Macroeconomic impacts of US Federal Reserve policies on external commercial borrowings
Question
Consider the following statements: Which of the statements given above are correct?
- 1.
Tight monetary policy of US Federal Reserve could lead to capital flight.
- 2.
Capital flight may increase the interest cost of firms with existing External Commercial Borrowings (ECBs).
- 3.
Devaluation of domestic currency decreases the currency risk associated with ECBs.
Options
1 and 2 only
2 and 3 only
1 and 3 only
1, 2 and 3
Explanation
Statements 1 and 2 are correct. A tight monetary policy in the US (raising interest rates) attracts investors, causing capital flight from emerging markets. This capital flight depreciates the local currency, which mathematically increases the interest cost burden for domestic firms holding foreign-currency-denominated External Commercial Borrowings (ECBs). Statement 3 is definitively incorrect; devaluation of the domestic currency heavily increases (not decreases) the currency risk and repayment burden of ECBs.
Answer: (a).
Question details
Year
2022
Paper
GS Paper 1
Question
Q61
Subject
Economy
Sub-topic
External Sector & Trade
Type
Statement-based
Difficulty
Medium
Nature
Current-affairs-linked
Source hint
NCERT Economy Cl.12 Ch.6 / Capital Flight Exchange Depreciations
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