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Question 1 of 20
1. Question
1 pointsWhich of the following is not matched correctly:
1.Ad Valorem Tax: Based on the assessed value of the product.
2.Specific Tax: Bases on the volume of the item purchased.
3.Capital Gain Tax: Regressive TaxSelect the correct answer using the code given below:
Correct
Theme : Taxation in India
Similar question on Taxation was asked in UPSC Prelims 2014,2017 and 2018.
Statement 3 is incorrectly matched : Capital Gain Tax is a example of progressive Tax.
Notes:
Ad Valorem
Ad valorem tax is based on the assessed value of the product. In Fact, ‘Ad Valorem’ is a Latin word meaning ‘According to Value’.
Most Ad valorem taxes are levied based on the value of the item purchased.
The tax is usually expressed in percentage. Example GST in India has 5 tax rate slabs- 0, 5. 12, 18 and 28 percent.
Example: GST, Property tax, sales tax.
They are progressive in nature.Specific Tax
Specific tax is a fixed amount tax based on the quantity of unit sold.
Specific tax is levied based on the volume of the item purchased.
The tax is usually expressed in specific sums. Example: Excise Duty on Petrol.
Example: Excise duty on petrol and liquor products.
They are regressive in nature.Capital Gain Tax
Capital Gain Tax: Ay profit or gain that arises from the sale of the capital asset is a capital gain. The profit from the sale of capital is taxed. Capital Asset includes land, building, house, jewellery, patents, copyrights etc.Short-term capital asset – An asset which is held for not more than 36 months or less is a short-term capital asset.
Long-term capital asset – An asset that is held for more than 36 months is a long-term capital asset.
From FY 2017-18 onwards – The criteria of 36 months has been reduced to 24 months in the case of immovable property being land, building, and house property.
For instance, if you sell house property after holding it for a period of 24 months, any income arising will be treated as long-term capital gain provided that property is sold after 31st March 2017.
But this change is not applicable to movable property such as jewellery, debt oriented mutual funds etc. They will be classified as a long-term capital asset if held for more than 36 months as earlier.Tax on long-term capital gain: the Long-term capital gain is taxable at 20% + surcharge and education cess.
Tax on the short-term capital gain when securities transaction tax is not applicable: If securities transaction tax is not applicable, the short-term capital gain is added to your income tax return, and the taxpayer is taxed according to his income tax slab.
Tax on the short-term capital gain if securities transaction tax is applicable: If securities transaction tax is applicable, the short-term capital gain is taxable at the rate of 15% +surcharge and education cess.Incorrect
Theme : Taxation in India
Similar question on Taxation was asked in UPSC Prelims 2014,2017 and 2018.
Statement 3 is incorrectly matched : Capital Gain Tax is a example of progressive Tax.
Notes:
Ad Valorem
Ad valorem tax is based on the assessed value of the product. In Fact, ‘Ad Valorem’ is a Latin word meaning ‘According to Value’.
Most Ad valorem taxes are levied based on the value of the item purchased.
The tax is usually expressed in percentage. Example GST in India has 5 tax rate slabs- 0, 5. 12, 18 and 28 percent.
Example: GST, Property tax, sales tax.
They are progressive in nature.Specific Tax
Specific tax is a fixed amount tax based on the quantity of unit sold.
Specific tax is levied based on the volume of the item purchased.
The tax is usually expressed in specific sums. Example: Excise Duty on Petrol.
Example: Excise duty on petrol and liquor products.
They are regressive in nature.Capital Gain Tax
Capital Gain Tax: Ay profit or gain that arises from the sale of the capital asset is a capital gain. The profit from the sale of capital is taxed. Capital Asset includes land, building, house, jewellery, patents, copyrights etc.Short-term capital asset – An asset which is held for not more than 36 months or less is a short-term capital asset.
Long-term capital asset – An asset that is held for more than 36 months is a long-term capital asset.
From FY 2017-18 onwards – The criteria of 36 months has been reduced to 24 months in the case of immovable property being land, building, and house property.
For instance, if you sell house property after holding it for a period of 24 months, any income arising will be treated as long-term capital gain provided that property is sold after 31st March 2017.
But this change is not applicable to movable property such as jewellery, debt oriented mutual funds etc. They will be classified as a long-term capital asset if held for more than 36 months as earlier.Tax on long-term capital gain: the Long-term capital gain is taxable at 20% + surcharge and education cess.
Tax on the short-term capital gain when securities transaction tax is not applicable: If securities transaction tax is not applicable, the short-term capital gain is added to your income tax return, and the taxpayer is taxed according to his income tax slab.
Tax on the short-term capital gain if securities transaction tax is applicable: If securities transaction tax is applicable, the short-term capital gain is taxable at the rate of 15% +surcharge and education cess. -
Question 2 of 20
2. Question
1 pointsWhich of the following reform policies were initiated in India after 1991 liberalisation :
1.Deregulation of the Industrial Sector
2.Financial Sector Reforms
3.Tax Reforms
4. Foreign Exchange Reforms Select the correct answer using the code given below:
Correct
Theme : 1991 Reforms SImilar question on 1991 reforms was asked in UPSC Prelims 2017. Notes: Rules and laws which were aimed at regulating the economic activities became major hindrances in growth and development. Liberalization was introduced to put an end to these restrictions and open up various sectors of the economy. Though a few liberalization measures were introduced in 1980s in areas of industrial licensing, export import policy, technology up gradation, fiscal policy and foreign investment, reform policies initiated in 1991 were more comprehensive. Deregulation of industrial Sector: In India, regulatory mechanisms were enforced in various ways (i) industrial licensing under which every entrepreneur had to get permission from government officials to start a firm, close a firm or to decide the number of goods that could be produced (ii) private sector was not allowed in many industries (iii) some goods could be produced only in small scale industries and (iv) controls on price fixation and distribution of selected industrial products. The reform policies introduced in and after 1991 removed many of these restrictions. Financial Sector Reforms: Financial sector includes financial institutions such as commercial banks, investment banks, stock exchange operations and foreign exchange market. The financial sector in India is controlled by the Reserve Bank of India (RBI). You may be aware that all the banks and other financial institutions in India are controlled through various norms and regulations of the RBI. The RBI decides the amount of money that the banks can keep with themselves, fixes interest rates, nature of lending to various sectors etc. One of the major aims of financial sector reforms is to reduce the role of RBI from the regulator to facilitator of the financial sector. Tax Reforms: Tax reforms are concerned with the reforms in the government’s taxation and public expenditure policies which are collectively known as its fiscal policy. There are two types of taxes: direct and indirect. Direct taxes consist of taxes on incomes of individuals as well as profits of the business of enterprises. Since 1991, there has been a continuous reduction in the taxes on individual incomes as it was felt that high rates of income tax were an important reason for tax evasion. It is now widely accepted that moderate rates of income tax encourage savings and voluntary disclosure of income. The rate of corporation tax, which was very high earlier, has been gradually reduced. Efforts have also been made to reform the indirect taxes, taxes levied on commodities, in order to facilitate the establishment of a common national market for goods and commodities. Another component of reforms in this area is a simplification. In order to encourage better compliance on the part of taxpayers procedures have been simplified and the rates also substantially lowered. Foreign Exchange Reforms: The first important reform in the external sector was made in the foreign exchange market. In 1991, as an immediate measure to resolve the balance of payments crisis, the rupee was devalued against foreign currencies. This led to an increase in the inflow of foreign exchange. It also set the tone to free the determination of rupee value in the foreign exchange market from government control. Now, more often than not, markets determine exchange rates based on the demand and supply of foreign exchange
Incorrect
