Account Deficit (CAD) Lending and Borrowing + Other Investments.
increased to $23 billion (2.7 per cent of GDP) • A capital account deficit indicates that
in the third quarter (Q3) of 2021-22 from more money is moving out of the economy,
$9.9 billion (1.3 per cent of GDP) in Q2 of accompanied by a growth in the economy’s
2021-22 and $2.2 billion (0.3 per cent of ownership of foreign assets, whereas a
GDP) in Q3 of 2020-21, according to RBI data. surplus indicates the opposite.
Balance of Payment (BoP)
• It is the systematic record of the entire
economic transactions of a country/
resident of a country with the rest of the
world throughout a financial year.
• The components of the balance of payment
are:
o Current account: It includes all kinds
Fig. 11.5: Current Account Deficit as a percentage of current financial transactions of the
of GDP economy.
o Capital account: It includes all kinds
Impact of BREXIT on India’s External Debt
of capital financial transactions of the
It seems that there will be a change in the
economy.
short-term loan due to changes in exchange
o Official reserve transactions: It is
rates and loss of confidence of investors, but
conducted by the central bank in case
on long-term loans, there will not be much
of the BoP deficit or BoP surplus.
effect. (BREXIT’s name is given to the United
Kingdom’s departure from the European o Errors and omissions: It refers to the
Union. It is a combination of Britain and exit.) balancing items reflecting the inability
to record all the international financial
Capital Account transactions
• The capital account tracks all transactions • The Balance of Payments of a country
between the country’s citizens and the indicates whether or not it saves enough to
rest of the world that result in changes in cover its imports.
the residents’ or government’s assets or • The Balance of the Payment account is kept
liabilities. in accordance with the requirements of the
• Capital account includes the following: double-entry accounting system. Under this,
o Foreign Direct Investment (FDI), every entry shown either as a credit (inflow)
or debit (outflow) is made in the account for
o Foreign Portfolio Investment (FPI),
every transaction is always equal.
o External Lending and Borrowing,
• If the country’s Balance of Payments is
o Foreign Currency Deposits of banks,
positive at the conclusion of the fiscal year,
o External Bonds Issued by the Central the excess is immediately transferred to
Government. the country’s FOREX reserves.
• The capital account depicts changes in • If the outcome is negative, an equal
asset ownership both within and outside amount of foreign exchange is taken from
the country. the country’s FOREX reserves. A BoP crisis

External Sector 195

 · Contact Admin ·

occurs when FOREX reserves are insufficient • Financial account:

to cover the negative BoP balance. o When a country’s ownership of foreign
assets matches the ownership of
domestic assets by other countries, the
financial account is in balance.
o A deficit can occur if a country’s
foreign ownership grows faster than its
domestic ownership.
o When a country’s Balance of Payments
Fig. 11.6: Balance of Payment accounts for a deficit, it signifies the
country sells more assets than it gains.
Components of Balance of Payments
Balance of Payment Disequilibrium
There are three components of Balance of
The Balance of Payment deficit or surplus
Payment, namely:
shows an imbalance in the Balance of
• Current account: Payment. This imbalance is termed Balance
o The current account covers a country’s of Payment disequilibrium. When a country’s
net goods and services trade with other receipts do not equal its payments, the
countries, as well as its net revenues country’s Balance of Payments is said to be
from overseas investments and net in disequilibrium.
transfer payments. Types of Disequilibrium
o It is used to track the flow of • Cyclical disequilibrium:
commodities and services into and out
o Trade cycles have created a state of
of the country.
disequilibrium.
o It comprises all revenues and payments
o As a result of trade cycles, terms of
related to raw materials and finished
trade fluctuate. It has an impact on the
commodities.
payment balance.
• Capital Accounts
o It can be fixed by adjusting the import-
o It entails the purchase and sale of export ratio.
assets such as land and buildings.
• Secular disequilibrium:
o This covers the flow of taxes, the
When an economy experiences significant
acquisition and sale of fixed assets, and
changes, the Balance of Payments suffers
other financial transactions involving
from secular or long-term disequilibrium.
migrants who are relocating to another
• Structural disequilibrium:
country.
When structural changes occur in certain
o A capital account has three major
areas of the economy, they have an impact
components:
on the country’s import-export trade,
■ Loans and borrowings: This category
resulting in structural disequilibrium.
encompasses all forms of loans
• Fundamental disequilibrium:
made in other countries by both the
private and state sectors. A deep-rooted, chronic deficit or surplus in
a country’s Balance of Payments is referred
■ Non-residents’ investments: These are
to as fundamental disequilibrium.
funds invested in corporate equities.
• Temporary disequilibrium:
■ The capital account is influenced by
foreign exchange reserves, which are The Balance of Payments of a country is of
held by a country’s central bank to a transient nature, lasting just a brief time
monitor and control exchange rates. and occurring only once in a while.

196 External Sector

 · Contact Admin ·

Causes of Disequilibrium in Balance of Payment Measures to correct the Disequilibrium in the

• Unfavourable Balance of Trade Balance of payment
When a country imports more items than it • Export encouragement:
exports, there is an overall outflow of dollars, Manufacturers and exporters should be
resulting in a Balance of Payment imbalance. given numerous concessions to encourage
• Development programmes: them to export. Imports should be
Projects in developing countries require discouraged at the same time by attempting
the importation of finances, capital, to replace them with local alternatives and
skilled labour, and technology from setting acceptable tariffs.
wealthy countries. These development • Import reduction:
programmes are very consuming, and the Restricting imports and promoting the
import procedure might take a long period, use of local alternatives to imports like
resulting in a state of disequilibrium. increasing use of their own made country
• High Population Growth products for correcting disequilibrium.
As the country’s population grows, it • Reducing inflation:
imports more, causing an imbalance in the Exports are discouraged by inflation, while
Balance of Payments. imports are encouraged. As a result, the
• Demonstration effect: government should keep an eye on inflation
It refers to developing or underdeveloped and cut prices throughout the country.
countries imitating the consumption • Exchange control:
patterns of affluent countries. Importing Foreign exchange should be controlled by
more items becomes necessary when the government by requiring all exporters
people seek to increase the level of a to submit their foreign money to the central
consumption pattern. bank, which would then be distributed
• Natural factors: among approved importers.
Natural calamities like floods, drought • Depreciation of domain currency:
and earthquakes destroy agricultural land It refers to a decrease in the exchange
production and industrial production which value of a home currency in terms of a
adversely affects exports and increases foreign exchange unit, lowering the price of
imports. relevant goods on the international market.
• Inflation: When a country needs to adjust to a new
As the price of goods in the country increases exchange rate system, the government
the export price also increases and this issues a depreciation order. It is important
would lead to a decline in export and lead to ensure that depreciation does not lead
to disequilibrium in the Balance of Payment. to an increase in local costs.
• Huge External Borrowing • Depreciations:
When a country borrows heavily from other Depreciation reduces the purchasing
countries, its Balance of Payments displays power of the local currency in international
markets. Depreciation takes place in a free
increased debt.
market system wherein demand for foreign
• Political conditions:
currency passes the supply of foreign
Due to political uncertainty, countries
currency in the market of a country.
may value their foreign exchange and gold
Indian Balance of Payments Crisis (1991)
reserves. Foreign investors may relocate
During the year 1991, India faced a huge
their capital to protect themselves from
economic problem in the way of the
political instability, producing an outflow of
“Balance of Payment Crisis”. This is also
funds and causing disequilibrium.
called the currency crisis.

External Sector 197

 · Contact Admin ·

Causes of Balance of payment crisis in 1991 • India was on the verge of defaulting on its debt
• In 1990-91, the fiscal deficit increased obligations to the international community.
from 9% of GDP in 1980-81 to 12% percent • Investors withdrew their funds.
of GDP. • Exporters were concerned that they would not
• Internal debt increased from 35% of GDP in be paid, therefore short-term funding dried up.
1985-36 to 53% of GDP in 1990-91. • Inflation rates have soared dramatically.
• The current account deficit was substantial. Effects of Balance of payment Crisis 1991
• The increase in crude oil prices as a result • Restriction on imports.
of the Gulf War triggered the current • Hike in the price of fuels.
account imbalance. India’s foreign exchange
• Bank rates were to rise.
reserves were severely drained as a result
• The government had to cut its spending on
of this. Despite taking out large loans from
various schemes and projects.
the International Monetary Fund (IMF)
earlier this year. • By promising 67 tonnes of gold as collateral
security, India was able to get a $2.2-billion
• By June 1991, India had less than $1 billion
emergency loan from the IMF.
in foreign exchange reserves, barely enough
to cover import needs for three weeks. • India delivered 20 tonnes of gold to Union
Bank & Switzerland in Zurich in May 1991,
• India lacked sufficient foreign exchange
and 47 tonnes of gold to the Bank of England
reserves to conduct international trade.
in July 1991, to raise a total of $600 million.

Previous Year Question (PYQ) (2015, Mains)

Q. Craze for gold in India has led to a surge in the import of gold in recent years and put
pressure on the Balance of Payments and the external value of the rupee. In view of this,
examine the merits of the Gold Monetization Scheme. (200 Words, 12.5 Marks)
Decoding the question:
• In the introduction, try to show the status of the surge in gold imports.
• In the body,
⚪ Impact on BoP and the value of rupee.
⚪ Examine the merits of the Gold Monetisation Scheme (GMS).
• In conclusion, conclude your answer with RBI’s new norms.
Answer:
India is the largest importer of gold, which mainly caters to the demand of the jewellery industry.
In volume terms, the country imports 800-900 tonnes of gold annually. Gold is a very significant
part of Indian cultural life as it is seen as a powerful tool to increase presence in society and
impress others. This high craze for gold every year increases imports and consequent increase
in the import bill of the country and puts pressure on the balance of payment and external
value of the rupee. As gold imports increase the Current Account Deficit (CAD) and this CAD
led to the devaluation of the rupee in comparison to the dollar.
The Government of India announced the Gold Monetisation Scheme in 2015. The objective of the
scheme is to mobilise gold held by households and institutions of the country and facilitate its use
for productive purposes, and in the long run, reduce the country’s reliance on the import of gold.
Merits of gold monetisation can be seen in the following manner:
Consumers:
• Fall in prices of the gold.

