UPSC Prelims 2021 Analysis

Explanation

Statement 1 is correct. The Governor of RBI is appointed by the Central Government under the RBI Act, 1934. The Appointments Committee of the Cabinet (ACC), led by the Prime Minister, finalizes the selection. The tenure is typically four years, but the government has the authority to extend or terminate the term.

Statement 2 is incorrect. The Constitution of India does not have any direct provision allowing the Central Government to issue directions to the RBI. However, Section 7 of the RBI Act, 1934, gives the Central Government the power to issue directions to the RBI in the public interest, but this is a statutory provision, not a constitutional one.

Statement 3 is correct. The powers, functions, and responsibilities of the RBI Governor come from the Reserve Bank of India Act, 1934. The Act defines the Governor's role, monetary policy responsibilities, and overall authority over banking regulations.

Explanation

Statement 1 is correct Yes, Retail investors through demat accounts can invest in Treasury Bills and Government of India Debt Bonds in the primary market.

Statement 2 is correct The Negotiated Dealing System-Order Matching is a government securities trading platform of the Reserve Bank of India.

Statement 3 is incorrect Central Depository Services Ltd (CDSL), is the first listed Indian central securities depository based in Mumbai. CDSL is promoted by BSE Ltd. jointly with leading banks such as State Bank of India, Bank of India, Bank of Baroda, HDFC Bank, and Standard Chartered Bank.

Explanation

During an economic recession, the goal is to stimulate economic activity and consumer spending.

A. Cut in Tax Rates & Increase in Interest Rates Cutting taxes puts more money in people's pockets, potentially increasing spending. However, raising interest rates discourages borrowing and investment, potentially hindering economic growth. This combination could have offsetting effects.

B. Increase in Expenditure on Public Projects This injects money into the economy through government spending, creating jobs and boosting demand for goods and services. This is a typical measure during recessions.

C. Increase in Tax Rates & Reduction of Interest Rates Increasing taxes reduces disposable income, dampening consumer spending. Lowering interest rates encourages borrowing and investment, but it might not be effective if there's low confidence in the economy.

D. Reduction of Expenditure on Public Projects This reduces government spending, taking money out of circulation and potentially worsening the recession.

Therefore, the most likely step during an economic recession is (B) Increase in expenditure on public projects

Explanation

A. Diversion to Real Estate While this can happen, it still involves some economic activity and might generate taxes (though potentially not on the full value of the transaction if black money is used).

B. Investment in Unproductive Activities This can hurt the economy, but the government loses tax revenue regardless of the type of investment if it's funded by black money.

C. Donations to Political Parties This is a concern, but the lost tax revenue likely outweighs the impact of such donations.

D. Loss of Revenue Black money, by definition, avoids taxes. This directly reduces the government's income, limiting its ability to fund public services, infrastructure, and social welfare programs.

Tax evasion through black money creation significantly hinders the government's ability to function effectively and meet the needs of its citizens. This is why it's a major concern.

Explanation

Statement 1 is incorrect. The ‘lender of last resort’ (LoLR) function of the central bank primarily applies to commercial banks and financial institutions, not trade and industry bodies. Businesses and industries generally rely on commercial banks, financial institutions, and capital markets for funds. The Reserve Bank of India (RBI) does not directly lend to trade and industry bodies under its LoLR function.

Statement 2 is correct. The central bank (RBI) acts as the ‘lender of last resort’ for commercial banks facing liquidity shortages. This helps prevent bank failures and maintains financial stability. RBI provides liquidity through mechanisms like repo operations, open market operations (OMO), and special liquidity facilities.

Statement 3 is incorrect. The RBI does not directly lend to the government to cover budgetary deficits under the 'lender of last resort' function. The government primarily finances deficits through market borrowings, treasury bills, and bonds. However, RBI can indirectly support the government by purchasing government securities in the open market (OMO) or monetizing debt in special situations (historically, through ways and means advances - WMA).

Explanation

Price of Substitute Increases When the price of a substitute good goes up, consumers may switch to the original good as a more affordable alternative. This increases demand for the original good.

Price of Complement Increases In some cases, an increase in the price of a complementary good can lead to a decrease in demand for the original good (e.g., bread and butter). However, this isn't always the case.

Inferior Good and Income Increase If the good is inferior (a good for which demand decreases as income rises), then an increase in income will lead to a decrease in demand for that good, not an increase.

Price Falls According to the law of demand, when the price of a good falls, consumers tend to buy more of it, assuming other factors remain constant. This is because the goods become more affordable.

Therefore, the correct code is 1 and 4 only.

Explanation

Expansionary policies: Expansionary policies like increased government spending or lower interest rates can stimulate economic activity and consumer spending. This can lead to excess demand that outstrips supply, causing prices to rise.

Fiscal stimulus: Similar to expansionary policies, fiscal stimulus through government spending injections can create an inflationary gap if it's excessive.

Higher purchasing power: Higher purchasing power can contribute to demand-pull inflation. If people have more money to spend due to factors like wage increases or wealth accumulation, it can lead to increased demand for goods and services.

Inflation-indexing wages: While inflation-indexing wages can contribute to a wage-price spiral in some cases, it's not necessarily a direct cause of demand-pull inflation. It can be a consequence of inflation rather than a primary driver.

Rising interest rates: Rising interest rates generally act as a tool to cool down an economy and reduce inflation. They make borrowing more expensive and encourage saving, thereby reducing the money supply and aggregate demand.

Therefore, the correct code is 1, 2, and 4.