Theme : 1991 Reforms SImilar question on 1991 reforms was asked in UPSC Prelims 2017. Notes: Rules and laws which were aimed at regulating the economic activities became major hindrances in growth and development. Liberalization was introduced to put an end to these restrictions and open up various sectors of the economy. Though a few liberalization measures were introduced in 1980s in areas of industrial licensing, export import policy, technology up gradation, fiscal policy and foreign investment, reform policies initiated in 1991 were more comprehensive. Deregulation of industrial Sector: In India, regulatory mechanisms were enforced in various ways (i) industrial licensing under which every entrepreneur had to get permission from government officials to start a firm, close a firm or to decide the number of goods that could be produced (ii) private sector was not allowed in many industries (iii) some goods could be produced only in small scale industries and (iv) controls on price fixation and distribution of selected industrial products. The reform policies introduced in and after 1991 removed many of these restrictions. Financial Sector Reforms: Financial sector includes financial institutions such as commercial banks, investment banks, stock exchange operations and foreign exchange market. The financial sector in India is controlled by the Reserve Bank of India (RBI). You may be aware that all the banks and other financial institutions in India are controlled through various norms and regulations of the RBI. The RBI decides the amount of money that the banks can keep with themselves, fixes interest rates, nature of lending to various sectors etc. One of the major aims of financial sector reforms is to reduce the role of RBI from the regulator to facilitator of the financial sector. Tax Reforms: Tax reforms are concerned with the reforms in the government’s taxation and public expenditure policies which are collectively known as its fiscal policy. There are two types of taxes: direct and indirect. Direct taxes consist of taxes on incomes of individuals as well as profits of the business of enterprises. Since 1991, there has been a continuous reduction in the taxes on individual incomes as it was felt that high rates of income tax were an important reason for tax evasion. It is now widely accepted that moderate rates of income tax encourage savings and voluntary disclosure of income. The rate of corporation tax, which was very high earlier, has been gradually reduced. Efforts have also been made to reform the indirect taxes, taxes levied on commodities, in order to facilitate the establishment of a common national market for goods and commodities. Another component of reforms in this area is a simplification. In order to encourage better compliance on the part of taxpayers procedures have been simplified and the rates also substantially lowered. Foreign Exchange Reforms: The first important reform in the external sector was made in the foreign exchange market. In 1991, as an immediate measure to resolve the balance of payments crisis, the rupee was devalued against foreign currencies. This led to an increase in the inflow of foreign exchange. It also set the tone to free the determination of rupee value in the foreign exchange market from government control. Now, more often than not, markets determine exchange rates based on the demand and supply of foreign exchange
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Question 3 of 20
3. Question
1 pointsWhich of the following tool can be used by RBI for Controlling Credit/Money Supply:
1.Bank Rate
2.Statutory Reserve Ratio
3.Moral Suasion
4.Cash Reserve Ratio
Select the correct statements using the code below :
Correct
Theme : Monetary Policy Monetary Policy is always a hot topic and similar question on Monetary Policy was asked in UPSC Prelims consecutively from 2013 to 2018. Notes: RBI Tools for Controlling Credit/Money Supply Broadly speaking, there are two types of methods of controlling credit. 1.Quantitative Methods Bank Rate Policy Bank rate is the minimum rate at which the central bank of a country provides a loan to the commercial bank of the country. Bank rate is also called discount rate because the central bank provides finance to commercial banks by rediscounting bills. The RBI uses bank rate to control credit in the economy. For instance, in an inflationary scenario, the RBI increases the Bank Rate, which increases the cost of borrowing for commercial banks, this would discourage the commercial bank from borrowing from the RBI, hence lending in the economy will fall along with increase in lending rates by commercial bank, increase in lending rate will discourage investment and hence Aggregate Demand will fall. A fall in AD will reduce income and output in the economy. Thus, Inflation will Subside. Cash Reserve Ratio Banks in India are required to keep certain proportions of their deposits in the form of cash with themselves as reserves. If the legal CRR is 10%, then the bank will have to keep Rs 100 as reserves against the deposit of Rs 1000. If at any time, the RBI decides to increase the CRR from 10 to 20%, then bank have to keep Rs 200 as reserves against the deposit of Rs 1000. This will reduce the credit in the economy as the banks now have less money to lend (800 in our example), less lending means less borrowing and investment and hence reduction in income and aggregate demand. Similarly, a reduction in CRR from 10 to 5%, will reduce the reserve requirement and hence increases the lending capacity of the banks. Increased lending will lead to increased investment, increase investment will increase AD and Income. Statutory Liquidity Ratio SLR is that percentage of the deposits which the banks have to hold with themselves in highly liquid government securities. SLR is one of the many arrows in the RBI’s monetary policy quiver. These are used, sometimes in isolation, sometimes in combination, to manage the money supply, interest rates and credit availability in the country. The SLR is an important tool of monetary policy, and its primary aim is to ensure that banks always have enough liquidity (cash and cash equivalent securities) to honour depositor’s demands and that they don’t lend away all their funds. 2.Qualitative Methods Credit Rationing Central Bank fixes credit amount to be granted. Credit is rationed by limiting the amount available for each commercial bank. This method controls even bill rediscounting. For certain purpose, the upper limit of credit can be fixed, and banks are told to stick to this limit. This can help in lowering banks credit exposure to unwanted sectors. Moral Suasion It implies to pressure exerted by the RBI on the Indian banking system without any strict action for compliance with the rules. It is a suggestion to banks. It helps in restraining credit during inflationary periods. Commercial banks are informed about the expectations of the central bank through monetary policy. Under moral suasion, central banks can issue directives, guidelines and suggestions for commercial banks regarding reducing credit supply for speculative purposes. Consumer Credit Regulation Under this method, consumer credit supply is regulated through hire-purchase and instalment sale of consumer goods. Under this method, the down payment, instalment amount, loan duration, etc., is fixed in advance. This can help in checking the credit use and then inflation in a country.
Incorrect
Theme : Monetary Policy Monetary Policy is always a hot topic and similar question on Monetary Policy was asked in UPSC Prelims consecutively from 2013 to 2018. Notes: RBI Tools for Controlling Credit/Money Supply Broadly speaking, there are two types of methods of controlling credit. 1.Quantitative Methods Bank Rate Policy Bank rate is the minimum rate at which the central bank of a country provides a loan to the commercial bank of the country. Bank rate is also called discount rate because the central bank provides finance to commercial banks by rediscounting bills. The RBI uses bank rate to control credit in the economy. For instance, in an inflationary scenario, the RBI increases the Bank Rate, which increases the cost of borrowing for commercial banks, this would discourage the commercial bank from borrowing from the RBI, hence lending in the economy will fall along with increase in lending rates by commercial bank, increase in lending rate will discourage investment and hence Aggregate Demand will fall. A fall in AD will reduce income and output in the economy. Thus, Inflation will Subside. Cash Reserve Ratio Banks in India are required to keep certain proportions of their deposits in the form of cash with themselves as reserves. If the legal CRR is 10%, then the bank will have to keep Rs 100 as reserves against the deposit of Rs 1000. If at any time, the RBI decides to increase the CRR from 10 to 20%, then bank have to keep Rs 200 as reserves against the deposit of Rs 1000. This will reduce the credit in the economy as the banks now have less money to lend (800 in our example), less lending means less borrowing and investment and hence reduction in income and aggregate demand. Similarly, a reduction in CRR from 10 to 5%, will reduce the reserve requirement and hence increases the lending capacity of the banks. Increased lending will lead to increased investment, increase investment will increase AD and Income. Statutory Liquidity Ratio SLR is that percentage of the deposits which the banks have to hold with themselves in highly liquid government securities. SLR is one of the many arrows in the RBI’s monetary policy quiver. These are used, sometimes in isolation, sometimes in combination, to manage the money supply, interest rates and credit availability in the country. The SLR is an important tool of monetary policy, and its primary aim is to ensure that banks always have enough liquidity (cash and cash equivalent securities) to honour depositor’s demands and that they don’t lend away all their funds. 2.Qualitative Methods Credit Rationing Central Bank fixes credit amount to be granted. Credit is rationed by limiting the amount available for each commercial bank. This method controls even bill rediscounting. For certain purpose, the upper limit of credit can be fixed, and banks are told to stick to this limit. This can help in lowering banks credit exposure to unwanted sectors. Moral Suasion It implies to pressure exerted by the RBI on the Indian banking system without any strict action for compliance with the rules. It is a suggestion to banks. It helps in restraining credit during inflationary periods. Commercial banks are informed about the expectations of the central bank through monetary policy. Under moral suasion, central banks can issue directives, guidelines and suggestions for commercial banks regarding reducing credit supply for speculative purposes. Consumer Credit Regulation Under this method, consumer credit supply is regulated through hire-purchase and instalment sale of consumer goods. Under this method, the down payment, instalment amount, loan duration, etc., is fixed in advance. This can help in checking the credit use and then inflation in a country.
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Question 4 of 20
4. Question
1 pointsWith reference to Non-scheduled Banks, consider the following statements:
1. Banks with a reserve capital of less than 10 lakh rupees qualify as non-scheduled banks.
2. Like scheduled banks, they are also entitled to borrow from the RBI for normal banking purposes but at the different interest rate.Select the incorrect statements using the code below :
Correct
Factual/Tikdam Theme: Banking in India Banking is always a hot topic and similar question on Monetary Policy was asked in UPSC Prelims consecutively from 2013 to 2018.
Statement 1 is incorrect: Banks with a reserve capital of less than 5 lakh rupees qualify as non-scheduled banks.