198 External Sector

 · Contact Admin ·

• Gold will be securely maintained by the bank.

• Consumers earn interest on the gold otherwise lying idle in the households.
• It will ascertain the purity of gold held by people.
• The carrying cost for gold is saved.
• Earnings are exempt from the capital gains tax, wealth tax and income tax. There will be no
capital gains tax on the appreciation in the value of gold deposited.
Banks:
• Banks may sell the gold to generate foreign currency. The foreign currency thus generated
can then be used for onward lending to exporters/importers.
• Banks to buy and sell on domestic commodity exchanges, where mobilised gold can be
delivered.
• Lending to jewellers and earning extra cash.
• Banks may convert mobilised gold into coins for onward sale to their customers.
Government:
• The import bill of India can go down by 10 to 20 per cent even if 1% of the gold lying with
people is deposited into banks under the scheme.
• The Gold Monetisation scheme may lead to greater investment and accelerate growth.
Other Benefits:
• Reduce Black Money: The gold owned most of the time is through the use of black money.
This gold through GMS will be used for the general well-being of the people and the economy
at large.
• Income addition: Ideal gold at homes can be used to earn interest, and this will give additional
income sources for individuals. Through the earning of interest, a person can augment his/her
income. Even this will improve earnings in rural areas as well.
• Reduce Current Account Deficit: Most of the gold in India is imported from abroad with
high duty. This import of gold and paying off high duty is resulting in pressure on the forex
reserve of the country. By supplying gold through banks, the demand for import of gold will
be reduced.
• Boost Jewellery Sector: With easy and cheaper availability of gold, the domestic jewellery
industry will become more competitive and boost its production. In addition, the local
industry can borrow gold on loans from banks, which can provide stability to prices.
The Reserve Bank of India (RBI), in consultation with the government, has issued new norms. New
norms include making the scheme more accessible for potential gold depositors and allowing
premature redemptions after three years and five years for medium-term and long-term deposits,
respectively. These suggestions, if implemented, can go a long way in ensuring that GMS does not
go the same way as the GDS, at least as far as the consumer side of the equation is concerned.

Opening of Indian Economy- Neo-Liberal • It desired economic stability and the

Economic Reforms 1991 transformation of the Indian economy into
Main objectives of Neo-Liberal Economic a market economy by reducing needless
Reforms (1991): barriers.
• Globalising the Indian Economy gave a new • It intended to foster the free movement of
boost to market orientation. products, services, capital, human resources,
and technology across international borders.
• The rate of inflation was reduced.
• It aimed to enhance the private sector
• It was intended to accelerate its economic
engagement in practically every sector of
growth and accumulate sufficient foreign
the Indian economy.
currency reserves.

External Sector 199

 · Contact Admin ·

Steps Under Economic Reforms of 1991 • Freedom to import capital goods: To achieve
The branches of the Neo-liberal Economic holistic development, industries were free
Reform 1991 policy are threefold: to purchase machines and raw materials
from other countries.
• Liberalisation
• Freedom for expansion and production
• Privatisation
to Industries: Limits on the production of
• Globalisation industries were removed.
Steps were taken under liberalisation: • Removal of Industrial Licensing and Registration:
• Free determination of interest rate & by Except for the following, the private sector
the commercial Banks: Commercial banks has been exempted from licencing and other
were allowed by the RBI to determine their restrictions under this policy:
own interest rates. o Liquor
• Increase the investment limit in small o Cigarette
scale industries: Small-scale industry
o Defence equipment
investment limits have been lifted to one
o Industrial explosive
crore rupees, allowing these businesses to
modernise their equipment and improve o Drugs
their efficiency. o Hazardous chemicals

Previous Year Question (PYQ) (2013, Mains)

Q. Examine the impact of liberalisation on companies owned by Indians. Is it competing with

the MNCs satisfactorily? (200 Words, 10 Marks)
Decoding the question:
• In the introduction try to define the meaning of liberalisation:
• In the body,
o Do scrutiny of impacts of liberalisation (Write both positive and negative impacts but
keep more focus on positive outcomes).
o In the second part, you need to discuss whether they are competing with MNCs
satisfactorily.
• Try to conclude the answer by underlining the need for improvement in corporate
governance, especially in Indian corporates.
Answer:
In Economic terms, Liberalization means minimizing government restrictions and all types of
regulations. This deregularization of the economy and opening of all the sectors, except a few
national significance sectors like nuclear energy and railways, are opened up for the private
sector. This brings many advantages for the country in general and the corporate sector in
particular, both private and public sector companies.
Positive impacts on Indian companies:
• Impact on Small Industries: Indian manufacturing industries are dominated by Micro, Small,
and Medium enterprises. After following up on liberalization policy this sector has seen
some technological advancement and become a supplementary industry for big industries.
• Unrestrictive Capital Flow: This unrestricted flow of capital in the country brought much-
needed capital for expansion and technology adoption. Newer technology adoptions and
capital investment improved manufacturing sector output.

200 External Sector

 · Contact Admin ·

• Growth of Service Industry: New Economic policies brought the biggest thrust to the growth
of the service industry. Many private firms from abroad and India got opportunities and
incentives to start a business in the service sector like Information technology, software
companies, etc.
• Tourism industry: Liberalisation policy allowed and attracted foreign tourists to visit India.
This visit and the popularity of India among foreign tourists have increased manifold. This
growth gives a boost to the tourism sector.
• Impact on Agriculture Sector: In the agricultural sector, modern equipment-making
companies were established in India, which brought down the cost of this equipment and
decreased the input cost of agriculture.
• Outsourcing: In Knowledge Processing Organisations (KPOs), Business Processing Outsourcing
(BPOs), and other cheap and effective service industries, human resources are now outsourced
by foreign companies.
• Improved Ease of Doing Business: NEP has drastically reduced bureaucratic hurdles in the
form of license raj, permit system, over bureaucratic control, etc. This has been a major
reason behind the growth of companies in India in the first generation of economic reforms.
Removing the Restrictive Trade Practices Act is an example of removing control of the
government.
Although various sectors of the Indian economy have witnessed positive impacts, certain
negative impacts have also been witnessed in Indian Industries, such as:
• Sudden competition: The sudden opening of the Indian economy and liberalised policy had
negatively impacted Indian companies as they are facing tough competition from MNCs.
• Impact on MSMEs: The impact on SMEs can be widely discussed as this is the sector
that received relatively fewer advantages but got higher disadvantages. As most of the
investment and capital come from big corporates and sectors, but are not given much
focus on the modernisation of MSME.
• Agriculture sector: Agriculture sector sees monopolisation in seeds, fertilisers, chemicals,
and even duplicate seeds and costly inputs like HYV seeds, herbicides, fungicides, etc. This
resulted in the exposure of Indian farmers to increased input costs and a higher level of
investment for agricultural operations.
• Unequal competition: Some companies are not able to compete with foreign companies
or MNCs which further leads to a monopoly in the market in which consumers and other
companies suffer.
• Commercialisation of some sectors: sectors like education, health, and higher education
have seen trends of commercialisation which are again becoming costly for the general
public, and only wealthy people can afford quality education, health care, etc.
Although all the Indian companies have seen some negative and positive outcomes, Indian
companies are more or less competing with global giants:
• IT sector: Many IT sector companies are successfully competing with global giants. Now,
India is considered the Silicon Valley of the east. Companies like TCS, Infosys, etc, are
known for their global presence and competence.
• Automobile: The automobile sector is another sector where Indian brands are considered
the best options for foreign car brands. TATA Motors, Maruti Suzuki, Mahindra, etc. are
Indian giants in the automobile sector. Even, Tata Motors has acquired British carmaker

External Sector 201

 · Contact Admin ·

Jaguar Land Rover company and become one of the biggest companies in the world in the
automobile industry.
• Oil and Gas Exploration: Indian giants like ONGC, Reliance Petroleum, and Gas Authority of
India Limited (GAIL) are now global giants in oil and gas exploration and even in the supply
and processing sector. They are one of the major competitors in oil and gas exploration.
However, Indian corporates and companies are suffering from poor corporate governance, as
corporate governance is widely discussed in India and abroad concerning Indian companies.
Indian companies need to improve corporate governance and try to invest more in R&D so
that technological advancement can make Indian companies in every field a competitor.

Steps were taken under Privatisation Criticism of Neo-Liberal Economic Reforms

• Sale of shares of PSUs: The Indian • Even though there was an increase in GDP,
government has begun selling PSU shares indicating economic growth, employment
to public and private organisations. did not increase.
• Disinvestment in PSUs: The government • The industrial and service sector was given
has started disinvestment in PSUs, which priority, and the agriculture sector was
was running into the loss which means that neglected.
the government was selling out shares of • Low level of industrial growth competition
these industries to the private sector. with cheap imports.
• Minimisation of Public Sectors: The • Ineffective disinvestment policy as the
public sector was given priority in order earnings were used to meet the insufficient
to aid in industrialisation and poverty revenue and not for the development of the
alleviation. However, PSUs were unable to Indian economy.
fulfil this goal, and under new economic • Ineffective fiscal Policy due to the reduction
reforms, a strategy of PSU downsizing was of direct and indirect taxes and other
implemented. duties, the revenue of the government was
Steps were taken for Globalisation. significantly reduced.
• Reduction in tariffs: Import and export Importance of BoP
customs charges and tariffs were imposed • It provides detailed information related
to entice international investors. to the demand and supply of a country’s
• Long-term trade policy: Its main feature currency. For example, if India imports more
were: than it exports, then this means that there
o Liberal policy. will be more outflow of foreign currency from
o All controls on foreign trade were the domestic market. Thus, rupee would be
removed. under pressure to depreciate against other
o Competition has been encouraged. currencies (other things being constant).
• Partial convertibility of Indian currency: It • It examines all the export and import
is described as the process of converting transactions of goods and services.
Indian rupees into the currencies of other • It can be used to evaluate the country’s
countries in order to facilitate the flow of performance in international economic
foreign investment. competition.
• Equity limit of foreign investment • It helps the government to analyse the
increased: In 47 high-priority industries, the export potential of a particular sector and
equity limit for foreign investment has been formulate policies to support its export
lifted from 40% to 100%. growth.

