Explanation : 

Household Financial Savings and Government Borrowings

In India, household savings are a significant source of funds for the government. Households invest in various financial instruments such as bank deposits, pension funds, insurance schemes, and government securities. A portion of these savings is channeled into government borrowings through the purchase of government bonds and securities. This helps the government to finance its deficit and undertake public expenditures.

Role of Dated Securities in Government’s Internal Debt

The Indian government raises funds through the issuance of dated securities, which are long-term government bonds with a fixed maturity date. These securities are issued at market-related rates, meaning that the interest rates are determined by the demand and supply dynamics in the market. The government conducts auctions for these securities, where various financial institutions and investors bid to purchase them. These dated securities constitute a large portion of the government’s internal debt, which is the debt owed by the government to domestic creditors.

Explanation : 

Capital Expenditure

Acquiring new technology is capital expenditure. This statement is correct. Capital expenditure (CapEx) refers to the funds used by a company to acquire, upgrade, and maintain physical assets such as property, industrial buildings, or equipment. This can also include investment in technology such as new software or hardware that is expected to improve the company’s productivity or capacity over the long term. These types of expenses are capitalized, meaning the cost is spread out over the useful life of the asset rather than being fully expensed in the year they were incurred.

Difference Between Capital and Revenue Expenditure

Debt financing is considered capital expenditure, while equity financing is considered revenue expenditure. This statement is incorrect. Debt financing and equity financing are not categorized as expenditures but as forms of raising capital for the company. Debt financing involves borrowing funds that will need to be repaid over time with interest, while equity financing involves selling shares of the company’s stock to raise funds.

Debt Financing Explained

Debt financing does not constitute an expenditure but rather a liability that the company takes on. The interest payments made on the debt can be considered an operating expense, but the principal amount borrowed is not an expenditure; it’s a form of financing.

Equity Financing Explained

Equity financing is not an expenditure either. It is a transaction where the company is exchanging ownership (equity) for capital. It does not appear on the income statement like revenue or expenses do. Instead, it is recorded in the equity section of the balance sheet.

Therefore, the first statement is correct in identifying the acquisition of new technology as capital expenditure, while the second statement is incorrect in categorizing debt and equity financing as capital and revenue expenditures, respectively.

Explanation : 

Indirect Transfers and Taxation in India

The concept of indirect transfers has been a hot topic in India, especially following the landmark Vodafone case. An indirect transfer involves a situation where a foreign entity sells shares that derive their substantial value from assets located in a country different from the entity’s base. The tax implications of such transfers have led to significant debate and regulatory scrutiny.

Direct vs. Indirect Investment

When considering the different types of cross-border transactions, it is essential to distinguish between direct investments and indirect transfers to understand the tax obligations in India:

1. An Indian company investing in a foreign enterprise and paying taxes to the foreign country on the profits arising out of its investment: This represents a direct investment and is not related to the concept of an indirect transfer.

2. A foreign company investing in India and paying taxes to the country of its base on the profits arising out of its investment: Although this involves a foreign entity, it does not encapsulate the essence of an indirect transfer as the investment is direct.

3. An Indian company purchases tangible assets in a foreign country and sells such assets after their value increases, transferring the proceeds to India: This transaction is a direct international investment and does not involve the transfer of shares that derive their value from assets located in India.

The Case of Indirect Transfers Involving Indian Assets

4. A foreign company transfers shares and such shares derive their substantial value from assets located in India: This scenario is at the heart of the indirect transfer debate. When a foreign company transfers shares of another foreign company, and these shares are substantially valued based on Indian assets, the Indian tax authorities may claim a right to tax the capital gains from such a transfer.

Explanation : 

Real Sector of the Economy

The real sector of the economy is integral to economic development and growth. It encompasses the production of goods and services, involving the actual physical creation of commodities. This sector utilizes natural resources, labor, and capital to meet human wants and needs. Key activities within the real sector include agriculture, manufacturing, construction, and mining.