Statement 2 is incorrect: Unlike scheduled banks, they are not entitled to borrow from the RBI for normal banking purposes, except, in emergency or “abnormal circumstances.” Notes: Scheduled Commercial Banks All the commercial banks in India- Scheduled and Non-Scheduled is regulated under Banking Regulation Act 1949. By definition, any bank which is listed in the 2nd schedule of the Reserve Bank of India Act, 1934 is considered a scheduled bank. The list includes the State Bank of India and its subsidiaries (like State Bank of Travancore), all nationalised banks (Bank of Baroda, Bank of India etc), Private sector banks, Foreign banks, regional rural banks (RRBs), foreign banks (HSBC Holdings Plc, Citibank NA) and some co-operative banks. Till 2017, Scheduled commercial banks in India comprised 26 Public sector banks including SBI and its associates, and 19 Nationalised Bank and IDBI. The creation of Bhartiya Mahila Bank has increased the total no of Public sector SCB’s to 27, but the recent merger of the Mahaila Bank with SBI had reduced the list back to 26. The scheduled private sector bank includes old private sector banks and new private sector banks. There are 13 old private sector banks and 9 new private sector banks including the newly formed IDFC and Bandhan Bank. There are also 43 Foreign National Banks operating in India. The Regional Rural Banks were started in India back in the 1970s due to the inability of the commercial banks to lend to farmers/rural sectors/agriculture. The governance structure/shareholding of RRBs is as follows: Central Government: 50%, State Government: 15% and Sponsor Bank: 35%. RBI has kept CRR (Cash Reserve Requirements) of RRBs at 3% and SLR (Statutory Liquidity Requirement) at 25% of their total net liabilities. Non-scheduled Banks Non-scheduled banks by definition are those which are not listed in the 2nd schedule of the RBI Act, 1934. Banks with a reserve capital of less than 5 lakh rupees qualify as non-scheduled banks. Unlike scheduled banks, they are not entitled to borrow from the RBI for normal banking purposes, except, in emergency or “abnormal circumstances.” Jammu & Kashmir Bank is an example of a non-scheduled commercial bank. Cooperative Banks Co-operative banks operate in both urban and non-urban areas. All banks registered under the Cooperative Societies Act, 1912 are considered co-operative banks. In the urban centres, they mainly finance entrepreneurs, small businesses, industries, self-employment and cater to home buying and educational loans. Likewise, co-operative banks in the rural areas primarily cater to agricultural-based activities, which include farming, livestock’s, diaries and hatcheries etc. They also extend loans to small scale units, cottage industries, and self-employment activities like artisanship. Unlike commercial banks, who are driven by profit, cooperative banks work on a “no profit, no loss” basis. Co-operative Banks are regulated by the Reserve Bank of India under the Banking Regulation Act, 1949 and Banking Laws (Application to Co-operative Societies) Act, 1965.
Incorrect
Factual/Tikdam Theme: Banking in India Banking is always a hot topic and similar question on Monetary Policy was asked in UPSC Prelims consecutively from 2013 to 2018.
Statement 1 is incorrect: Banks with a reserve capital of less than 5 lakh rupees qualify as non-scheduled banks.
Statement 2 is incorrect: Unlike scheduled banks, they are not entitled to borrow from the RBI for normal banking purposes, except, in emergency or “abnormal circumstances.” Notes: Scheduled Commercial Banks All the commercial banks in India- Scheduled and Non-Scheduled is regulated under Banking Regulation Act 1949. By definition, any bank which is listed in the 2nd schedule of the Reserve Bank of India Act, 1934 is considered a scheduled bank. The list includes the State Bank of India and its subsidiaries (like State Bank of Travancore), all nationalised banks (Bank of Baroda, Bank of India etc), Private sector banks, Foreign banks, regional rural banks (RRBs), foreign banks (HSBC Holdings Plc, Citibank NA) and some co-operative banks. Till 2017, Scheduled commercial banks in India comprised 26 Public sector banks including SBI and its associates, and 19 Nationalised Bank and IDBI. The creation of Bhartiya Mahila Bank has increased the total no of Public sector SCB’s to 27, but the recent merger of the Mahaila Bank with SBI had reduced the list back to 26. The scheduled private sector bank includes old private sector banks and new private sector banks. There are 13 old private sector banks and 9 new private sector banks including the newly formed IDFC and Bandhan Bank. There are also 43 Foreign National Banks operating in India. The Regional Rural Banks were started in India back in the 1970s due to the inability of the commercial banks to lend to farmers/rural sectors/agriculture. The governance structure/shareholding of RRBs is as follows: Central Government: 50%, State Government: 15% and Sponsor Bank: 35%. RBI has kept CRR (Cash Reserve Requirements) of RRBs at 3% and SLR (Statutory Liquidity Requirement) at 25% of their total net liabilities. Non-scheduled Banks Non-scheduled banks by definition are those which are not listed in the 2nd schedule of the RBI Act, 1934. Banks with a reserve capital of less than 5 lakh rupees qualify as non-scheduled banks. Unlike scheduled banks, they are not entitled to borrow from the RBI for normal banking purposes, except, in emergency or “abnormal circumstances.” Jammu & Kashmir Bank is an example of a non-scheduled commercial bank. Cooperative Banks Co-operative banks operate in both urban and non-urban areas. All banks registered under the Cooperative Societies Act, 1912 are considered co-operative banks. In the urban centres, they mainly finance entrepreneurs, small businesses, industries, self-employment and cater to home buying and educational loans. Likewise, co-operative banks in the rural areas primarily cater to agricultural-based activities, which include farming, livestock’s, diaries and hatcheries etc. They also extend loans to small scale units, cottage industries, and self-employment activities like artisanship. Unlike commercial banks, who are driven by profit, cooperative banks work on a “no profit, no loss” basis. Co-operative Banks are regulated by the Reserve Bank of India under the Banking Regulation Act, 1949 and Banking Laws (Application to Co-operative Societies) Act, 1965.
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Question 5 of 20
5. Question
1 pointsWith reference to the Liquidity Adjustment Facility(LAF), consider the following statements:
1.LAF is used to aid banks in adjusting the day to day fluctuations in liquidity.
2.RBI extends LAF facility to all banks operating in India.Select the correct statements using the code below :
Correct
Interactive/Tikdam Theme: Monetary Policy Monetary Policy is always a hot topic and similar question on Monetary Policy was asked in UPSC Prelims consecutively from 2013 to 2018. Statement 2 is incorrect: RBI extends LAF facility only to commercial banks (excluding RRBs) and Primary dealers. Notes: Liquidity Adjustment Facility: Liquidity Adjustment Facility (LAF) is the primary instrument of Reserve Bank of India for modulating liquidity and transmitting interest rate signals to the market. It refers to the difference between the two key rates viz. repo rate and reverse repo rate. Informally, Liquidity Adjustment Facility is also known as Liquidity Corridor. How Liquidity Adjustment Facility works : As mentioned above, the two components of LAF are repo rate and reverse repo rate. Under Repo, the banks borrow money from RBI to meet short term needs by putting government securities (G-secs) as collateral. Under Reverse Repo, RBI borrows money from banks by lending securities. While repo injects liquidity into the system, the Reverse repo absorbs the liquidity from the system. RBI only announces Repo Rate. The Reverse Repo Rate is linked to Repo Rate and is 100 basis points (1%) below repo rate. RBI makes decision regarding Repo Rate on the basis of prevalent market conditions and relevant factors. Banks participating in LAF auctions: All the Scheduled Commercial Banks are eligible to participate in auctions except the Regional Rural Banks. Further, the Primary Dealers (PDs) having Current Account and SGL Account (Subsidiary General Ledger Account ) with Reserve Bank, Mumbai are also eligible to participate in the Repo and Reverse Repo auctions. Tikdam: Statement 2 is an extreme statement as it uses the term ‘all’.Using this, options can be narrowed down.
Incorrect
Interactive/Tikdam Theme: Monetary Policy Monetary Policy is always a hot topic and similar question on Monetary Policy was asked in UPSC Prelims consecutively from 2013 to 2018. Statement 2 is incorrect: RBI extends LAF facility only to commercial banks (excluding RRBs) and Primary dealers. Notes: Liquidity Adjustment Facility: Liquidity Adjustment Facility (LAF) is the primary instrument of Reserve Bank of India for modulating liquidity and transmitting interest rate signals to the market. It refers to the difference between the two key rates viz. repo rate and reverse repo rate. Informally, Liquidity Adjustment Facility is also known as Liquidity Corridor. How Liquidity Adjustment Facility works : As mentioned above, the two components of LAF are repo rate and reverse repo rate. Under Repo, the banks borrow money from RBI to meet short term needs by putting government securities (G-secs) as collateral. Under Reverse Repo, RBI borrows money from banks by lending securities. While repo injects liquidity into the system, the Reverse repo absorbs the liquidity from the system. RBI only announces Repo Rate. The Reverse Repo Rate is linked to Repo Rate and is 100 basis points (1%) below repo rate. RBI makes decision regarding Repo Rate on the basis of prevalent market conditions and relevant factors. Banks participating in LAF auctions: All the Scheduled Commercial Banks are eligible to participate in auctions except the Regional Rural Banks. Further, the Primary Dealers (PDs) having Current Account and SGL Account (Subsidiary General Ledger Account ) with Reserve Bank, Mumbai are also eligible to participate in the Repo and Reverse Repo auctions. Tikdam: Statement 2 is an extreme statement as it uses the term ‘all’.Using this, options can be narrowed down.
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Question 6 of 20
6. Question
1 pointsWith reference to Measure of Money Supply in India, consider the following statements:
1.M1 is equal to the sum of Currency with Public.,Demand Deposit with the public in the Banks, Other Deposits held by the public with RBI.
2.M3 is also known as Broad Money.
3.M4 is the most liquid form of the money supply.Correct
Factual
Theme : Monetary Policy
Monetary Policy is always a hot topic and similar question on Monetary Policy was asked in UPSC Prelims consecutively from 2013 to 2018.
Statement 3 is incorrect: M1 is the most liquid form of the money supply.
Notes:
Measure of Money Supply in India1.M1
It is also known as Narrow Money.