202 External Sector

 · Contact Admin ·

Previous Year Question (PYQ) (2014, Mains)

Q. Normally, countries shift from agriculture to industry and then later to services, but India
shifted directly from agriculture to services. What are the reasons for the huge growth of
services vis-a-vis the industry in the country? Can India become a developed country without
a strong industrial base? (200 Words, 12.5 Marks)
Decoding the question:
• In the introduction, try to write a contextual introduction.
• In the body,
o Discuss the reasons behind this shift
o Justify the need for the manufacturing industry and why it needs to make India a
developed country.
• Try to conclude, answer by writing about the manufacturing sector and the $5trillion
dollar economy.
Answer:
The normal course of economic progress and development path takes from agriculture to
services via industrialisation or manufacturing or secondary sector. But India took a leap from the
agricultural sector to the Services sector without the presence of the manufacturing sector.
Gross Value Added (GVA) at current prices for the services sector accounts for 53.89% of India’s
GVA. The Industry sector contributes 25.92% to GVA. Agriculture and allied sectors’ share is
20.19%. The services sector accounted for 18.1 per cent of the total employment during 1965-66,
going up to 23.5 per cent in 1999-2000.
There was a certain reason behind this direct shift, which can be understood in the following
manner:
• Globalisation and LPG policy: In 1991, India started opening its economy in terms to achieve
greater integration of the world economy and rapid economic development. These policies
created were mainly inclined towards the service sector.
• External demand and skilled manpower: Once India became part of the global market,
the fluent English-speaking skills and technological know-how fulfilled the demand for
the services outsourcing such as KPO and BPO. The cost-effective and efficient service
delivery made India a preferred destination for the service sector investments.
• License raj: The permit system and license raj were great impediments even after New
Economic Policy. This bureaucratic process hindered the growth of the manufacturing or
secondary sector. But, on the other hand, service sectors did not face any such issues, and
available resources made fertile ground for their growth.
• Income Elasticity of Demand for Services: A rising share of services in GDP is regarded
as an outcome of higher income elasticity of demand for services. Income elasticity of
demand for services increases with rising income which favours the fulfilment of more
sophisticated desires. During the development process, the distribution of GDP and
employment register sectoral shifts. Such shifts may occur on account of the hierarchy of
needs, distinguished into basic needs for food and shelter and needs for other material
and non-material goods including services.
• Services, Employment, and Productivity: While, agricultural and manufacturing activities
account for a major share of employment in developing countries, services activities account
for a major portion of employment in most developed countries. Lagging productivity

External Sector 203

 · Contact Admin ·

in the services sector is considered the main reason behind the rising share of service
employment in total employment even though the share of services in real GDP remains
constant, i.e. Baumol’s cost disease.
Can India become a developed country without a strong industrial base?
• Many economists view industrialisation as the only route to rapid economic development
for developing countries. Its potential lies in mass employment generation-ability as well as
the ability to strengthen domestic consumption.
• However, the fourth Industrial Revolution and digital technological changes have changed
the growth drivers in developing and developed countries. Technology-enabled services
have lowered transaction costs and overcome problems of asymmetric information making
this sector more dynamic than in the past. The emergence of e-commerce platforms is an
example of how the digital revolution can lower transaction costs, increase productivity as
well as make it more inclusive.
• For many internet-based businesses or services, fixed up-front costs can be high initially, but
once the physical infrastructure is in place, each additional customer, user, or transaction
incurs very little extra cost.
• On the other hand, still, it is imperative to grow the manufacturing sector not just to provide
employment to the largest working population (to absorb the labour force from agriculture),
but also to boost self-reliance and reduce total dependence on imports.
• Apart from this, a solid and higher industrial base is much required for the growth of the
agriculture and services sectors, and all the three sectors are dependent on each other therefore
the growth of the manufacturing sector is imperative for the growth of the other sectors.
• Industry experts are also important to increasing forex reserve industries and integration
into the global supply chain.
Therefore, there is still a rationale for making India an Industrialised nation. In fact, it shall
provide a much-needed base for the sustained growth of India in the coming decades. Mere
reliance on the service sector as a driver of growth is neither pragmatic nor sustainable. To
make India a $ 5 trillion dollar economy, it is imperative to have a robust Industrial sector.

Convertibility ■ Example: FDI, loans, borrowing,

• It is a situation in which domestic currency etc.
can be converted into a foreign currency Impact of Convertibility/Current Account
and vice versa at the prevailing exchange Convertibility
rate without government intervention. Positive impact:
• There are two types of convertibility: • It promotes foreign investment as it enables
o Current account convertibility: foreign investors to withdraw FOREX at will.
■ The freedom to convert domestic • It promotes inward remittances and non-
currency into a foreign currency residential deposits.
with respect to the current account • It supplements domestic capital formation
transaction of BoP. which increases output and employment in
■ Example: Import/export of goods the economy.
and services, remittances, etc. • It enables domestic investors and
o Capital Account Convertibility companies to invest abroad.
■ The freedom to convert domestic • It enables domestic firms to borrow from
financial assets/liabilities and vice- abroad at a relatively lower rate of interest.
versa.

204 External Sector

 · Contact Admin ·

• It reduces the scope of illegal trade and • It will instil greater confidence in the Indian
financial transactions like smuggling, economy among foreign investors.
hawala, etc. • Capital gains accruing from the conversion
Negative impact: of rupees into other currencies are tax-free.
• Flight of capital, i.e., withdrawal of huge • If the rupee gains in value by the time the
FOREX within a short period of time (South bond matures. It is advantageous to the
Asian crisis 1997). investor.
• It increases the vulnerability of the domestic The benefits for the borrowers are:
economy to external shocks. • The borrower gains since there is no
• It increases volatility in domestic financial currency risk. Borrowers are protected
markets. against currency volatility.
• It increases the scope of speculation in • Borrowers did not have to be concerned
domestic currencies and securities. about currency depreciation because the
bonds were issued in Indian rupees.
Introduction of Convertibility in India
• It aids the Indian organisation that issues
• The budget 1992-93 replaced the fixed
these bonds in diversifying its portfolio.
exchange rate system with the Liberalised
• It helps borrowers save money because it is
Exchange Rate Management System
issued outside of India at a rate of less than 7%.
(LERMS) i.e., a dual exchange rate system.
• It enables borrowers to reach out to a huge
• The budget 1993-94 replaced the LERMS
number of international investors.
with the managed exchanged floating rate
Committee on Capital Account Convertibility
system. It also introduced the convertibility
Tarapore Committee (1997)
of the Rupee for trade account transactions.
• In 1997, the Reserve Bank of India
• In August 1994, the government established the Committee on Capital
introduced current account convertibility Account Convertibility (CAC) or Tarapore
[it is mandatory as per Article 8 of IMF Committee to provide a roadmap for full
(International Monetary Fund), in case the rupee capital account convertibility.
BoP (Balance of Payment) situation of the • The key highlights of the report, including
member country is stable]. the preconditions to be achieved for the
• Since, 1994 government and RBI have full floating of money are as follows:
been gradually liberalising capital account o Gross Fiscal Deficit to GDP ratio to be
convertibility (CAC) norms, i.e.: reduced from a budgeted 4.5% in 1997-
o The External Commercial Borrowing 98 to 3.5% in 1999-2000.
(ECB) ceiling has gradually been raised. o For the three-year period between 1997
o NRI deposit has been made fully and 2000, the inflation rate should
convertible. maintain between 3-5 per cent.
o Outward remittance ceilings are o External sector policies should be
gradually being raised. designed in such a way that current
Masala Bonds receipts to GDP ratios are raised, and
debt servicing ratios are reduced from
Masala Bonds are bonds issued in other
25% to 20%.
countries in Indian rupees, rather than the
o A consolidated sinking fund should be
local currency. It was introduced in India by the
constituted to meet the debt repayment
International Finance Corporation (IFC) in 2014
needs of the government. The fund
for funding infrastructure projects.
should be financed by increasing RBI’s
Benefits of Masala Bonds
profit transfer to the government and
The benefits for the investors are: disinvestment proceeds of the public
• It has a high rate of interest. sector undertakings.