Real Sector Activities

1. Farmers harvesting their crops – This activity falls under the agricultural sector, a vital part of the real sector, focusing on food production and raw materials.
2. Textile mills converting raw cotton into fabrics – This manufacturing process is a transformation of raw materials into finished goods, representing another essential aspect of the real sector.

Non-Real Sector Activities

3. A commercial bank lending money to a trading company – This is a financial sector activity, which deals with financial services rather than the production of goods.
4. A corporate body issuing Rupee Denominated Bonds overseas – Similar to banking, this is a financial activity aimed at raising capital in the financial markets, not producing goods or services.

In summary, the activities that are part of the real sector in the economy from the provided options are:

• Farmers harvesting their crops
• Textile mills converting raw cotton into fabrics

The correct answer is “1 and 2 only.”.

Explanation :

1. Foreign-owned e-commerce firms operating in India are not allowed to sell their own goods directly to consumers. They can only operate as marketplaces where third-party sellers can list and sell their products. This means that statement 1 is incorrect.
2. Incorrect according to official answer key.

Explanation : 

Inflation-Indexed Bonds (IIBs) UPSC

Inflation-Indexed Bonds (IIBs) are a type of bond designed to help protect investors from inflation. The principal amount of the bond is indexed to inflation, ensuring that the purchasing power of the investor’s money is maintained.

Benefits of IIBs for Government Borrowing

Government can reduce the coupon rates on its borrowing by way of IIBs. Since IIBs provide a hedge against inflation, investors are typically willing to accept lower nominal coupon rates on these bonds compared to conventional bonds. The real return is adjusted for inflation, so the government can issue these bonds with a lower coupon rate, potentially reducing its cost of borrowing.

Protection from Inflation Uncertainty

IIBs provide protection to the investors from uncertainty regarding inflation. The principal value of IIBs is adjusted according to the inflation rate, which means that the returns on these bonds are designed to keep up with inflation. This protects investors from the erosion of purchasing power that can occur with fixed-rate bonds during periods of high inflation.

Tax Implications of IIBs

The interest received as well as capital gains on IIBs are not taxable. This statement is incorrect. In India, like many other countries, the interest received on bonds is typically subject to income tax. Capital gains from bonds may also be taxable depending on the holding period and applicable tax laws at the time of sale or redemption. There may be specific tax-exempt bonds issued by the government, but IIBs do not inherently come with a tax exemption on interest and capital gains.

Explanation : 

G20 Common Framework Initiative

The G20 Common Framework is an initiative that has been endorsed by the G20 together with the Paris Club. The Paris Club is a group of officials from major creditor countries whose role is to find coordinated and sustainable solutions to the payment difficulties experienced by debtor countries. The G20 is an international forum for governments and central bank governors from 19 countries and the European Union.

Addressing Debt Challenges in Low-Income Countries

The G20 Common Framework for Debt Treatments beyond the Debt Service Suspension Initiative (DSSI) is designed to address the challenges faced by Low-Income Countries (LICs) with unsustainable debt. The framework aims to provide a structured approach to debt treatment for these countries, ensuring that all creditors (both public and private) work together to address the debt vulnerabilities so that the affected countries can work towards achieving economic stability and sustainable growth.

The Common Framework was established in response to the financial strains caused by the COVID-19 pandemic, which exacerbated the debt vulnerabilities of many developing countries. It seeks to provide a coordinated approach to debt restructuring, tailored to the needs of each eligible country, while ensuring fair burden-sharing among creditors and maintaining the debtor country’s access to financing.

Explanation : 

Role of the Reserve Bank of India in the Indian Economy

The Reserve Bank of India (RBI) plays a pivotal role in managing the Indian economy, especially in terms of controlling inflation, stabilizing the currency, and influencing capital flows. Here we analyze three statements concerning the actions the RBI might take under different economic scenarios.