M1= C+DD+OD
C= Currency with Public.
DD= Demand Deposit with the public in the Banks.
OD= Other Deposits held by the public with RBI.
It is the most liquid form of the money supply.2.M2
It is a broader concept of the money supply.
M2= M1 + Saving deposits with the post office saving banks.
M1 is distinguished from M2 because the post office saving deposits are not as liquid as Bank deposits.3.M3
It is also known as Broad Money.
M3 = M1+ Time Deposits with the Bank.
Time deposits serve as a store of wealth and represent a saving of the people and are not as liquid as they cannot be withdrawn through cheques or ATMs as compared to money deposited in Demand deposits.
M3 is the most popular and essential measure of the money supply. The monetary committee headed by late Prof Sukhamoy Chakravarty recommended its use for monetary planning in the economy. M3 is also called Aggregate Monetary Resource4.M4
M4 includes all items of M3 along with total deposits of post office saving accounts.
M4= M3+Total Deposits with Post Office Saving Organisations.
M4 however, excludes National Saving Certificates of Post Offices.Incorrect
Factual
Theme : Monetary Policy
Monetary Policy is always a hot topic and similar question on Monetary Policy was asked in UPSC Prelims consecutively from 2013 to 2018.
Statement 3 is incorrect: M1 is the most liquid form of the money supply.
Notes:
Measure of Money Supply in India1.M1
It is also known as Narrow Money.
M1= C+DD+OD
C= Currency with Public.
DD= Demand Deposit with the public in the Banks.
OD= Other Deposits held by the public with RBI.
It is the most liquid form of the money supply.2.M2
It is a broader concept of the money supply.
M2= M1 + Saving deposits with the post office saving banks.
M1 is distinguished from M2 because the post office saving deposits are not as liquid as Bank deposits.3.M3
It is also known as Broad Money.
M3 = M1+ Time Deposits with the Bank.
Time deposits serve as a store of wealth and represent a saving of the people and are not as liquid as they cannot be withdrawn through cheques or ATMs as compared to money deposited in Demand deposits.
M3 is the most popular and essential measure of the money supply. The monetary committee headed by late Prof Sukhamoy Chakravarty recommended its use for monetary planning in the economy. M3 is also called Aggregate Monetary Resource4.M4
M4 includes all items of M3 along with total deposits of post office saving accounts.
M4= M3+Total Deposits with Post Office Saving Organisations.
M4 however, excludes National Saving Certificates of Post Offices. -
Question 7 of 20
7. Question
1 pointsConsider the following statements regarding Balance of payments :
1. It includes all international transactions between a domestic country and Rest of the World
2. BOP surplus is always a good sign for the economy.Select the correct statements using the code below :
Correct
Tikdam/Interactive Theme: External Sector Similar question on External Sector was asked in UPSC Prelims consecutively from 2013 to 2016. Statement 2 is incorrect: Bop surplus need not to be good always.If the overall BOP surplus is caused by current account surplus (Excess of exports over imports), as opposed to capital account surplus, then the surplus may be good for economies. Notes: Balance of Payment It includes the sum of both Capital and Current account put together. It includes all international transactions between a host/domestic country and Rest of the World. It includes items of goods account, services account, unilateral transfers and capital accounts. Can an overall BOP surplus is a good sign? And BOP deficit is a bad sign? The above is not always true, and we have to dig deeper to understand the nature of surplus and deficits in overall BOP. If the overall BOP deficit is caused by Current account deficits (Excess of imports over exports), as opposed to capital account deficits, then BOP deficits are bad for countries. If the overall BOP surplus is caused by current account surplus (Excess of exports over imports), as opposed to capital account surplus, then the surplus may be good for economies. Tikdam: Statement 2 is an extreme statement as it uses the term ‘always’.Extreme statements are generally wrong.Using this fact,correct answer can be deduced
Incorrect
Tikdam/Interactive Theme: External Sector Similar question on External Sector was asked in UPSC Prelims consecutively from 2013 to 2016. Statement 2 is incorrect: Bop surplus need not to be good always.If the overall BOP surplus is caused by current account surplus (Excess of exports over imports), as opposed to capital account surplus, then the surplus may be good for economies. Notes: Balance of Payment It includes the sum of both Capital and Current account put together. It includes all international transactions between a host/domestic country and Rest of the World. It includes items of goods account, services account, unilateral transfers and capital accounts. Can an overall BOP surplus is a good sign? And BOP deficit is a bad sign? The above is not always true, and we have to dig deeper to understand the nature of surplus and deficits in overall BOP. If the overall BOP deficit is caused by Current account deficits (Excess of imports over exports), as opposed to capital account deficits, then BOP deficits are bad for countries. If the overall BOP surplus is caused by current account surplus (Excess of exports over imports), as opposed to capital account surplus, then the surplus may be good for economies. Tikdam: Statement 2 is an extreme statement as it uses the term ‘always’.Extreme statements are generally wrong.Using this fact,correct answer can be deduced
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Question 8 of 20
8. Question
1 pointsWhich of the following are known as the ‘Twin Deficits’:
Correct
Theme : External Sector
Similar question on External Sector was asked in UPSC Prelims consecutively from 2013 to 2016.
Notes :Fiscal Deficit and Current Account Deficit: The Twin Deficits
What is Fiscal Deficit?
The fiscal deficit is the difference between the government’s total expenditure and its total receipts (excluding borrowing). Fiscal deficit in layman’s terms corresponds to the borrowings and liabilities of the government. As per the technical definition, Fiscal Deficit = Budgetary Deficit + Borrowings and Other Liabilities of the government.What is Current Account Deficit (CAD)?
Current Account is the sum of the balance of trade (exports minus imports of goods and services), net factor income (such as interest and dividends) and net transfer payments (such as foreign aid).Dangers of twin deficit
Twin deficit basically refers to a situation where the country runs relatively large current account and fiscal deficits. Higher twin deficit is inherently destabilizing and was the primary reason why India faced a currency crisis back in 1991.
Higher current account deficit means higher demand for foreign currency, which results in depreciation of the domestic currency. It also discourages capital inflow and leads to capital flight from the country. Although all the signs are not yet visible in India as of now, the vulnerability has only increased.Incorrect
Theme : External Sector
Similar question on External Sector was asked in UPSC Prelims consecutively from 2013 to 2016.
Notes :Fiscal Deficit and Current Account Deficit: The Twin Deficits
What is Fiscal Deficit?
The fiscal deficit is the difference between the government’s total expenditure and its total receipts (excluding borrowing). Fiscal deficit in layman’s terms corresponds to the borrowings and liabilities of the government. As per the technical definition, Fiscal Deficit = Budgetary Deficit + Borrowings and Other Liabilities of the government.What is Current Account Deficit (CAD)?
Current Account is the sum of the balance of trade (exports minus imports of goods and services), net factor income (such as interest and dividends) and net transfer payments (such as foreign aid).Dangers of twin deficit
Twin deficit basically refers to a situation where the country runs relatively large current account and fiscal deficits. Higher twin deficit is inherently destabilizing and was the primary reason why India faced a currency crisis back in 1991.
Higher current account deficit means higher demand for foreign currency, which results in depreciation of the domestic currency. It also discourages capital inflow and leads to capital flight from the country. Although all the signs are not yet visible in India as of now, the vulnerability has only increased. -
Question 9 of 20
9. Question
1 pointsConsider the following statements regarding the indirect tax:
1. The impact and incidence of this tax lie on different people.
2. They are progressive in nature.
3. Corporate tax is an example of Indirect tax.
Select the correct answer using the code below:Correct
Theme : Taxation in India
Similar question on Taxation was asked in UPSC Prelims 2014,2017 and 2018.
Statement 2 is incorrect : They are regressive in nature
Statement 3 is incorrect : Corporate tax is an example of Indirect tax.
Notes:
Indirect Tax
1.Meaning : The tax that is levied by the government on one entity (Manufacturer of goods), but is passed on to the final consumer by the manufacturer.
2.Incidence : The incidence and impact of the tax fall on different persons.
3.Example : VAT, Service tax, GST, Excise duty, entertainment tax and Customs Duty.
4. Nature : They are regressive in nature.
5. Objective: Only Economical. When an indirect tax is levied on a product, both rich and poor must pay at the same rate. A person earning 10 lakh a month pays the same tax on the Wheat purchase as the person earning 3000 Re a month. This principle is called regressive taxation.
6.Impact : Is inflationary.Incorrect
Theme : Taxation in India
Similar question on Taxation was asked in UPSC Prelims 2014,2017 and 2018.
Statement 2 is incorrect : They are regressive in nature
Statement 3 is incorrect : Corporate tax is an example of Indirect tax.
Notes:
Indirect Tax
1.Meaning : The tax that is levied by the government on one entity (Manufacturer of goods), but is passed on to the final consumer by the manufacturer.
2.Incidence : The incidence and impact of the tax fall on different persons.
3.Example : VAT, Service tax, GST, Excise duty, entertainment tax and Customs Duty.