External Sector 205

 · Contact Admin ·

o To assess the adequacy of foreign o Improvement of the financial system in

exchange reserves in the event of an the context of global competition
emergency, four indications should be Foreign Investment
considered. In addition, the RBI Act • The foreign investment includes capital
should establish a minimum net foreign flows from one country to another country.
asset to currency ratio of 40%.
• With globalisation, more and more
Second Tarapore Committee on Capital
companies have branches in countries
Account Convertibility (2006)
around the world because of the attractive
• Reserve Bank of India set up the second
opportunities of cheaper production due to
Tarapore committee to set out the
the availability of labour at lower costs and
framework for Fuller Capital Account
lower or fewer taxes.
Convertibility in relation to the progress
made in economic reforms, the stability in • Foreign investment in a country is a good
the external and country’s financial sectors, sign that often leads to an increase in jobs
accelerated growth and integration with and income.
the global economy. • As more foreign investment comes into a
• The following are some of the committee’s country, it can lead to greater investments
key recommendations: because individuals/companies see the
o The committee proposed three stages country as economically stable.
for implementing full rupee convertibility • Foreign investments can be divided into:
in capital accounts. o Foreign Direct Investment (FDI)
o First Phase in 2006-07 o Foreign Portfolio Investment (FPI)
o The second phase in 2007-09
Foreign Direct Investment (FDI)
o Third Phase by 2011.
o External Commercial Borrowings (ECB) • A Foreign Direct Investment (FDI) is a financial
should have a higher upper ceiling for investment made by a person or a company
automatic approval. from one country into a company in another.
o NRIs should be allowed to participate in • A foreign investor establishes/acquires a
capital markets. business entity in the host country, as well
o NRI deposits should be tax-favoured. as management rights, through FDI.
o Existing P-notes holders should be • Definition of FDI by the IMF (International
provided with a way out before the Monetary Fund): “An investment through
P-notes are totally phased out. which an investor acquires lasting and
o Acts governing banking regulation are substantial management control (at least
being improved. 10% equity or voting rights) in the foreign
o On the current account, the rupee affiliates”.
is fully convertible, but only partially • FDI is usually made in open economies
convertible on the capital account. which offer skilled labour and growth
• Tarapore Committee has given the following potential for the investors, as opposed to
benefits of capital account convertibility to strictly regulated economies.
India:
Gaps Between MoUs and FDI
o Availability of large funds to supplement
• It is the difference between the investment
domestic resources and thereby
committed by the foreign investors and the
promote economic growth.
actual foreign investment made. This may
o Improved access to international
be due to the following reasons:
financial credit markets and a reduction
o Unfavourable investment climate
in the cost of capital.
characterised by excessive paperwork
o The incentive for Indians to acquire and
and red tape.
hold international securities and assets

206 External Sector

 · Contact Admin ·

o Inadequate infrastructure and a scarcity Advantage of FDI

of skilled labour.
• FDI helps the host country’s economy
o Labour and contract enforcement thrive by supplementing domestic capital
legislation are out of date. formation, which creates jobs and supports
o In the official machinery, there is economic growth.
corruption and kickbacks.
• They bring modern technologies, managerial
o The fiscal deficit is high. and entrepreneurial skills, marketing
o There is no proper market exit strategies, etc., along with foreign capital
mechanism. to the host country.
Measures to Reduce the Gap between MoUs • They promote competition by suppressing
and FDI domestic monopolies.
• Developing viable projects.
• They provide a wide variety of quality
• Single window clearances should be products to people at competitive prices. It
started. increases the standard of living of people.
• Government spending on physical
• They promote industrial diversification in
infrastructure, the industrial corridor, and
host countries.
ports should be increased.
• They promote the development of
• Reduced corporate taxes and rational tax
infrastructure by directly investing in
laws.
infrastructure projects as well as by creating
• Having a firm grip on finances and cash
demand for such services.
flow.
• They provide significant tax revenue to the
• Reducing the number of negative FDI
host government.
investments.
• They promote the globalisation of the host
• Faster dispute resolution and improved
economies.
contract enforcement mechanisms.
• They tend to reduce the factor price
Components of FDI
differential across nations, i.e., they tend to
• Foreign direct investment has the following
increase wage rates and decrease interest
component as mentioned by IMF:
rates in underdeveloped countries and
o Equity investment: Foreign direct
developing countries and vice-versa in
investor’s purchase of shares of an
developed countries.
enterprise.
Disadvantages of FDI
o Retained Earnings/Reinvested earnings:
Earnings are not distributed as dividends. • They adversely affect domestic companies
especially MSME (micro small and
o Intra Company Debt Transfer: Short/
medium). It may worsen unemployment
long-term borrowing and lending
in the host (developing) countries due to
between direct investors.
export substitution and reimports than
Methods of FDI
employment through additional exports to
• There are several ways for foreign direct host countries.
investment to get voting power in a company
• It can be the new wave of imperialism
in a given economy:
reflected by the use of power and economic
o By acquiring shares in an enterprise influence to dominate smaller countries.
o Mergers and acquisitions • They may intervene in the domestic
o Establishing a subsidiary of a domestic economic policy of the host government.
company in a foreign country • They aggravate income and regional
o Joint ventures with foreign corporations inequalities.

External Sector 207

 · Contact Admin ·

• They induce dualism (the sharp difference Exchange Management Act (FEMA)
between traditional and modern sectors) in 1999.
in the host (developing) countries. o Press Note 18 was abolished in 2005:
• They repatriate huge FOREX reserves ■ Under PN18, the foreign investor
in various forms like high dividends, who has joint ventures in India
interest, royalties etc. In the long run, they needed a No Objection Certificate
deteriorate the Current Account Deficit (NOC) from their Indian joint
(CAD) of host (developing) countries. venture partner for investing in any
• They promote excessive consumerism by business in India.
indulging in excessive advertisement and o FDI in Multibrand Retail 2012:
superficial product differences.
■ Allowing 100% FDI ownership in
• It leads to an escalation in the prices of single-brand retail trading and up to
assets which may lead to local resentment 51% FDI in multi-brand retail.
(Asset Price Bubble).
Recent FDI Reform
India’s FDI Policy
• International firms will be attracted to
• India’s FDI policy comes under the Ministry the coal sector by 100 per cent FDI via
of Industry and Commerce [Department the automatic route for coal mining
for Promotion of Industry and Internal and activities linked with processing
Trade (DPIIT)]. infrastructure, resulting in a more efficient
• The 1991, Balance of Payment (BoP) crisis and competitive coal market.
led to major reform in FDI policy. Some of • Contract manufacturing has been
them are as follows: authorised to accept 100 per cent FDI
o New Industrial Policy, 1991: through the automated approach, boosting
o Industrial licensing was abolished domestic manufacturing significantly.
except for a few important sectors. • The concept of 30% local sourcing has been
o Many sectors are open to foreign altered in single-brand retail trade (SBRT),
participation. and online sales are now authorised without
o Major bodies set up to promote the need to construct physical locations.
and facilitate FDI inflows, such as • According to the revised guidelines, Foreign
the Foreign Investment Promotion Direct Investment Cap is 100% in the
Board (FIPB). defence sector.
o Liberalisation of Exchange Rate o Up to 49% is allowed through automatic
System (LERMS): route and above 49% under government
route; wherever it is likely to result in
o With the initiation of economic
access to modern technology or for
reforms, India moved to a floating
other reasons to be recorded.
currency regime, which involved the
dual exchange rate system (one official • 100 % FDI is permitted for insurance
and the other market-determined). intermediaries.
India and FDI
o In March 1993, the unified exchange
rate system was introduced by • FDI equity inflows into India totalled US$
replacing the dual exchange rate 446.11 billion from March 2000 to September
system. 2019, according to the Department for
Promotion of Industry and Internal Trade
o Introduction of partial Capital
(DPIIT), indicating that the government’s
Account Convertibility (CAC).
efforts and initiatives to improve the ease
o Foreign Exchange Regulation Act
of doing business climate and relax FDI
(FERA) was replaced by the Foreign
norms are paying off.

208 External Sector

 · Contact Admin ·

• Data for Q2 2019-20 indicates that the • During, Q2 2019-20, India received
service sector attracted the highest the maximum FDI equity inflows from
FDI equity inflow, followed by the Singapore, followed by Mauritius,
telecommunications sector, and computer Netherlands, USA, and Japan.
software and hardware.
• An increase in net FDI inflow also gives
a more stable source of funding than
the Current Account Deficit, and in that
sense provides greater stability to the
improvement in BoP position as compared
to other capital inflows.
Note:
• India received a total foreign direct
investment of USD 60.3 billion from April
to December 2021, which is 10.6 per cent
lower compared to the USD 67.5 billion
of FDI received in the same period of
2020-21, according to the government’s
data.
Fig. 11.7: FDI Inflows in India

Previous Year Question (PYQ) (2013, Mains)

Q. Discuss the impact of FDI entry into the multi-trade retail sector on supply chain
management in commodity trade patterns of the economy. (100 Words, 5 Marks)
Decoding the question:
• In the introduction, try to write the definition of FDI.
• In the body,
⚪ Discuss the impact of FDI on supply-chain management in commodity trade patterns.
• Try to conclude the answer by highlighting the need for FDI in the multi-trade sector.
Answer:
A foreign direct investment (FDI) is an investment made by a firm or individual in one country
into business interests located in another country. Generally, FDI takes place when an investor
establishes foreign business operations or acquires foreign business assets in a foreign
company. Currently, 51% of FDI is allowed into the multi-trade retail sector.
Multi-brand retail trading is selling products of different brands under one roof. For example,
Big Bazar, Reliance, Shopper Stop, etc. These establishments sell products of different brands
at one establishment. With regards to multi-brand retail trading, the central government has
just framed an enabling policy specifying the maximum FDI which is allowed.
Impact on the multi-trade retail sector:
• Improved supply: Once, FDI is allowed in the multi-brand retail sector various suppliers
in different brands will synergise their supplies to various areas. This synergies supply will
improve the overall chain.
• Improve warehousing: Warehousing facilities may improve as huge investment will come
into this sector. This improves storage facilities and helps to augment various brands’ value
and improve their sales in the market.

External Sector 209

 · Contact Admin ·

• Employment generation: FDI in the multi-brand retail sector will increase employment
as many logistics-related jobs, delivery boys, and sales girls/boys demand will increase.
Hence, this will give full employment to youths.
• Technologies: Cold storage facilities may be improved and bring newer technologies to
the cold storage system. India currently needs investment and technologies concerning
cold storage both static and mobile cold systems.
• Opportunities for everyone: Opening up the multi-brand retail trade sector has brought
opportunities for small traders, producers, and tribal people to participate in huge markets
and sell products all over the country as well as exporting these products help them to
earn more.
Though, there is a lot of controversy regarding allowing FDI in the retail sector, these
controversies regarding policies need to be resolved and promote FDI in various other sectors
as well. India needs FDI to generate employment and a value chain.

