If another global financial crisis happens in the near future, which of the following action/policies are most likely to give some immunity to India? 1. No

1. A. 1 only
2. B. 1 and 2 only
3. C. 3 only
4. D. 1, 2 and 3

Answer: A

Explanation

If a global financial crisis happens in the future, lesser exposure to the foreign financial markets is likely to give some immunity to India. Option 1 is correct: Short-term borrowings would lead to the burden of paying back the debt, and could result in stressful conditions for the borrowing economy/ India. Option 2 is not correct: Opening up to more foreign banks would lead to an enhanced exposure to the global economy, and hence an increased risk. Option 3 is not correct: Currency convertibility refers to a situation in which a currency can be converted into a foreign currency, and vice-versa at the prevailing exchange rate without any government intervention. In India, we cannot completely convert rupees to dollars- There are restrictions to the same. Now, capital account convertibility is the freedom to convert domestic currency into a foreign currency, and vice-versa wrt capital account transactions of the Balance of Payments accounts. It could also be the freedom to convert domestic financial assets (like rupees) / liabilities into foreign assets / liabilities and vice-versa. It is more risky, as the foreign investors can withdraw all their money at once which called capital flight. Risks associated with full capital account convertability: It increases the vulnerability of the domestic economy to external economic shocks. Hence the economy becomes unstable- For example, during the American recession- countries that were more connected were affected more. Flight of capital- i.e. the withdrawal of huge foreign exchange within a short period of time. If full convertibility is not there, the RBI can check the complete withdrawal of funds. (This flight of capital happened in the South East Asian crisis of 1997. For these Asian tigers- the fastest growing economies of the world- the current account was in a deficit, but there was significant inflow in their capital accounts. However, as interest rates in America increased, people withdrew their money and foreign exchange began to deplete. The people began to fear that they would not be able to take their money out. Out of this fear, everybody started to withdraw their investments- FDI was also withdrawn and the recession set in- they collapsed in one go!) It increases volatility in the domestic financial markets The capital Account is potentially more volatile than the current account- People cannot start consuming double/ triple/ four times the previous amount. But investment in shares accumulates, and the entire money can be immediately withdrawn.