Explanation

Statement 1 is incorrect. The oil palm tree (Elaeis guineensis) is native to West Africa, not Southeast Asia. However, Indonesia and Malaysia are now the largest producers of palm oil because the tree was introduced and widely cultivated there due to favorable tropical conditions. Statement 2 is correct. Palm oil and its derivatives (such as palm kernel oil) are widely used in cosmetic and personal care products, including lipsticks, soaps, and perfumes. It acts as a moisturizing agent, emulsifier, and texture enhancer in these products.

Statement 3 is correct. Palm oil is a major feedstock for biodiesel production. Palm-based biodiesel (Palm Methyl Ester - PME) is used as a renewable fuel alternative in several countries, including Malaysia, Indonesia, and parts of Europe.

Explanation

When a country devalues its currency, it becomes cheaper for foreign buyers to purchase the country's exports. This can lead to increased demand for exports, making domestic producers more competitive in the international market. Hence, statement 1 is correct.

Devaluation actually decreases the foreign value of the domestic currency. The whole point is to make the domestic currency less expensive relative to foreign currencies. Hence, statement 2 is incorrect.

While improved export competitiveness can lead to a better trade balance (more exports, fewer imports), it's not a guaranteed outcome. Other factors like import prices, global demand, and domestic production costs can also influence the trade balance. Devaluation can also lead to increased import costs if the country relies on imported raw materials. Hence, statement 3 is also incorrect.

Therefore, the correct code is 1 only.

Explanation

Statement 1 is incorrect. Urban Cooperative Banks (UCBs) are not solely regulated by State Governments. They are jointly regulated by the Reserve Bank of India (RBI) and the respective State Governments. In 2020, the Banking Regulation (Amendment) Act, 2020 gave RBI more control over UCBs, bringing them largely under its regulatory framework for financial stability.

Statement 2 is correct. As per the Banking Regulation (Amendment) Act, 2020, Urban Cooperative Banks can raise funds by issuing equity shares, preference shares, and unsecured debentures with RBI approval. This allows UCBs to strengthen their capital base and improve financial health.

Statement 3 is correct. Initially, cooperative banks were regulated under state laws. In 1966, an amendment to the Banking Regulation Act, 1949, brought Urban Cooperative Banks (UCBs) under RBI's purview for banking-related functions. However, their management and administrative aspects remained under state cooperative laws.

Explanation

Statement 1 is incorrect: Increase in the Cash Reserve Ratio (CRR) in banks
CRR is the percentage of deposits banks must keep with the RBI. If CRR increases, banks have less money to lend, reducing the money multiplier.

Statement 2 is incorrect: Increase in the Statutory Liquidity Ratio (SLR) in banks. SLR is the percentage of deposits banks must keep in liquid assets like gold or government securities. A higher SLR means less lending capacity, reducing the money multiplier.

Statement 3 is correct: Increase in the banking habits of the people. If more people deposit money in banks instead of holding cash, banks get more reserves to lend, increasing the money multiplier. This expands the credit creation process, leading to a higher money supply.

Statement 4 is incorrect: Increase in the population of the country. A higher population does not directly impact the money multiplier unless it leads to a rise in banking habits or economic activity.

Explanation

Statements 1, 2 and 3 are correct.

Foreign Currency Convertible Bond (FCCB) is a bond issued under the Issue of Foreign Currency Convertible Bonds and Ordinary Shares (Through Depository Receipt Mechanism) Scheme, 1993.

Foreign Portfolio Investment is any investment made by a person resident outside India in capital instruments. It is the percentage which defines whether it is a direct or institutional investment.

FII made above 10 per cent of the post-issue paid-up equity capital will be considered FDI. But Once an FDI always an FDI.

Foreign investment in Indian securities has been made possible through the purchase of Global Depository Receipts, Foreign Currency Convertible Bonds and Foreign Currency Bonds issued by Indian issuers which are listed, traded and settled overseas.

A Non-Resident External (NRE) account is a rupee-dominated account opened by an NRI to facilitate the deposit of foreign currency earnings. It is not an FDI. Hence, statement 4 is incorrect.

Explanation

Out of the given options, the most inflationary effect is likely caused by

D) Creation of new money to finance a budget deficit

Repayment of public debt (A) This actually removes money from circulation, potentially leading to deflationary pressure.

Borrowing from the public (B) or banks (C) While these options involve increasing government debt, they don't directly increase the money supply. The government essentially takes money that already exists in the economy.

Creation of new money (D) This is the most inflationary option. This can lead to an increase in the money supply, which can put upward pressure on prices (inflation) if not accompanied by a corresponding increase in goods and services.

In essence, printing new money directly expands the money supply, potentially outpacing economic growth and leading to inflation.

Explanation

Actions of the United States Federal Reserve The Federal Reserve's monetary policy decisions, particularly regarding interest rates, can impact global capital flows. If the Fed raises interest rates, it can make US investments more attractive, potentially leading to some outflow of capital from India. This could affect demand for Indian government bonds and influence their yield.

Actions of the Reserve Bank of India (RBI) The RBI's monetary policy plays a crucial role in influencing Indian government bond yields. The RBI's actions like setting repo rates, open market operations, and cash reserve ratio (CRR) can affect the overall liquidity in the banking system. Higher liquidity can lead to lower yields, and vice versa.

Inflation and Short-Term Interest Rates Inflation expectations and short-term interest rates are important factors for investors when considering the return on government bonds. Higher inflation expectations can lead investors to demand higher yields to compensate for the potential erosion of purchasing power. Similarly, short-term interest rates can act as a benchmark for bond yields.

Therefore, all three factors significantly influence the yields of Indian government bonds.