Previous Year Question (PYQ) (2013, Mains)

Q: Though India allowed foreign direct investment (FDI) in what is called multi-brand retail
through a joint venture route in September 2012, the FDI even after a year, has not picked up.
Discuss the reasons. (100 Words, 5 Marks)
Decoding the question:
• In the introduction, try to write the definition of joint- venture.
• In the body,
⚪ Discuss why FDI has still not picked up in the multi-brand retail sector.
• Try to conclude the answer with suggestions.
Answer:
When 2 or more parties come together in an arrangement for business purposes so as to pool
their resources and complete a particular task, then it’s called A joint venture (JV). In this
venture, each of the participants is responsible for profit, losses, and costs associated with it.
In 2012 the Government allowed 51% FDI in the multi-brand retail sector but it has not picked
up since then. Reasons include-
• Euro crisis: The Euro crisis, a current account deficit of over 4%, double-digit inflation,
corruption in governance and a failing political system. It would not be wrong to say that
the above factors are the reasons behind the unhappy growth story of India.
• Unclear Policy Framework: It has been said that unclear policies or an environment of
confusion lead to unattractive offers to foreign investors to invest In India in the multi-
brand trade sector.
• Politicisation: Many political parties are claiming that if FDI is allowed in the multi-brand
retail sector, it will lead to the economic colonisation of India. (Currently, FD in this sector
is allowed to 100%, with 51% MSME content compulsory).
• Bureaucratisation: Getting approval from various government departments, including
state-level approval, is another problem in not picking up FDI in this sector.

210 External Sector

 · Contact Admin ·

Hence, to promote FDI in the multi-brand sector, first, we need to improve ease of doing and
its various sub-categories. This may lead to increased job creation, and consumer asking can
become true if this FDI takes place and achieves its intended objectives.

Previous Year Question (PYQ) (2014, Mains)

Q. Foreign Direct Investment (FDI) in the defence sector is now set to be liberalised: What
influence is this expected to have on Indian defence and economy in the short and long run?
(200 Words, 12.5 Marks)
Decoding the question:
• In the introduction, try to write about India’s FDI in the defence sector (recent policy
changes)
• In the body,
o The first part of the answer discusses the short and long-term impact of the new FDI
policy on the Indian defence sector.
• Try to conclude the answer as per the context of the question.
Answer:
In the recent policy change of the Government of India, the Ministry of Finance has allowed
or increased the FDI limit from 49% to 74% with automatic approval. This new policy shift is
in accordance with the Make in India policy. The Indian defence industry has been very vibrant
and can be very competitive if it gets some critical technologies. For making India a defence
manufacturing hub and making India “ATMA NIRBHAR BHARAT” or “SELF RELIANT INDIA” in defence
equipment.
Short-term impact:
• Revive economy: The Indian economy is facing a slowdown and fresh investment
opportunities will generate employment and revive India’s economic growth by increasing
production in Micro, Small and Medium Industries (MSMEs)
• Fulfil immediate requirement: As tension with China has increased, the immediate need for
some of the equipment can be fulfilled by foreign defence corporations. Most corporations
are keen to invest in the Indian defence industry.
• Positive sentiments: With an increased limit of FDI will give positive signs in the pandemic
affected world economy and enhance the confidence of investors to invest in various
segments of the defence sector. It will attract newer domestic investors.
• Increases jobs: Slowing economy and jobless growth need economic growth with jobs.
The defence industry has immense potential to generate a number of direct and indirect
jobs.
• Reduced import: It will have both short term and long-term impacts as increased
investment will increase indigenous production and in long term, it will reduce India’s
import dependency and forex reserves as well.
• Boost Morale of Armed Forces: Indigenous manufacturing will boost armed forces as
modernisation of Indian armed forces may be done in a timely and faster manner, with
indigenous systems.

External Sector 211

 · Contact Admin ·

• Start-ups: Easing FDI norms will also lead to a thrust to set up newer start-ups in defence
manufacturing. This will also help in making the most innovative defence products for the
Indian armed forces and for exports.
Long-Term impacts:
• Create Defence Ecosystem: Increased FDI limit will make foreign investors build a proper
defence ecosystem In India. If a proper ecosystem is developed in the defence ecosystem
it will help in building the state of the technologies.
• Increasing defence export: In the long term, India will become a well-established defence
manufacturer, which will help in increasing defence export. India has set a target of export
of rupees 35 thousand Crore or $5 billion dollars by 2025.
• Strategy in Indian Ocean region: Exporting defence equipment to friendly countries,
especially south-east Asian countries. The Government of India has been in talks about the
export of the BRAHMOS missile system to the Philippines, and recently Malaysia showed
interest in Tejas LCA.
• Making India ATMA NIRBHAR: Government has announced last year a policy of making India
ATMA NIRBHAR in the defence sector. The Ministry of Defense has declared a list of import
bans on some of the defence products.
• Future programmes: India is still lacking in critical technology like jet engine technology.
After spending thousands of crore rupees, India’s Kaveri Jet engine programme is still
not fully developed. One’s foreign companies start coming to India. The Kaveri engine
programme will get much-needed thrust.
• Strengthen the Indian rupee: Every year huge amount of dollars is spent on defence items
imports but an increased FDI limit will help in saving foreign currencies and help keep
the rupee value stable.
• Competitive atmosphere: By bringing new private players into the Indian defence industry
will create a competitive environment which will further improve quality, research, and
development and cheap but most advanced products can be produced within India.
Thus, recent initiatives in India’s defence sector will give expected results in upcoming
times. The Indian government has been looking forward to increasing exports and building
a sustainable and matured defence sector and the related ecosystem. The constant policy
support and political support will make India self-reliant in defence industries.

Previous Year Question (PYQ) (2016, Mains)

Q. Justify the need for FDI for the development of the Indian economy. Why there is a gap
between MOUs signed and actual FDIs? Suggest remedial steps to be taken for increasing
actual FDIs in India. (200 Words, 12.5 Marks)
Decoding the question:
• In the introduction, try to start your answer by defining FDI.
• In the body,
o Discuss the need for FDI in the first part of the answer in brief.
o In the second part of the answer, you need to discuss the reasons behind the gap
between MOU signed and the actual FDI.

212 External Sector

 · Contact Admin ·

o Suggest measures for the realising of MOU signed FDI.

• Try to conclude as per the context of the question.
Answer:
A foreign direct investment (FDI) is an investment made by a firm or individual of one country
into business interests located in another country. Generally, FDI takes place when an
investor establishes foreign business operations or acquires foreign business assets in a
foreign country. FDIs are distinguished from portfolio investments in which an investor merely
purchases equities of foreign-based companies.
Need for FDI for India’s development:
• Economic growth: The growth of FDI is needed to boost economic growth. Higher FDI will
release pressure from domestic savings constraints, and also it will help to overcome foreign
exchange barriers, thereby, providing risk-sharing capital infusion.
• Industries and employment: Higher inflow of FDI will help to improve higher economic
activities of industries. Higher investment in the manufacturing sector will result in greater
employment generation.
The reason behind the gap between MOU signed and actual FDI’s:
• Ease of Doing Business: Infrastructural and regulatory bottlenecks such as, dealing with
construction permits, registering properties, availability of electricity, paying taxes, trading
across borders, corruption, strict labour laws etc. delay project implementation, and sometimes
rolling back investment decisions. For example, POSCO signed a preliminary agreement of
investment of more than $5 billion dollars but on the issue of securing mining rights and
regulatory clearance/litigations, it decided to pull out.
• Land acquisition: Land acquisition is the biggest hurdle in achieving the desired level of
FDI inflow. As major infrastructure projects and industrial clusters need concessional land,
delay in land acquisition leads to increased cost of projects.
• Red tapism: Increasing corruption and maladministration in granting all the required
permissions for investments have been not addressed. This restrictive behaviour resulted in
the realisation of the signed MOU and the actual inflow of FDI.
• Vested interests: Several reports by GoI have pointed toward the role of some NGOs
obstructing the course of projects by playing with popular sentiments. Such tactics not only
delay implementation but also create a negative image of India as a business destination to
attract FDI.
Suggestions for increasing actual FDIs in India:
• Need to pursue economic reforms and business-friendly legal frameworks such as insolvency
and bankruptcy code, and easy exit norms.
• Land acquisition related infrastructure needs, such as special economic zones etc, should
be given priority.
• Strong political will at the level of state governments is needed to allay apprehensions in
the mind of the local population and tide over negative sentiments fostered in the local
community by some vested interest. Government must engage people proactively to stop
the spread of misinformation.
FDI is the need of the hour for further development of the Indian economy. By making it more
competitive, it also holds the key to making India part of the global supply chain. GoI along with
respective state governments must engage the global community to attract more and more FDI
and prioritise their implementation.

External Sector 213

 · Contact Admin ·

Foreign Portfolio Investment (FPI) o FII (Foreign Institutional Investor)

• Non-residents can invest in Indian financial o Sub Accounts
assets like shares, government bonds, o Qualified Foreign Investors (QFI)
corporate bonds, convertible securities, • Foreign Portfolio Investment (FPI) is more
infrastructure securities, and so on through liquid than foreign direct investment
Foreign Portfolio Investment (FPI). because FPIs can be sold off quickly and
• Foreign Portfolio Investors are a type of FPIs are seen as short-term attempts
investor who makes investments in these to make money, rather than a long-term
securities. investment in the economy.
• Foreign Portfolio Investor (FPI) was created • Portfolio Investment by any single investor
based on the recommendation of the K. M. or investor group cannot exceed 10% of the
Chandrasekhar Committee by merging the equity of an Indian company, beyond which
existing three investor classes: it will now be treated as FDI.

