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UPSC Prelims 2022 Paper-1 📅 05 Jun, 2022

Consider the following statements:
1. Tight monetary policy of US Federal Reserve could lead to capital flight.
2. Capital flight may increase the interest cost of firms with existing External Commercial Borrowings (ECBs).
3. Devaluation of domestic currency decreases the currency risk associated with ECBs.

Which of the statements given above are correct?

A
(a) 1 and 2 only
B
(b) 2 and 3 only
C
(c) 1 and 3 only
D
(d) 1, 2 and 3
Result Summary
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UPSC Prelims
2022 • 05 Jun, 2022 • Paper-1
Consider the following statements:
1. Tight monetary policy of US Federal Reserve could lead to capital flight.
2. Capital flight may increase the interest cost of firms with existing External Commercial Borrowings (ECBs).
3. Devaluation of domestic currency decreases the currency risk associated with ECBs.

Which of the statements given above are correct?
Correct Answer
(a) 1 and 2 only
Monetary Dynamics: Statement 1 is correct. A tight monetary policy by the US Federal Reserve involves aggressively raising interest rates. This attracts global ......
Ref/Book : UPSC Prelims 2022
Ref. Subject Economy
Chapter -
Ref. Topic Macroeconomics
Pg. No -
💡 Analysis & Explanation
Monetary Dynamics ▼
Statement 1 is correct. A tight monetary policy by the US Federal Reserve involves aggressively raising interest rates. This attracts global investors seeking safer, higher returns, triggering massive capital flight from emerging markets back to the US.
Corporate Debt Impact ▼
Statement 2 is correct. As capital flees, the domestic currency depreciates. For domestic firms relying on dollar-denominated External Commercial Borrowings (ECBs), the cost of servicing this debt skyrockets in rupee terms, drastically increasing their effective interest burden.
Currency Risk Assessment ▼
Statement 3 is fundamentally incorrect. The devaluation or depreciation of the domestic currency actively *increases*, not decreases, the currency risk for ECBs, since the borrower must generate far more domestic revenue to repay the exact same amount of foreign currency.
Conclusion ▼
Statements 1 and 2 represent accurate macroeconomic principles. (Note: This question was officially dropped by UPSC, but 'A' remains the factually correct choice).
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