4. Nature : They are regressive in nature.
5. Objective: Only Economical. When an indirect tax is levied on a product, both rich and poor must pay at the same rate. A person earning 10 lakh a month pays the same tax on the Wheat purchase as the person earning 3000 Re a month. This principle is called regressive taxation.
6.Impact : Is inflationary. -
Question 10 of 20
10. Question
1 pointsConsider the following statements regarding Money Market:
1.It deals in financial assets whose period of maturity is upto one year.
2.Money market is regulated by SEBI.Correct
Theme : Financial Market
Similar question on Financial Market was asked in UPSC Prelims 2016.
Statement 2 is incorrect : Money market is regulated by RBI.Money Market
The money market is a market for short-term funds, which deals in financial assets whose period of maturity is upto one year. It should be noted that money market does not deal in cash or money as such but simply provides a market for credit instruments such as bills of exchange, promissory notes, commercial paper, treasury bills, etc. These financial instruments are close substitute of money. These instruments help the business units, other organisations and the Government to borrow the funds to meet their short-term requirement.The Indian money market consists of Reserve Bank of India, Commercial banks, Co-operative banks, and other specialised financial institutions. The Reserve Bank of India is the leader of the money market in India. Some Non-Banking Financial Companies (NBFCs) and financial institutions like LIC, GIC, UTI, etc. also operate in the Indian money market.
Incorrect
Theme : Financial Market
Similar question on Financial Market was asked in UPSC Prelims 2016.
Statement 2 is incorrect : Money market is regulated by RBI.Money Market
The money market is a market for short-term funds, which deals in financial assets whose period of maturity is upto one year. It should be noted that money market does not deal in cash or money as such but simply provides a market for credit instruments such as bills of exchange, promissory notes, commercial paper, treasury bills, etc. These financial instruments are close substitute of money. These instruments help the business units, other organisations and the Government to borrow the funds to meet their short-term requirement.The Indian money market consists of Reserve Bank of India, Commercial banks, Co-operative banks, and other specialised financial institutions. The Reserve Bank of India is the leader of the money market in India. Some Non-Banking Financial Companies (NBFCs) and financial institutions like LIC, GIC, UTI, etc. also operate in the Indian money market.
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Question 11 of 20
11. Question
1 pointsWith reference to External Commercial Borrowings(ECBs), consider the following statements:
1.It is an instrument used in India to facilitate access to foreign money by Indian corporations and PSUs.
2.ECB’s are primarily used for investment in the stock market.
3.Enforcement Directorate monitors and regulates ECB guidelines and policies.Correct
Theme : External Sector
Similar question on External Sector was asked in UPSC Prelims consecutively from 2013 to 2016.
Statement 2 is incorrect : ECBs cannot be used for investment in Stock Market or speculation in real estate.
Statement 3 is incorrect : The DEA (Department of Economic Affairs), Ministry of Finance, Government of India along with Reserve Bank of India, monitors and regulates ECB guidelines and policies
Notes:External Commercial Borrowings
An external commercial borrowing(ECB) is an instrument used in India to facilitate the access to foreign money by Indian corporations and PSUs (public sector undertakings). ECBs include commercial banks loans, buyers’ credit, suppliers’ credit, securitised instruments such as floating rate notes and fixed rate bonds etc., credit from official export credit agencies and commercial borrowings from the private sector window of multilateral financial institutions such as International Finance Corporation (Washington), ADB, AFIC, CDC, etc. ECBs cannot be used for investment in Stock Market or speculation in real estate.
The DEA (Department of Economic Affairs), Ministry of Finance, Government of India along with Reserve Bank of India, monitors and regulates ECB guidelines and policies. For infrastructure and greenfield projects, funding up to 50% (through ECB) is allowed. In telecom sector too, up to 50% funding through ECBs is allowed. Recently Government of India allowed borrowings in Chinese currency yuan. Corporate sectors can mobilize USD 750 million via automatic route, whereas service sectors and NGOs for microfinance can mobilize USD 200 million and 10 million respectively.
Borrowers can use 25 percent of the ECB to repay rupee debt and the remaining 75 per cent should be used for new projects. A borrower can not refinance its entire existing rupee loan through ECB. The money raised through ECB is cheaper given near-zero interest rates in the US and Europe, Indian companies can repay part of their existing expensive loans from that.Incorrect
Theme : External Sector
Similar question on External Sector was asked in UPSC Prelims consecutively from 2013 to 2016.
Statement 2 is incorrect : ECBs cannot be used for investment in Stock Market or speculation in real estate.
Statement 3 is incorrect : The DEA (Department of Economic Affairs), Ministry of Finance, Government of India along with Reserve Bank of India, monitors and regulates ECB guidelines and policies
Notes:External Commercial Borrowings
An external commercial borrowing(ECB) is an instrument used in India to facilitate the access to foreign money by Indian corporations and PSUs (public sector undertakings). ECBs include commercial banks loans, buyers’ credit, suppliers’ credit, securitised instruments such as floating rate notes and fixed rate bonds etc., credit from official export credit agencies and commercial borrowings from the private sector window of multilateral financial institutions such as International Finance Corporation (Washington), ADB, AFIC, CDC, etc. ECBs cannot be used for investment in Stock Market or speculation in real estate.
The DEA (Department of Economic Affairs), Ministry of Finance, Government of India along with Reserve Bank of India, monitors and regulates ECB guidelines and policies. For infrastructure and greenfield projects, funding up to 50% (through ECB) is allowed. In telecom sector too, up to 50% funding through ECBs is allowed. Recently Government of India allowed borrowings in Chinese currency yuan. Corporate sectors can mobilize USD 750 million via automatic route, whereas service sectors and NGOs for microfinance can mobilize USD 200 million and 10 million respectively.
Borrowers can use 25 percent of the ECB to repay rupee debt and the remaining 75 per cent should be used for new projects. A borrower can not refinance its entire existing rupee loan through ECB. The money raised through ECB is cheaper given near-zero interest rates in the US and Europe, Indian companies can repay part of their existing expensive loans from that. -
Question 12 of 20
12. Question
1 pointsWith reference to Tax Buoyancy, consider the following statements:
1. It is a measure of the responsiveness of the tax receipts with respect to GDP.
2. A tax is said to be buoyant if the tax revenues decrease more than proportionately in response to a rise in national income or output.
3. Tax Buoyancy is also known as bracket creep.Select the correct statements using the code below:
Correct
Theme : Taxation in India
Similar question on Taxation was asked in UPSC Prelims 2014,2017 and 2018.
Statement 2 is incorrect : A tax is considered buoyant when tax revenue increases with GDP.
Statement 3 is incorrect : Fiscal drag is also known as bracket creep.Notes:
Key Concepts Relating to TaxationTax Incidence
The key to imposing the tax is who bears its burden. If the person on whom the tax is imposed have the flexibility to transfer it on to the other person, then we say tax incidence has shifted. The shifting of tax form one person to the other is known as tax incidence.All indirect tax comes under this category. For all direct tax, the incidence of tax and burden lies with the same person.
Tax Avoidance
It refers to minimising the tax liabilities using an available source of exemptions and tax laws. It is by means of taking advantage of shortcomings of tax structure. It usually happens at the tax planning stage.Tax Evasion
It refers to reducing the tax liabilities using illegal measures. Tax evasion is a clear case of forgery of accounts as it uses measures which are unforbidden in law.Cascading Effect in Taxation
A Cascading tax is one, which is not just on final product value but also on the raw materials used as input. The tax is levied at every stage of production and distribution. It is a tax on tax.Tax Buoyancy
Tax buoyancy is a measure of the responsiveness of the tax receipts with respect to GDP.
A tax is considered buoyant when revenue increase by more than one percent if the GDP has increased by 1 percent.Fiscal drag
Fiscal drag is a concept where inflation and earnings growth may push more tax payers into higher tax brackets. Therefore, fiscal drag has the effect of raising government tax revenue without explicitly raising tax rates.Incorrect
Theme : Taxation in India
Similar question on Taxation was asked in UPSC Prelims 2014,2017 and 2018.
Statement 2 is incorrect : A tax is considered buoyant when tax revenue increases with GDP.
Statement 3 is incorrect : Fiscal drag is also known as bracket creep.Notes:
Key Concepts Relating to TaxationTax Incidence
The key to imposing the tax is who bears its burden. If the person on whom the tax is imposed have the flexibility to transfer it on to the other person, then we say tax incidence has shifted. The shifting of tax form one person to the other is known as tax incidence.All indirect tax comes under this category. For all direct tax, the incidence of tax and burden lies with the same person.
Tax Avoidance
It refers to minimising the tax liabilities using an available source of exemptions and tax laws. It is by means of taking advantage of shortcomings of tax structure. It usually happens at the tax planning stage.Tax Evasion
It refers to reducing the tax liabilities using illegal measures. Tax evasion is a clear case of forgery of accounts as it uses measures which are unforbidden in law.Cascading Effect in Taxation
A Cascading tax is one, which is not just on final product value but also on the raw materials used as input. The tax is levied at every stage of production and distribution. It is a tax on tax.Tax Buoyancy
Tax buoyancy is a measure of the responsiveness of the tax receipts with respect to GDP.