Fig. 11.8: FPI Net Investment Yearwise

• An increase in net FPI inflows improves

the BoP position and arises on account
of cross-border transactions involving
debt or equity securities, other than those
included in direct investment or reserve
assets.
• Portfolio investment is generally referred to as
“hot money” because of its tendency to flee
at the first signs of trouble in the economy
or improvement in investment attractiveness
elsewhere in the world.
Fig. 11.9: FDI & FPI Inflow

214 External Sector

 · Contact Admin ·

Committee on Rationalisation of Roots of HR Khan Committee on Foreign Portfolio

Portfolio Investment Investment
• To rationalise/harmonise, and thereby, • In 2014, SEBI established the H R Khan
ease the entry routes for various foreign Committee to investigate FPI guidelines
portfolio investors into India, SEBI set up a and investor concerns.
committee in 2014 under the Chairmanship • The committee’s key recommendations are
of K.M. Chandrasekhar. as follows:
• The major recommendations of the o NRIs, Indians living abroad, and resident
committee are as follows: Indians should be allowed to own
o A new investor type, “Foreign Portfolio non-controlling holdings in FPIs and
Investor” (“FPI”), by replacing FIIs and should not be restricted from managing
QFIs. Existing FIIs, their sub-accounts non-investing FPIs or SEBI-registered
and QFIs are to be merged into FPIs. offshore funds.
o Portfolio investments are defined as o According to the panel, NRIs will be
investments made by a single investor or allowed to invest as FPIs if their single
a group of investors that do not exceed holding is less than 25%, and their group
10% of an Indian company’s or firm’s holding is less than 50% in a fund.
equity. FDI is defined as an investment o In the case of government-related FPIs,
that exceeds a 10% threshold. SEBI should eliminate the additional
o FPIs will be allowed to invest up to 24 Know Your Customer (KYC) requirements
per cent of their total assets (being the for the beneficial owner.
present default aggregate limit for FIIs, o The panel also suggested that the new
which can be increased by the company restrictions be implemented equally for
up to the sectoral cap). investors who use participatory notes
• Know Your Client (“KYC”) checks are based (P-notes).
on the risk categorisation of FPI. o The committee proposed that former
o Low Risk (Category I): Government and PIOs (Persons of Indian Origin) be
Government-related entities. exempt from any restrictions and that
o Medium Risk (Category II): Regulated well-regulated and publicly owned FPIs
entities such as banks, asset with common control be allowed to
management companies, broad-based pool their investment limits.
funds such as Mutual Funds etc. o After the new regulations are
o High Risk (Category III): All other FPIs implemented, the time for compliance
that do not meet the criteria for the first should be extended by six months, and
two categories are placed in Category III non-compliant investors should be
(High Risk). granted an additional 180 days to wind
■ FPIs under the Category III are not down their existing positions.
allowed to issue Offshore Derivative o Changes to the rules for identifying
Instruments (“ODI”)/Participatory senior managing officials of FPIs and
Notes (“PN”). beneficial owners of publicly traded
firms were also proposed by the panel.

External Sector 215

 · Contact Admin ·

Difference Between FDI vs FPI

Basis for Comparison Foreign Direct Investment (FDI) Foreign Portfolio Investment (FPI)
Definition FDI is the investment made FPI refers to investing in a foreign
by foreign investors to gain a country’s financial assets, such as
substantial interest in a company bonds and stocks.
located in a different country.
Role of Investors Active Passive
Type Direct Investment Indirect Investment
Investment Invests in financial & non-financial Invests only in financial assets.
assets.
Term Long-term investment Short-term investment
Volatility Stable Highly volatile
Table 11.1: Difference Between FDI and FPI

Foreign Trade • It is always termed as an inward-oriented

• Foreign trade includes all imports and trade policy.
exports to and from India. • Trade barrier: Government policy to restrict
trade. It includes:
• At the level of the Central Government, it is
o Tariff barriers:
administered by the Ministry of Commerce
■ It is a custom, duty or a tax imposed
and Industry.
on products that move across
• The inflow of goods is called import trade
borders.
whereas the outflow of goods is called ■ It includes import duty, export duty,
export trade.
etc.
• One of the most important macroeconomic o Non-Tariffs barriers:
indicators is the trade balance, which is the ■ These are non-tariff restrictions
difference between the monetary value of such as government regulations
exports and imports in the economy. and policies with respect to overall
Foreign Trade Policy trade.
Free Trade Policy ■ It includes quotas, subsidies, sanitary
• It is a trade policy with the least restriction and Phytosanitary requirements, etc.
on trade, i.e., trade takes place without ■ A number of times Alphonso
barriers such as quotas, tariffs, and foreign mangoes from Maharashtra are
exchange controls. rejected by European countries on
• Thus, under free trade, goods and services grounds of not meeting the sanitary
flow freely between countries. and phytosanitary requirements.
• Free trade implies an absence of Export Promotion Schemes
governmental intervention in international
• Duty Drawback Schemes:
trade among different countries of the
o Under this scheme, custom/excise duty
world.
paid by exporters of selected products
• It is also termed an outward-oriented trade
is partially or wholly reimbursed.
policy.
Protectionist Trade Policy • Export Promotion Capital Goods (EPCG):
• It is a trade policy with a restriction on o Under this scheme, exporters can import
trade through various trade barriers. capital goods at zero or concessional

216 External Sector

 · Contact Admin ·

custom duty subject to an export o The schemes which are replaced by the
obligation. MEIS scheme are:
• Focus Market Scheme: ■ Focus Product Scheme (FPS)
o Exporters are provided duty credit ■ Focus Market Scheme (FMS)
scripts equivalent to 3% of the Free ■ Market Linked Focus Product
on Board (FOB) value of exports if they Scheme (MLFPS)
are exporting to selected destinations/ ■ Agri. Infrastructure Incentive Scheme
countries. ■ Vishesh Krishi and Gram Udyog
• Focus Product Scheme: Yojna (VKGUY)
o Under this exporter of selected labour- o The system compensates the exporter
intensive products (e.g., handicrafts) are for his loss of duty payment by providing
provided duty credit scrip equivalent to incentives in the form of duty credit
2% of the FOB value of exports. scrip (which permits the bearer to
India’s Medium-Term Export Policy: Foreign receive something in return).
Trade Policy, FTP (2015-20) o For notified commodities sold in notified
• It was announced on 1st April 2015 by the markets, the incentive is provided as a
Ministry of Industry and Commerce. percentage of the realised FOB value (in
• It seeks to enhance the competitiveness free foreign exchange).
of export by adopting systemic reforms • Service Exports from India Scheme (SEIS):
rather than incentivising exports through o The government has also introduced
subsidies. the Service Exports from India Scheme
• It seeks to focus on higher-value addition (SEIS) under the Foreign Trade Policy
and technology in future with a focus on (FTP)- 2015-20. It replaced the earlier
quality and standard. scheme ‘Served from India Scheme’
• It seeks to rectify the inverted duty under Foreign Trade Policy, 2009-15.
structure. It is a situation in which higher o The key objective is to make our services
custom duties are imposed on imports of globally competitive in terms of price.
input/raw material vis-a-vis on import of o These SEIS scrips are transferable
finished or final goods. and can also be used for payment of a
• It is drafted in consonance with other number of central taxes/duties including
initiatives of the government like Make in the basic customs duty.
India, Ease of Doing Business, Digital India, • Export Promotion Capital Goods (EPCG):
Skill India, etc. o Under this scheme, the export obligation
Objective has been reduced to 75%.
• To increase India’s share in world export • Trade facilitation:
to 2% to 3.5% by 2020. o Online filling of documente/application
• To double the export of goods and services in a 24*7 environment.
by 2020. o CA/CS can file digitally signed
Features documents.
• Merchandise Exports Incentive Scheme o Exporter/importers profiles will
(MEIS) be created to eliminate multiple
o The Merchandise Exports Incentive submissions of the document.
Scheme (MEIS) was created by the o The FTP is to be reviewed after two and
Indian government to replace five a half years instead of annual reviews.
existing incentive schemes from the Critical Appraisal of FTP Policy (2015-20):
Foreign Trade Policy 2009-14. • Subsidies have been reduced.

External Sector 217

 · Contact Admin ·

• Gave more flexibility to exporters and • According to the SEZ Act, India’s SEZs are
importers. divided into four categories based on their
• Aligned with Make in India. size:
Special Economic Zones (SEZ) o (1,000+ hectares) multi-sector.
• A Special Economic Zone is a part of a o Specific to the sector (100+ hectares).
country that has its own set of economic o (40+ hectares) Free Trade and
rules and regulations that differ from those Warehousing Zone (FTWZ).
in other parts of the country. o (10+ hectares): Technology, handicraft,
• High tariffs and taxes, as well as red tape and non-conventional energy, gems, and
tight labour rules, have traditionally been jewellery.
the major barriers to foreign investment • Currently, 378 SEZs have been notified,
in India. Foreign Direct Investment was with 265 of them operational according to
encouraged by the SEZ regulations (FDI). the data of the Ministry of Commerce &
• Infrastructure has been established Industry.
in these locations, as well as a liberal Exclusive Economic Zone (EEZ)
economic policy and favourable tax rates • The Exclusive Economic Zone is a particular
for businesses. territory that extends outside and adjacent
• In the year 2000, India implemented the to a country’s territorial sea, and it should
Special Economic Zones policy. Prior to be subject to the rights and authority of the
the implementation of SEZs, India relied coastal state.
on Export Processing Zzones (EPZs), which • The coastal state’s exclusive economic
failed to attract global capital. zone rights, authority, and responsibilities
• Instilling investor confidence and are as follows:
emphasising the government’s commitment o Coastal governments have legal
to a stable SEZ policy system. The Special authority over discovering and
Economic Zones Act of 2005 was passed by exploiting, protecting, and managing
the parliament in May 2005. natural resources, whether alive or non-
• The following are the main goals of the SEZ living, in the seabed or near the seabed,
Act of 2005: as well as the seabed’s boundary soil.
o Additional economic activities are o The coastal states should have the right
created. to the economic exploration of zones
o Exporting goods and services is such as to produce energy from water,
encouraged. winds and currents.
o Increasing investment from both • There will be many permissions under the
domestic and international sources. exclusive economic zone, such as:
o Employment opportunities are created. o They can establish and use artificial
o Infrastructure facilities are being islands under the area limit of EEZ.
developed. o They can do scientific research like
• SEZs can be established by: marine scientific research in the EEZ.
o They have the power to protect and
o The federal or state government, or its
preserve the marine environment.
agencies
• Any country’s exclusive economic zone
o The private/joint sector is a combination
cannot be extended beyond 200 nautical
of the public and private sectors.
miles. This distance should be measured
o A foreign agency.
from the baselines (and baseline means

218 External Sector

 · Contact Admin ·

from where the breadth of the territorial Importance of EEZ

sea is measured) and one nautical mile • In a country, the ocean is a major hub of
equal to 1.852km. economic activity as it serves as a source of food
• The exclusive economic zone of India is and good minerals such as salt, magnesium,
available under the Maritime Zones Act etc., and the ocean is a highway for commerce
of 1976 under section 7. In India, EEZ is because major of the international trade is
guarded by the Indian Coast Guard. The done through the ocean with the help of giant
EEZ does not permit a coastal state to ships. So, EEZ is a big source of revenue from
prohibit or limit freedom of navigation or trade to the government.
overflight.