1. RBI’s Response to High Inflation

Contrary to the statement that the RBI is likely to buy government securities when inflation is too high, the central bank’s typical response is to sell these securities. Through open market operations (OMOs), selling government securities helps to absorb liquidity from the market, which is essential in reducing the money supply and combating high inflation.

2. RBI’s Strategy Against Rupee Depreciation

The statement that the RBI is likely to sell dollars in the market if the rupee is rapidly depreciating is accurate. By selling dollars, the RBI increases the supply of the US currency while simultaneously boosting demand for the rupee, which can help to stabilize its value against other currencies.

3. RBI’s Actions in Response to Foreign Interest Rate Changes

The RBI may indeed buy dollars if interest rates in the USA or European Union were to fall. Lower interest rates in these economies could lead to increased capital flows into India, causing the rupee to appreciate. To maintain export competitiveness and prevent excessive currency strength, the RBI might intervene by purchasing dollars, thereby increasing its foreign exchange reserves.

In conclusion, the correct assessment of the RBI’s likely actions is “2 and 3 only.” The RBI would sell government securities to fight inflation and sell dollars to support a depreciating rupee, while it might buy dollars in response to an influx of foreign capital due to lower interest rates in the USA or EU.

Explanation : 

Nominal Effective Exchange Rate (NEER) & Real Effective Exchange Rate (REER)

1. An increase in Nominal Effective Exchange Rate (NEER) indicates the appreciation of the rupee.

This statement is correct. The NEER is an index that measures the value of a country’s currency relative to a basket of other major currencies, weighted by their relative trade with the country. An increase in NEER means that the Indian rupee has appreciated in value compared to this basket of currencies, which implies that it takes fewer rupees to buy the same amount of foreign currency.

2. An increase in Real Effective Exchange Rate (REER) indicates an improvement in trade competitiveness.

This statement is not necessarily correct. The REER adjusts the NEER for inflation differentials between India and its trading partners. An increase in REER suggests that the Indian currency has appreciated in real terms, which could make Indian exports more expensive and imports cheaper, potentially reducing trade competitiveness. However, it is also possible that an increase in REER reflects higher productivity or quality improvements in a country’s goods and services, which could enhance competitiveness. Therefore, an increase in REER does not unambiguously indicate an improvement in trade competitiveness.

3. An increasing trend in domestic inflation relative to inflation in other countries is likely to cause an increasing divergence between NEER and REER.

This statement is correct. If India experiences higher inflation than its trading partners, the NEER may not change much, but the REER will increase because the domestic currency’s real value is eroding due to higher prices. This divergence occurs because the REER is adjusted for inflation, while the NEER is not.

Given the explanations above, the correct answer is that statements 1 and 3 are correct, making the correct choice “1 and 3 only”.

Explanation : 

IMF’s Rapid Financing Instrument (RFI) and Rapid Credit Facility (RCF)

The “Rapid Financing Instrument” (RFI) and the “Rapid Credit Facility” (RCF) are lending mechanisms provided by the International Monetary Fund (IMF). These instruments are designed to provide rapid financial assistance to member countries facing urgent balance of payments needs, without the need to have a full-fledged program in place. They are particularly useful in addressing crises and emergencies where policy adjustments may not be immediately feasible.

The RFI is available to all member countries of the IMF and provides rapid financial assistance with limited conditionality. It is meant for situations where a full economic program is either not necessary or not feasible. The RFI can be used in a wide range of circumstances, including commodity price shocks, natural disasters, and emergencies resulting from fragility and conflict.

The RCF, on the other hand, is specifically tailored for low-income countries and provides immediate financial assistance with zero interest rates. The RCF also has limited conditionality and is designed to support countries with an urgent balance of payments need, particularly where a full-fledged economic program is not in place.

Both the RFI and RCF are part of the IMF’s broader toolkit to help member countries deal with balance of payments problems and are designed to provide rapid financial support with the aim of stabilizing the economy and restoring confidence.