A tax is considered buoyant when revenue increase by more than one percent if the GDP has increased by 1 percent.Fiscal drag
Fiscal drag is a concept where inflation and earnings growth may push more tax payers into higher tax brackets. Therefore, fiscal drag has the effect of raising government tax revenue without explicitly raising tax rates. -
Question 13 of 20
13. Question
1 pointsWith reference to Capital Account Convertibility, consider the following statements:
1.It means the freedom to convert rupee into any foreign currency and foreign currency back into rupee for capital account transactions
2.Recently, full Capital Account Convertibility has been allowed in India.Correct
Theme : External Sector
Similar question on External Sector was asked in UPSC Prelims consecutively from 2013 to 2016.
Statement 2 is incorrect : India is still a country of partial convertibility (40:60) in the capital account.
Notes :
What does Capital Account Convertibility mean?CAC means the freedom to convert rupee into any foreign currency (Euro, Dollar, Yen, Renminbi etc.) and foreign currency back into rupee for capital account transactions. In very simple terms it means, Indian’s having the freedom to convert their local financial assets into foreign ones at market determined exchange rate. CAC will lead to a free exchange of currency at a lower rate and an unrestricted movement of capital.
Capital Account Convertibility in India:
After the recommendations of the S.S. Tarapore Committee (1997) on Capital Account Convertibility, India has been moving in the direction of allowing full convertibility in this account, but with required precautions. India is still a country of partial convertibility (40:60) in the capital account, but inside this overall policy, enough reforms have been made, and to certain levels of foreign exchange requirements, it is an economy allowing full capital account convertibility. Following steps have been taken in the direction of capital account convertibility.
Indian corporate is allowed full convertibility in the automatic route up to $ 500 million overseas ventures (investment by Ltd. companies in foreign countries allowed).
Indian corporate is allowed to prepay their external commercial borrowings (ECBs) via automatic route if the loan is above $ 500 million.
Individuals are allowed to invest in foreign assets, shares, etc., up to the level of $ 2,50,000 per annum.
Unlimited amount of gold is allowed to be imported (this is equal to allowing full convertibility in the capital account via current account route, but not feasible for everybody) which is not allowed now.
The Second Committee on the Capital Account Convertibility (CAC)— again chaired by S.S. Tarapore— handed over its report in September 2006 on which the RBI/the government is having consultations.Incorrect
Theme : External Sector
Similar question on External Sector was asked in UPSC Prelims consecutively from 2013 to 2016.
Statement 2 is incorrect : India is still a country of partial convertibility (40:60) in the capital account.
Notes :
What does Capital Account Convertibility mean?CAC means the freedom to convert rupee into any foreign currency (Euro, Dollar, Yen, Renminbi etc.) and foreign currency back into rupee for capital account transactions. In very simple terms it means, Indian’s having the freedom to convert their local financial assets into foreign ones at market determined exchange rate. CAC will lead to a free exchange of currency at a lower rate and an unrestricted movement of capital.
Capital Account Convertibility in India:
After the recommendations of the S.S. Tarapore Committee (1997) on Capital Account Convertibility, India has been moving in the direction of allowing full convertibility in this account, but with required precautions. India is still a country of partial convertibility (40:60) in the capital account, but inside this overall policy, enough reforms have been made, and to certain levels of foreign exchange requirements, it is an economy allowing full capital account convertibility. Following steps have been taken in the direction of capital account convertibility.
Indian corporate is allowed full convertibility in the automatic route up to $ 500 million overseas ventures (investment by Ltd. companies in foreign countries allowed).
Indian corporate is allowed to prepay their external commercial borrowings (ECBs) via automatic route if the loan is above $ 500 million.
Individuals are allowed to invest in foreign assets, shares, etc., up to the level of $ 2,50,000 per annum.
Unlimited amount of gold is allowed to be imported (this is equal to allowing full convertibility in the capital account via current account route, but not feasible for everybody) which is not allowed now.
The Second Committee on the Capital Account Convertibility (CAC)— again chaired by S.S. Tarapore— handed over its report in September 2006 on which the RBI/the government is having consultations. -
Question 14 of 20
14. Question
1 pointsWith reference to the Marginal Cost of Funds based Lending Rate, consider the following statements :
1.It refers to the minimum interest rate of a bank below which it cannot lend,
2.Lending rates based on the marginal cost of funds are more sensitive to changes in the policy rates by RBI.Select the correct statements using the code below :
Correct
Conceptual
Theme : Banking in India
Banking is always a hot topic and similar question on Monetary Policy was asked in UPSC Prelims consecutively from 2013 to 2018.
Notes:.
The marginal cost of funds based lending rate (MCLR) refers to the minimum interest rate of a bank below which it cannot lend, except in some cases allowed by the RBI. It is an internal benchmark or reference rate for the bank.MCLR actually describes the method by which the minimum interest rate for loans is determined by a bank – on the basis of marginal cost or the additional or incremental cost of arranging one more rupee to the prospective borrower.
The MCLR methodology for fixing interest rates for advances was introduced by the Reserve Bank of India with effect from April 1, 2016. This new methodology replaced the base rate system introduced in July 2010.
RBI decided to shift from base rate to MCLR because the rates based on marginal cost of funds are more
sensitive to changes in the policy rates. This is very essential for the effective implementation of monetary
policy. Prior to MCLR system, different banks were following different methodology for calculation of
base rate /minimum rate – that is either on the basis of average cost of funds or marginal cost of funds or
blended cost of funds. Thus, MCLR aims
To improve the transmission of policy rates into the lending rates of banks. Hence statement 2 is correct.
To bring transparency in the methodology followed by banks for determining interest rates on advances.
To ensure availability of bank credit at interest rates which are fair to borrowers as well as banks.
To enable banks to become more competitive and enhance their long run value and contribution to economic growth.Incorrect
Conceptual
Theme : Banking in India
Banking is always a hot topic and similar question on Monetary Policy was asked in UPSC Prelims consecutively from 2013 to 2018.
Notes:.
The marginal cost of funds based lending rate (MCLR) refers to the minimum interest rate of a bank below which it cannot lend, except in some cases allowed by the RBI. It is an internal benchmark or reference rate for the bank.MCLR actually describes the method by which the minimum interest rate for loans is determined by a bank – on the basis of marginal cost or the additional or incremental cost of arranging one more rupee to the prospective borrower.
The MCLR methodology for fixing interest rates for advances was introduced by the Reserve Bank of India with effect from April 1, 2016. This new methodology replaced the base rate system introduced in July 2010.
RBI decided to shift from base rate to MCLR because the rates based on marginal cost of funds are more
sensitive to changes in the policy rates. This is very essential for the effective implementation of monetary
policy. Prior to MCLR system, different banks were following different methodology for calculation of
base rate /minimum rate – that is either on the basis of average cost of funds or marginal cost of funds or
blended cost of funds. Thus, MCLR aims
To improve the transmission of policy rates into the lending rates of banks. Hence statement 2 is correct.
To bring transparency in the methodology followed by banks for determining interest rates on advances.
To ensure availability of bank credit at interest rates which are fair to borrowers as well as banks.
To enable banks to become more competitive and enhance their long run value and contribution to economic growth. -
Question 15 of 20
15. Question
1 pointsWhich of the following statement is incorrect with reference to Floating Exchange Rate :
Correct
Theme : External Sector
Option d is incorrect : Under Floating Exchange Rate,the exchange rate is determined in well-functioning foreign exchange markets with no government interference.The exchange rate reflects the true value of the domestic currency which helps in establishing the trust among foreign investor.
Similar question on External Sector was asked in UPSC Prelims consecutively from 2013 to 2016.
Notes:
Under this system, the market is allowed to determine the value of exchange rate freely.
The exchange rate is determined by the forces of demand and supply.
If due to any reason exchange rate fluctuates, the government never intervenes and allows the market to function and determine the true value of exchange rate.
The only demerit of floating exchange rate system is that exchange rate fluctuates a lot on day to day basis.
The advantages of such a system are: the exchange rate is determined in well-functioning foreign exchange markets with no government interference.
The exchange rate reflects the true value of the domestic currency which helps in establishing the trust among foreign investor.A country can easily access funds/ loans from IMF and other international institutions if the exchange rate is market determined.
Incorrect
Theme : External Sector
Option d is incorrect : Under Floating Exchange Rate,the exchange rate is determined in well-functioning foreign exchange markets with no government interference.The exchange rate reflects the true value of the domestic currency which helps in establishing the trust among foreign investor.
Similar question on External Sector was asked in UPSC Prelims consecutively from 2013 to 2016.
Notes:
Under this system, the market is allowed to determine the value of exchange rate freely.
The exchange rate is determined by the forces of demand and supply.
If due to any reason exchange rate fluctuates, the government never intervenes and allows the market to function and determine the true value of exchange rate.
The only demerit of floating exchange rate system is that exchange rate fluctuates a lot on day to day basis.
The advantages of such a system are: the exchange rate is determined in well-functioning foreign exchange markets with no government interference.
The exchange rate reflects the true value of the domestic currency which helps in establishing the trust among foreign investor.A country can easily access funds/ loans from IMF and other international institutions if the exchange rate is market determined.