Previous Year Question (PYQ) (2015, Mains)

Q. There is a clear acknowledgement that Special Economic Zones (SEZs) are a tool for
industrial development, manufacturing, and exports. Recognising this potential, the whole
instrumentality of SEZs requires augmentation. Discuss the issue plaguing the success of SEZs
with respect to taxation, governing laws, and administration. (200 Words, 12.5 Marks)
Decoding the Question:
• In the introduction, try to define SEZ.
• In the body,
o Discuss SEZ’s role in industrial development, manufacturing, and export.
o Discuss gaps which need to be filled in areas of taxation, governing laws, and
administration.
• Try to conclude with a way forward.
Answer:
To robust the economy there are some regions that are treated differently than the other
regions. These regions are having different sets of rules and regulations. These are called
Special economic zone (SEZ). SEZs are deliberately made attractive so as to attract potential
investors.
SEZ tool for Industrial Development, Manufacturing, and Export:
• Improved investment: SEZ has become an attractive investment destination for investors
from around the world. As fewer rules and regulations, quick approvals, less duty on
export etc. have benefits which resulted in an increased rate of industries. With increased
manufacturing and competitiveness, exports from SEZ have been increasing.
• Easy Availability of Resources: India already creates special economic zones where most
of the infrastructure facilities are available. These available resources and facilities made
industrialists invest in these economic enclaves. All these resources make manufacturing
and competitiveness of the overall industrial sector.
• Export competitiveness: Export competitiveness of the country will improve with improved
connectivity, giving opportunity for reduced cost of transportation of goods. SEZ provide
opportunities for other parts of the country to export their goods at cheaper rates and get
benefits from it.
This huge potential of SEZ can make it possible to achieve the target of Make in India, making
India a $5 trillion dollar economy. But its instrumentality needs complete overhauling to reap
potential benefits from it. Following gaps need to be plagued for the increasing development
of industries in India.

External Sector 219

 · Contact Admin ·

Issues plaguing SEZ in terms of Taxes, Governing Laws, and Administration:

• Unutilised land: More than 25,000 hectares of land are unutilized in SEZs. Lack of flexibility
to utilise land in SEZs for different sectors. The need is the optimal utilisation of vacant
land in SEZ. Allowing flexibility of land use and removing sector-specific constraints.
• Denotification of SEZ: The reasons given (by developers) for these requests for de-
notification include economic slowdown, poor market response, lack of demand for SEZ
space and change in the fiscal incentive regime for SEZs, etc
• Existence of Multiple Models: There are various models of economic zones such as NIMZ,
SEZ, CEZ, Delhi-Mumbai Industrial Corridor, food park and textile park.
• Under-utilisation of Existing Capacity: Currently, SEZ units are not allowed to do “job work”
for domestic tariff area (DTA) units.
o DTA is an area that is located outside the purview of SEZ and a custom bonded zone.
• Domestic Sales and Tax: Domestic sales of SEZs face a disadvantage as “they have to pay
full customs duty”, as compared to the lower rates with the Association of Southeast Asian
Nations (ASEAN) countries due to a free-trade agreement (FTA).
• Taxation: Imposition of Minimum Alternate Tax (MAT) on SEZs from 2012, as well as the
imposition of income tax on new SEZs and new units, has been stated as another major
challenge being faced by SEZs.
One of the well-known Industries bodies, The Confederation of Indian Industry (CII) expressed
some major issues regarding the Special economic zones —Industrial Parks and issues with
giving infrastructure status to SEZs, Issues regarding approval of external commercial borrowing
(ECB) for the SEZs, allow a refinancing option through ECB; relax the “risk weightage norms”
for the real estate sector.
China has tremendously utilised the potential of Special Economic zones. If India succeeds in
removing the obstacles it can also benefit from SEZs.

Coastal Economic Zone (CEZ) CEZs in India was constituted under the
• Coastal Economic Zones are those guidelines and collaboration of NITI Aayog.
economic regions, which include groups of • The Sagarmala Program, aims to lower
coastal districts, and the districts will have logistical costs and shorten the time it
a strong linkage to ports in the region to tap takes for international and domestic freight
like an organisation with planned industrial to move. The aim was to develop ports in a
corridor projects. way that they are used in an efficient way,
• These zones are developed to provide a and they can provide more space for cargo
business-friendly ecosystem, and it will and transport vehicles at a lower cost. So,
include ease of doing business, ease of in viewing this, the concepts of Coastal
exporting and importing, fast decisions for Economic Zones have been introduced.
environmental clearances and connections • In view of reducing logistics costs and
of electricity and water will be given in a reducing the time for movement of national
speedy manner. and international cargo, the government has
• Coastal Economic Zones are developed started 30 potential port-linked industrial
by the government under the Sagarmala clusters across three sectors, which are
Programme by the Ministry of Ports, Shipping energy, materials and discrete manufacturing.
and Waterways. An Inter-Ministerial There are nine bulk clusters for fundamental
Committee (IMC) for the development of input industries, such as power, refineries

220 External Sector

 · Contact Admin ·

and petrochemicals, and cement, as well as India leading to the adoption of the model
21 discrete manufacturing clusters in labour- BIT in 2016.
intensive industries such as electronics, • Now some examples of bilateral investment
apparel, leather products, furniture, and food treaties/ agreements in which treaty done
processing. A master plan for the maritime and terminated:
cluster in Gujarat and Tamil Nadu has already
SNo Country Date of Date of Date of
been established by the government. Agreement Enforcement Termination
Bilateral Investment Treaties (BIT) and Free 1 United 14 March 6 January 23 March
Trade Agreement (FTA) with Evaluation Kingdom 1994 1995 2017

Bilateral Investment Treaties (BIT) 2 Germany 10 13 July 1998 23 March

December 2017
• Bilateral Investment Treaties are those 1995
agreements which are done between two
3 Russian 23 5 August 11 April
countries to promote and protect their Federation December 1996 2017
investment. Investment in both countries 1994
can be done by companies or individuals of 4 Malaysia 3 August 12 April 1997 23 March
foreign nationals. 1995 2017

• In simple words, one can say it aims at 5 Italy 23 26 March 23 March

November 1998 2017
protecting the investment of investors in
1995
both countries.
Table 11.2: Bilateral Investment Treaties/ Agreements
• BIT encourages foreign nationals to invest
in states to overall develop the economy. India’s Experience with BITs
• India signed its first BIT with the UK in 1994
• The aim of BIT is as follows:
and subsequently with 83 countries. These
o It protects the investment of investors
BITs were negotiated based on the India BIT
who are investing in foreign countries
Model of 1993.
where already their rights are not
• These BITs have been one of the major
protected due to the prevailing rules
drivers of FDI inflows into India between
and regulations of trade, treaties, etc.
2001-2012.
o It also encourages the adoption of • Under the 1999 Indo-Australia BIT, an
market-oriented policies of domestic international tribunal ordered India to pay
nature, which will give benefit private 4.10 million Australian dollars to white
investment in an open and freeway and businesses in 2011.
non-discriminatory way. • Since then, India has signed BIT with 4 new
Important Features of BIT countries and terminated its older BIT with
• Investor-State Dispute Resolution. 77 countries.
• Repatriation of investment and trade. • After getting shocked by the award and
notices, India revised its BIT model in 2015.
• Most Favourable Nation Treatment.
• Simultaneously, India began getting many
• National treatment.
notices under its BITs as a result of the
• Full Protection and Security. Supreme Court’s rejection of the 2G licence
Reason for Termination of BITs and the retrospective taxation crisis.
• The BITs signed by India gave extensive FTA (Free Trade Agreement)
protection to foreign investment with scant • It is a fair set of rules for trade between the
regard for the state’s interest based on the agreeing countries. In FTAs, both countries
neoliberal model. will provide favourable treatment to each
• The Investment State Dispute Resolution other by reducing trade barriers. In FTA
Cases (ISDS) cases against India led to a countries will cut down on duties levied on
fundamental rethink and review of BITs in goods and services they are importing.

