If another global financial crisis happens in the near future, which of the following actions/policies are most likely to give some immunity to India?
- Not depending on short-term foreign borrowing.
- Opening up to more foreign banks
- Maintaining full capital account convertibility
Select the correct answer using the given code below:
- 1 only
- 1 and 2 only
- 3 only
- 1, 2 and 3
Explanation
Statement 1 is correct
- Short-term foreign borrowing is highly vulnerable to changes in global financial conditions. If there is a financial crisis, short-term creditors are likely to withdraw funds quickly, leading to a liquidity crunch, increased interest rates, and a depreciation of the domestic currency. By avoiding reliance on such borrowings, India would reduce its exposure to sudden capital flight and volatility in foreign exchange markets.
Statement 2 is incorrect
- While increasing the presence of foreign banks could enhance competition, technology transfer, and financial sector efficiency, it also makes the domestic financial system more interconnected with the global market. In times of global financial crises, these banks can act as transmission channels for financial stress from their home countries to India. Foreign banks may reduce lending, withdraw capital, or transmit negative external shocks, potentially destabilizing the local economy.
Statement 3 is incorrect
- Full capital account convertibility allows for the free flow of capital in and out of the country without restrictions. While this policy might be advantageous during stable times, it exposes the economy to sudden and massive capital movements during crises. Large and abrupt capital outflows can lead to currency depreciation, depletion of forex reserves, and economic instability. Countries like Thailand and South Korea faced severe repercussions during the 1997 Asian Financial Crisis partly due to unrestricted capital flows.