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Question 16 of 20
16. Question
1 pointsTax on any market activity that generates negative externalities is called
Correct
Theme : Taxation In India
Notes:
A Pigovian tax (also spelled Pigouvian tax) is a tax on any market activity that generates negative externalities (costs not included in the market price). The tax is intended to correct an undesirable or inefficient market outcome, and does so by being set equal to the social cost of the negative externalities.
The Tobin tax is a tax on spot currency conversions that was originally proposed with the intention of penalizing short-term currency speculation. Rather than a consumption tax paid by consumers, the Tobin tax was meant to apply to financial sector participants as a means of controlling the stability of a given country’s currency.
A ghetto tax is a term used to describe how people with low incomes pay higher prices for goods and services, particularly those living in poverty-stricken areas.
A sin tax is an excise tax specifically levied on certain goods deemed harmful to society, for example alcohol and tobacco, candies, drugs, soft drinks, fast foods, coffee, sugar, gambling etc.Incorrect
Theme : Taxation In India
Notes:
A Pigovian tax (also spelled Pigouvian tax) is a tax on any market activity that generates negative externalities (costs not included in the market price). The tax is intended to correct an undesirable or inefficient market outcome, and does so by being set equal to the social cost of the negative externalities.
The Tobin tax is a tax on spot currency conversions that was originally proposed with the intention of penalizing short-term currency speculation. Rather than a consumption tax paid by consumers, the Tobin tax was meant to apply to financial sector participants as a means of controlling the stability of a given country’s currency.
A ghetto tax is a term used to describe how people with low incomes pay higher prices for goods and services, particularly those living in poverty-stricken areas.
A sin tax is an excise tax specifically levied on certain goods deemed harmful to society, for example alcohol and tobacco, candies, drugs, soft drinks, fast foods, coffee, sugar, gambling etc. -
Question 17 of 20
17. Question
1 pointsConsider the following statements regarding the Liquidity Trap:
1. The prevailing interest rate is very low.
2. The conventional monetary policies do not yield any desired result during a liquidity trap.
3. It is a situation that is generally faced by emerging economies.
Select the correct statements using the code given below:Correct
Theme : Monetary Policy
Similar question on Monetary Policy was asked in UPSC Prelims consecutively from 2013 to 2015.
Statement 3 is incorrect : Developed economies generally go through liquidity trap.
Notes:
What is the ‘Liquidity Trap’
The liquidity trap is the situation in which the current interest rates are low and savings rates are high, rendering monetary policy ineffective. In a liquidity trap, consumers choose to avoid bonds and keep their funds in savings because of the prevailing belief that interest rates will soon rise. Because bonds have an inverse relationship to interest rates, many consumers do not want to hold an asset with a price that is expected to decline.As part of the liquidity trap, consumers continue to hold funds in standard deposit accounts, such as savings and checking accounts, instead of in other investment options, even when the central banking system attempts to stimulate the economy through the injection of additional funds. These consumer actions, often spurred by the belief of a negative economic event on the horizon, cause the monetary policy to be generally ineffective.
Incorrect
Theme : Monetary Policy
Similar question on Monetary Policy was asked in UPSC Prelims consecutively from 2013 to 2015.
Statement 3 is incorrect : Developed economies generally go through liquidity trap.
Notes:
What is the ‘Liquidity Trap’
The liquidity trap is the situation in which the current interest rates are low and savings rates are high, rendering monetary policy ineffective. In a liquidity trap, consumers choose to avoid bonds and keep their funds in savings because of the prevailing belief that interest rates will soon rise. Because bonds have an inverse relationship to interest rates, many consumers do not want to hold an asset with a price that is expected to decline.As part of the liquidity trap, consumers continue to hold funds in standard deposit accounts, such as savings and checking accounts, instead of in other investment options, even when the central banking system attempts to stimulate the economy through the injection of additional funds. These consumer actions, often spurred by the belief of a negative economic event on the horizon, cause the monetary policy to be generally ineffective.
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Question 18 of 20
18. Question
1 pointsWith reference to the Balance of Payment(BOP) crisis, consider the following statements:
1.A high current account deficit necessarily leads to a BOP crisis.
2.As a measure to come out of BOP crisis, the currency is usually devalued by the central bank.Select the correct statements using the code below:
Correct
Theme : External Sector
Statement 1 is incorrect : A high current account deficit does not necessarily leads to a BOP crisis.For instance there was high current account deficit in 2013 but India has sufficient Foreign exchange reserve to account for that deficit.
Notes:
1991 CRISIS
Towards the end of 1980s, India was facing a Balance of Payments (BoP) crisis, due to unsustainable borrowing and high expenditure. The Current Account Deficit (3.5 percent) in 1990-91 massively weakened the ability to finance deficit.
The main causes behind the Balance of Payments crisis of 1990-91 were as follows:Break-up of the Soviet Bloc: Rupee trade (payment for trade was made in rupees) with the Soviet Bloc was an important element of India’s total trade up to the 1980s. However, the introduction of Glasnost and Perestroika and the break-up of the Eastern European countries led to termination of several rupee payment agreements in 1990-91. As a consequence, the flow of new rupee trade credits declined abruptly in 1990-91. Further, there was also a decline in our exports to Eastern Europe—these exports constituted 22 .1 percent of total exports in 1980 and 19.3 percent in 1989; but they declined to 17.9 percent in 1990-91 and further to 10.9 percent in 1991-92.
Iraq-Kuwait War: The Gulf crisis began with the invasion of Kuwait by Iraq at the beginning of August 1990. Crude oil prices rose rapidly thereafter–from USD 15 per barrel in July 1990 to USD 35 per barrel in October 1990. Iraq and Kuwait were the major sources of India’s oil imports and the war made it necessary to buy oil from the spot market. Short term purchases from the spot market had to be followed up by new long term contracts at higher prices. As a result, the oil import bill increased by about 60 percent in 1990-91 and remained 40 percent above the 1989-90 level the next year. As noted in Economic Survey (1991-92):
“The immediate cause of the loss of reserves beginning in September 1990 was a sharp rise in the imports of oil and petroleum products (from an average of $ 287 million in June-August 1990, petroleum products imports rose sharply to $ 671 million in 6 months). This accounted for rise in trade deficit from an average of $ 356 million per month in June-August 1990 to $ 677 million per month in the following 6 months.”
Slow Growth of Important Trading Partners: The deterioration of the current account was also induced by slow growth in economies of important trading partners. Export markets were weak in the period leading up to India’s crisis, as the world growth declined steadily from 4.5 percent in 1988 to 2.25 percent in 1991. The decline was even greater for the U.S., India’s single largest export destination. In the United States, growth fell from 3.9 percent in 1988 to 0.8 percent in 1990 and to -1 percent in 1991.
Political Uncertainty and Instability: The period from November 1989 to May 1991 was marked with political uncertainty and instability in India. In fact, within a span of one and half years there were three coalition governments and three Prime Ministers. This led to delay in tackling the ongoing balance of payment crisis, and also led to a loss of investor confidence.
Loss of Investors’ Confidence: The widening current account deficits and reserve losses contributed to low investor confidence, which was further weakened by political uncertainty. This was aggravated by the downgrade of India’s credit rating by credit rating agencies. By March 1991, the International Credit Rating agencies Standard & Poor’s, and Moody’s, had downgraded India’s long term foreign debt rating to the bottom of investment grade. Due to the loss of investors’ confidence, commercial bank financing became hard to obtain, and outflows began to take place on short-term external debt, as creditors became reluctant to roll over maturing loans.
Fiscal Indiscipline: The Economic Survey (1991-92) had categorically remarked that:
“Throughout the eighties, all the important indicators of fiscal imbalances were on the rise. These were the conventional budgetary deficit, the revenue deficit, the monetized deficit and gross fiscal deficit. Moreover, the concept of fiscal deficit is a more complete measure of macroeconomic imbalance as it reflects the indebtedness of the Government. This gross fiscal deficit of the Central Government has been more than 8 percent of GDP since 1985 – 86, as compared with 6 percent in the beginning of 1980s and 4 percent in the mid – 1970s.”
Increase in Non-oil Imports: The trends in imports and exports show that imports rose much faster than exports during the eighties. Imports increased by 2.3 percent of GDP, while exports increased by only 0.3 percent of GDP. As a consequence, trade deficit increased from an average of 1.2 percent of GDP in the seventies, to 3.2 percent of GDP in eighties.Incorrect
Theme : External Sector
Statement 1 is incorrect : A high current account deficit does not necessarily leads to a BOP crisis.For instance there was high current account deficit in 2013 but India has sufficient Foreign exchange reserve to account for that deficit.
Notes:
1991 CRISIS
Towards the end of 1980s, India was facing a Balance of Payments (BoP) crisis, due to unsustainable borrowing and high expenditure. The Current Account Deficit (3.5 percent) in 1990-91 massively weakened the ability to finance deficit.