External Sector 221

 · Contact Admin ·

• There are different types of the trade like free trade. It was established by a foreign
bilateral and multilateral trade agreements. government as an alternative for countries
A bilateral trade agreement means when that do not want to join the European Union
two countries are ready to lose some trade (EC). The Stockholm Convention established
barriers and decrease duty on trade and a the European Free Trade Association (EFTA)
multilateral trade agreement means when on 3 May 1960, with Austria, Denmark, the
more than two countries are ready to lose United Kingdom, Norway, Portugal, Sweden,
trade barriers or decrease duty on imports and Switzerland as founding members.
between them. o EFTA membership is now confined
Benefits of FTA to four nations: Switzerland, Norway,
• It will create jobs and increase trade in Iceland, and Liechtenstein. These four
member countries. countries are not members of the
• It will help to gain economic growth in European Union (EU). In May 2005,
member countries. during the President of India’s visit to
• It will also improve the international Iceland, Iceland recommended to the
relations between the member countries. President that they negotiate a Free
Some of the Free Trade Agreements signed by Trade Agreement (FTA) with India.
India o Following that, in January 2006, during
• India-Gulf Cooperation Council (GCC) Free his meeting with India’s Commerce and
Trade Agreement (FTA) and negotiations: Industry Minister (CIM) in New Delhi, the
India signed an agreement on Economic Swiss Federal Councillor, who is also
Cooperation with the Gulf Cooperation the Head of the Federal Department
Council on 25th August 2004. The structure of Economic Affairs, proposed to
of the inked agreement states that both India a possible Preferential Trading
parties will study measures to expand and Arrangement (PTA) between India and
liberalise trade relations between the two EFTA. This request was made once more
nations, as well as begin discussions on the in October of 2006.
viability of a free trade agreement between Reverse Special Economic Zones (R-SEZ)
them to boost commerce. As a result,
• Reverse SEZ is an import-oriented area,
negotiations with the GCC began.
located outside the country’s border in
o So far, two rounds of negotiations have
order to get cheap, import duty-free/
taken place between the two countries,
exempt raw materials.
in 2006 and 2008. Because the Gulf
• Under this, Indian chemical and
Cooperation Council has deferred its
petrochemical companies will set up plants
discussions with all countries and
in other countries which have abundant
economic organisations throughout
and cheap feedstock for importing back
the world and is currently revising its
their output.
negotiating procedures with all countries
and economic groups, the third round • The Ministry of Chemical and Fertilisers is
has not taken place. The government is exploring options to set up R-SEZ in Iran,
working on resuming the negotiations and Myanmar.
as soon as possible on various bilateral • The 1st R-SEZ is proposed to be established
and multilateral platforms. in the Chabahar Port area of Iran.
India-EFTA: Broad-based Trade and Investment • Objective: To ensure the supply of cheap
Agreement (BTIA) industrialchemicalsforthe domestic chemical,
• The European Free Trade Association (EFTA) is petrochemical, and fertiliser industry in order
a non-profit intergovernmental organisation to enhance its competitiveness and increase
dedicated to promoting and expanding its export potential.

222 External Sector

 · Contact Admin ·

International Financial Service Centre (IFSC) regardless of whether they are residents
• International or Offshore Financial Centres or non-residents, as determined by the
(IFCs) are financial centres that serve regulatory authority.
clients from countries other than their own o Further, then specified limitations, no
(OFCs). other regulations apply to a unit located
• All of these centres are ‘international’ in the in the IFSC.
sense that they deal with the cross-border • Under the provisions of the SEZ Act, financial
flow of money and financial products and
regulators such as the Reserve Bank of India
services.
(RBI), the Securities and Exchange Board of
• An IFSC is thus a jurisdiction that delivers
India (SEBI), the Department of Financial
world-class financial services to non-
Services, and the Insurance Regulatory and
residents as well as residents in a currency
Development Authority of India (IRDAI) issued
other than the domestic currency of the
place where the IFSC is located, to the the following regulations and guidelines to
extent possible under current rules and operationalise IFSC-GIFT in India.
regulations. Cluster-Based Export Area
• The objective of IFSC are: • Clusters can be defined as a sectoral and
o To increase tax revenue. geographical concentration of businesses,
o To create a high-value job. particularly Small and Medium Businesses
o To create an avenue for financial (SMBs), who face similar opportunities and
globalisation. risks, such as the following:
GIFT City o External economies are created as a
• Under the terms of the SEZ Act 2005 result of these factors, such as special
(SEZ Act), SEZ Rules 2006, the Gujarat suppliers of raw materials, components,
International Finance Tec-City (GIFT City) and mechanical equipment, as well as
multi-services special economic zone sector-specific expertise.
(SEZ) has built the first International
▪ It will encourage the country to
Financial Service Centre in India (IFSC) in
focus on specialised technical,
Gandhinagar, Gujarat.
administrative, and financial
• The IFSC in GIFT City (IFSC-GIFT) will
services.
be established as a worldwide financial
and information technology services ▪ It will pave the way for inter-firm
hub, comparable to London, Hong Kong, collaboration and specialisation,
Singapore, and Dubai. as well as collaboration between
• An IFSC aims to introduce to India the types public and private local institutions
of financial services and transactions that to encourage local production,
are now provided outside of India by foreign new innovation techniques, and
financial institutions and their overseas collective learning.
branches/subsidiaries. Some Facts about Cluster Areas:
• For all practical reasons, the IFSC has been • According to government statistics, India has
defined as a ‘deemed foreign country,’ which
roughly 400 contemporary small businesses
has the same ecology as other offshore
and about 2000 rural and artisanal clusters.
locales but is physically on Indian land.
These are expected to account for up to
• The IFSC is home to any financial institution
60% of India’s manufacturing exports.
(or its branch).
In India, it is predicted that SSE clusters
o It is expected to do business in such
generate a significant amount of jobs
foreign currencies and with such entities,

External Sector 223

 · Contact Admin ·

Cluster-Based Export Area with Agriculture: vegetables including vegetables like potato,
• The first policy for this was announced and cashew, medical herbs got from plants
by the government in December 2018. A in value-added form and will include herbal
number of clusters have been established medicines, food-based nutrients products,
across the country for the development spices like cumin, turmeric, pepper, organic
of exports in order to meet the policy’s food have been identified as potential
objectives. winning sectors. Most of the products/
o Grapes, mango, pomegranate, banana, clusters are already aligned with this
oranges, and onions are among the objective of the policy.
products that have been identified in • Special emphasis has been given by the
Maharashtra’s six clusters. FPOs and co- government on processing and value
operatives should be linked with farmers addition in the policy through workshops for
and exporters to ensure a successful efficient synergy amongst all stakeholders
implementation of the strategy. who are relevant to policy, and they are
o The government must provide the expected to provide the necessary boost in
necessary infrastructure for these achieving the objective of higher exports of
clusters, and the agriculture industry India’s high-quality agricultural products.
must employ cutting-edge technology. Globalisation
Many countries in the Middle East • It refers to the integration of an economy
region are ready to invest and they want with the world economy. It is achieved
to invest in cold chain and warehousing by removing the restriction on the flows
facilities in India for the import of agro of goods and services, foreign capital,
and processed food products by them. technology transfer and movement of a
• The role of the state government is a very natural person across the nations.
important role in the implementation of the • It is a multidimensional concept, i.e., it
agriculture export policy. The main aim of includes the integration of nations in terms
the policy is to reach farmers at the grass- of social, cultural and political, etc.
root level, and the government wants to
Advantages of Globalisation
double their income for achieving the
• It allows for resource distribution based on
overall objective of the policy.
various countries’ comparative advantages.
• In India, agriculture and horticulture produce
Each country specialises in the production
over 600 million tonnes per year, and about
of these commodities in which they are
30% of fresh horticultural output is wasted,
most efficient. It increases productivity and
thus there is a pressing need to tighten the
production at the global level.
supply chain to prevent these losses. India’s
Agri production should not be stopped • It enables economic entities to specialise
within our country’s boundaries, and it and achieve economies of scale (benefit of
should reach out to international markets. large-scale production).
• One will have to see agriculture as an • Globalisation provides corporations
industry and all the stakeholders must work with worldwide access to low-cost raw
together to bring success to the agriculture materials, labour, and technology, allowing
industry. Industrialists can also invest in them to compete in both domestic and
agriculture, which will aid farmers while international markets.
also increasing industrialists’ earnings. • Globalisation has resulted in increasing
• As part of the policy, meat, basmati and non- inward investment flows across countries,
basmati rice, grapes, bananas, pomegranate, which has benefited recipient countries.

224 External Sector

 · Contact Admin ·

Disadvantages of Globalisation • Euro (€), Japanese Yen (¥) and pound

• Multinational corporations have grown sterling (£) are three of the best hard
currencies in the world today.
in power and influence as a result of
globalisation. Soft currency:
• The threat of employment loss in home • Soft currency is extremely volatile and
markets as a result of globalisation’s unfair, varies frequently. Such currencies are
free trade and structural changes. extremely sensitive to a country’s economic
• A typical critique of globalisation is the and political progress.
over-standardisation of items through • Because of its instability, it’s also known as
transnational branding chains. a “weak currency.”
• Globalisation has made the economies of • In any economy’s FOREX market, the soft
the world interdependent on each other. currency is readily available.
Failure of the economy of one country • In the Indian FOREX market, for example,
creates ripples in many countries. the rupee is a soft currency.
Other Important Terms and Their Meanings Hot currency:
J-Curve effect • The transfer of funds (or capital) from one
• It refers to a phenomenon wherein the trade country to another in order to make a quick
balance of a country worsens following profit is known as hot currency.
the depreciation of its currency before it • Hot currency is constantly shifting from
improves mainly because higher prices on countries with low-interest rates to those
imports will be greater than the reduced with higher interest rates.
volume of imports. • Such sudden withdrawal of foreign currency
• It has a short-run effect. from the market adversely impacts the
Free on Board (FOB) exchange rate and potentially impacts a
• Free on Board (FOB) takes into account country’s Balance of Payments
costs incurred on export/import till the • As international investors run behind
port of loading. profits, they substantially gain from higher
Cost Insurance Freight (CIF) interest rates in different markets.
• It takes into account costs incurred on Cheap currency:
export/import until the port of destination. • Cheap currency refers to money in which
Hard currency low-interest loans and advances are made
• Any globally traded currency that serves as available on simple terms.
a reliable and stable store of value is known • The money that comes into the economy
as hard currency or strong currency. when a government starts repurchasing its
• It’s a currency that everyone trusts because bonds before they mature (at full-maturity
they know it’ll keep its value and won’t be prices) is known as cheap currency.
subjected to frequent, large exchange rate Dear currency:
swings.
• Because of the high-interest rates, dear
• Hard currencies are widely accepted across money is difficult to come by.
the world since they are stable, convertible,
• Because it occurs when central banks
and enjoy the confidence of investors,
tighten monetary policy, it is commonly
traders, and tourists.
referred to as “tight money.”
• Essentially, an economy with big and diverse
• The money that flows from the people
exports that are mandatory imports for
to the government or the money in the
other countries would generate significant
economy, in general, is referred to as dear
demand for its currency around the world,
currency when a government issues bonds.
causing it to become a hard currency.

External Sector 225