Capital Inflows And Policy

FDI involves direct investment in physical assets or a significant degree of control or influence in the management of a company in a foreign country. It often focuses on specific sectors, such as manufacturing or infrastructure. On the other hand, FII refers to investments made by foreign institutions, such as mutual funds, hedge funds, and pension funds, into the financial markets of a country. FIIs usually invest in a broader range of securities, and their investments can help increase capital availability across various sectors of the economy.

Foreign direct investment (FDI) is an investment made by a firm or individual in one country into business interests located in another country. Foreign direct investments can be made in a variety of ways, including the opening of a subsidiary or associate company in a foreign country, acquiring a controlling interest in an existing foreign company, or by means of a merger or joint venture with a foreign company. Foreign direct investments are distinguished from portfolio investments in which an investor merely purchases equities of foreign-based companies. Therefore, the correct answer includes the first three options but not the fourth.

**Statement 1 is Incorrect:** Share of agriculture in GDP has actually decreased since 1991, as the service sector has grown significantly. **Statement 2 is Correct:** Share of India's exports in world trade has increased. India has become a more integrated part of the global economy, with a larger export footprint. **Statement 3 is Correct:** FDI inflows have increased considerably. The liberalisation measures made India a more attractive destination for foreign investment. **Statement 4 is Correct:** India's foreign exchange reserves have also increased enormously. This reflects India's improved ability to generate foreign currency and manage its external finances. Therefore, the correct answer is 2, 3, and 4 only. Hence, option B is the correct answer.

**Option A is incorrect.** Foreign Direct Investment (FDI) typically involves investment in unlisted companies or companies that involve a direct ownership stake, not just investments through capital instruments in listed companies. **Option B is correct.** FDI is considered a non-debt creating capital flow because it involves equity investments that do not require repayment, unlike loans or debt instruments. This type of investment brings in long-term capital and management expertise, which helps in the development of industries in the host country. **Option C is incorrect.** FDI does not involve debt-servicing. Unlike loans or bonds, FDI involves ownership stakes, and thus, there is no obligation to pay interest or principal repayments. **Option D is incorrect.** The investment in Government securities by foreign institutional investors (FIIs) is considered foreign portfolio investment (FPI), not FDI. FDI focuses on acquiring a substantial ownership stake in a company, whereas FPI involves short-term investments in financial assets.  Hence, option B is the correct answer.

Foreign Direct Investment (FDI) typically involves a long-term interest and control in a company. However, the definition includes specific instruments and thresholds. **Statement 1 and 3 are correct:** Foreign Currency Convertible Bonds (FCCBs) and Global Depository Receipts (GDRs) are instruments used by Indian companies to raise capital abroad. Since these are essentially precursors to equity (convertible to shares) or represent underlying shares, they are treated as part of the FDI policy framework and statistics under the "Foreign Investment" category. **Statement 2 is correct:** Foreign Institutional Investment (FII)—now largely subsumed under Foreign Portfolio Investment (FPI)—is generally considered short-term. However, with certain conditions, it becomes FDI. According to international standards and the Arvind Mayaram Committee recommendations adopted by India, if an FPI holds a stake of 10% or more in a company, it is reclassified and treated as FDI. **Statement 4 is incorrect:** Non-Resident External (NRE) deposits are simply bank accounts held by NRIs in India. These are classified as External Debt (if repatriable) or Banking Capital, not foreign investment in a productive enterprise.

Tight monetary policy is an action taken by a central bank, such as the Federal Reserve, to curb overheated economic growth. Central banks employ tight monetary policy when an economy is experiencing rapid acceleration or when inflation, which pertains to overall prices, is escalating too swiftly. **Statement 1 is correct.** A tight monetary policy by the US Federal Reserve means higher interest rates in the US. This attracts global investors to shift their capital towards US assets for better returns. As a result, there can be capital flight from emerging markets like India to the US. **Statement 2 is correct.** When capital flows out, the domestic currency tends to depreciate, and global interest rates rise. Firms that have borrowed in foreign currencies through External Commercial Borrowings (ECBs) will now face higher repayment costs in rupee terms. Thus, their cost of servicing these loans increases, raising their overall financial burden. **Statement 3 is incorrect.** Devaluation of the domestic currency actually increases the currency risk associated with ECBs. Since these loans are denominated in foreign currency (like USD), a weaker rupee means firms have to pay more in rupees to repay the same amount of foreign debt. Therefore, devaluation heightens, not reduces, currency risk. **NOTE**: The given question was dropped by UPSC from the Official Answer Key.