The main causes behind the Balance of Payments crisis of 1990-91 were as follows:Break-up of the Soviet Bloc: Rupee trade (payment for trade was made in rupees) with the Soviet Bloc was an important element of India’s total trade up to the 1980s. However, the introduction of Glasnost and Perestroika and the break-up of the Eastern European countries led to termination of several rupee payment agreements in 1990-91. As a consequence, the flow of new rupee trade credits declined abruptly in 1990-91. Further, there was also a decline in our exports to Eastern Europe—these exports constituted 22 .1 percent of total exports in 1980 and 19.3 percent in 1989; but they declined to 17.9 percent in 1990-91 and further to 10.9 percent in 1991-92.
Iraq-Kuwait War: The Gulf crisis began with the invasion of Kuwait by Iraq at the beginning of August 1990. Crude oil prices rose rapidly thereafter–from USD 15 per barrel in July 1990 to USD 35 per barrel in October 1990. Iraq and Kuwait were the major sources of India’s oil imports and the war made it necessary to buy oil from the spot market. Short term purchases from the spot market had to be followed up by new long term contracts at higher prices. As a result, the oil import bill increased by about 60 percent in 1990-91 and remained 40 percent above the 1989-90 level the next year. As noted in Economic Survey (1991-92):
“The immediate cause of the loss of reserves beginning in September 1990 was a sharp rise in the imports of oil and petroleum products (from an average of $ 287 million in June-August 1990, petroleum products imports rose sharply to $ 671 million in 6 months). This accounted for rise in trade deficit from an average of $ 356 million per month in June-August 1990 to $ 677 million per month in the following 6 months.”
Slow Growth of Important Trading Partners: The deterioration of the current account was also induced by slow growth in economies of important trading partners. Export markets were weak in the period leading up to India’s crisis, as the world growth declined steadily from 4.5 percent in 1988 to 2.25 percent in 1991. The decline was even greater for the U.S., India’s single largest export destination. In the United States, growth fell from 3.9 percent in 1988 to 0.8 percent in 1990 and to -1 percent in 1991.
Political Uncertainty and Instability: The period from November 1989 to May 1991 was marked with political uncertainty and instability in India. In fact, within a span of one and half years there were three coalition governments and three Prime Ministers. This led to delay in tackling the ongoing balance of payment crisis, and also led to a loss of investor confidence.
Loss of Investors’ Confidence: The widening current account deficits and reserve losses contributed to low investor confidence, which was further weakened by political uncertainty. This was aggravated by the downgrade of India’s credit rating by credit rating agencies. By March 1991, the International Credit Rating agencies Standard & Poor’s, and Moody’s, had downgraded India’s long term foreign debt rating to the bottom of investment grade. Due to the loss of investors’ confidence, commercial bank financing became hard to obtain, and outflows began to take place on short-term external debt, as creditors became reluctant to roll over maturing loans.
Fiscal Indiscipline: The Economic Survey (1991-92) had categorically remarked that:
“Throughout the eighties, all the important indicators of fiscal imbalances were on the rise. These were the conventional budgetary deficit, the revenue deficit, the monetized deficit and gross fiscal deficit. Moreover, the concept of fiscal deficit is a more complete measure of macroeconomic imbalance as it reflects the indebtedness of the Government. This gross fiscal deficit of the Central Government has been more than 8 percent of GDP since 1985 – 86, as compared with 6 percent in the beginning of 1980s and 4 percent in the mid – 1970s.”
Increase in Non-oil Imports: The trends in imports and exports show that imports rose much faster than exports during the eighties. Imports increased by 2.3 percent of GDP, while exports increased by only 0.3 percent of GDP. As a consequence, trade deficit increased from an average of 1.2 percent of GDP in the seventies, to 3.2 percent of GDP in eighties. -
Question 19 of 20
19. Question
1 pointsWith reference to India’s India’s Tax-GDP Ratio,consider the following statements:
1.Over past one decade,India’s Tax-GDP Ratio has steadily decreased.
2. Low per capita income, low average income and high poverty are some of the reasons for low Tax-GDP ratio in India.
Select the correct statements using the code below :Correct
Theme : Taxation In India
Statement 1 is incorrect : Over past one decade,India’s Tax-GDP Ratio has steadily decreased
Notes:India’s Tax-GDP Ratio
In 1950-51, India’s tax-GDP Ratio was around 6% only. It rose to around 10% in 2010-11. In last few years, the tax-GDP Ratio has increased substantially but still India is very far from being a full tax-paying democracy. It’s worth note that only 5.5% of earning people in India pay tax while only 15.5% of the Net National Income is reported to the tax authorities. Further, at present, India has 7 taxpayers for every 100 voters ranking us 13th amongst 18 of our democratic G-20 peers. Ideally, this number should be close to 23%. Due to under-tax compliance and narrow tax net, the tax-to-GDP ratio of the country stands at around 16-17%. This is much below the developed countries for example; the tax-GDP ratio in OECD countries is around 34%.
Reasons for Low Tax GDP RatioThere are several reasons for low-tax-GDP ratio.
Firstly, as mentioned above, India has a low population of taxpayers. Low per capita income, low average income and high poverty are key reasons for this.Secondly, those who pay tax either pay less due to exemptions or under-report the income. One example is unorganized sector and MSMEs. MSMEs have strong profitability but government is generally not able to capture their earnings in tax revenues due to variety of exemptions, compliance issues etc.
Thirdly, service tax in India was imposed late and imposed only on few sectors. Its share has been traditionally low in gross tax revenues of the government. Currently, services comprise about 60% of the GDP, yet the service tax collected is 15% of the Gross Tax Revenue
Incorrect
Theme : Taxation In India
Statement 1 is incorrect : Over past one decade,India’s Tax-GDP Ratio has steadily decreased
Notes:India’s Tax-GDP Ratio
In 1950-51, India’s tax-GDP Ratio was around 6% only. It rose to around 10% in 2010-11. In last few years, the tax-GDP Ratio has increased substantially but still India is very far from being a full tax-paying democracy. It’s worth note that only 5.5% of earning people in India pay tax while only 15.5% of the Net National Income is reported to the tax authorities. Further, at present, India has 7 taxpayers for every 100 voters ranking us 13th amongst 18 of our democratic G-20 peers. Ideally, this number should be close to 23%. Due to under-tax compliance and narrow tax net, the tax-to-GDP ratio of the country stands at around 16-17%. This is much below the developed countries for example; the tax-GDP ratio in OECD countries is around 34%.
Reasons for Low Tax GDP RatioThere are several reasons for low-tax-GDP ratio.
Firstly, as mentioned above, India has a low population of taxpayers. Low per capita income, low average income and high poverty are key reasons for this.Secondly, those who pay tax either pay less due to exemptions or under-report the income. One example is unorganized sector and MSMEs. MSMEs have strong profitability but government is generally not able to capture their earnings in tax revenues due to variety of exemptions, compliance issues etc.
Thirdly, service tax in India was imposed late and imposed only on few sectors. Its share has been traditionally low in gross tax revenues of the government. Currently, services comprise about 60% of the GDP, yet the service tax collected is 15% of the Gross Tax Revenue
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Question 20 of 20
20. Question
1 pointsConsider the following statements regarding the Liquidity Trap:
1. The prevailing interest rate is very low.
2. The conventional monetary policies do not yield any desired result during a liquidity trap.
3. It is a situation that is generally faced by emerging economies.
Select the correct statements using the code given below:Correct
Theme : Monetary Policy
Similar question on Monetary Policy was asked in UPSC Prelims consecutively from 2013 to 2015.
Statement 3 is incorrect : Developed economies generally go through liquidity trap.
Notes:
What is the ‘Liquidity Trap’
The liquidity trap is the situation in which the current interest rates are low and savings rates are high, rendering monetary policy ineffective. In a liquidity trap, consumers choose to avoid bonds and keep their funds in savings because of the prevailing belief that interest rates will soon rise. Because bonds have an inverse relationship to interest rates, many consumers do not want to hold an asset with a price that is expected to decline.As part of the liquidity trap, consumers continue to hold funds in standard deposit accounts, such as savings and checking accounts, instead of in other investment options, even when the central banking system attempts to stimulate the economy through the injection of additional funds. These consumer actions, often spurred by the belief of a negative economic event on the horizon, causes monetary policy to be generally ineffective.
Incorrect
Theme : Monetary Policy
Similar question on Monetary Policy was asked in UPSC Prelims consecutively from 2013 to 2015.
Statement 3 is incorrect : Developed economies generally go through liquidity trap.
Notes:
What is the ‘Liquidity Trap’
The liquidity trap is the situation in which the current interest rates are low and savings rates are high, rendering monetary policy ineffective. In a liquidity trap, consumers choose to avoid bonds and keep their funds in savings because of the prevailing belief that interest rates will soon rise. Because bonds have an inverse relationship to interest rates, many consumers do not want to hold an asset with a price that is expected to decline.As part of the liquidity trap, consumers continue to hold funds in standard deposit accounts, such as savings and checking accounts, instead of in other investment options, even when the central banking system attempts to stimulate the economy through the injection of additional funds. These consumer actions, often spurred by the belief of a negative economic event on the horizon, causes monetary policy to be generally ineffective.
Check answer of Question 1 if it is correct or not.