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UPSC Civil Services 2015 Prelims General Studies Paper II

PASSAGE - 2
The Global Financial Stability Report finds that the share of portfolio investments from advanced economies in the total debt and equity investments in emerging economies has doubled in the past decade to 12 percent. The phenomenon has implications for Indian policy makers as foreign portfolio investments in the debt and equity markets have been on the rise. The phenomenon is also flagged as a threat that could compromise global financial stability in a chain reaction, in the event of United States Federal Reserve's imminent reversal of its "Quantitative Easing" policy

Question : 62

Total: 80

Which among the following is the most rational and critical inference that can be made from the above passage?

Foregin portfolio investments are not good for emerging economies.
Advanced economies undermine the global financial stability.
India should desist from accepting foreign portfolio investments in the future.
Emerging economies are at a risk of shock from advanced economies.

Validate

Solution:

The passage asks for the most rational and critical inference from the passage. (a) is wrong as it just portrays one part of the passage. The portfolio investments have both the good and bad effects. (b) is wrong as the passage suggests threat from the portfolio investments. It cannot be stated from the passage that Advanced economies will always undermine the global financial stability. There are a lot of other external factors working simultaneously. For similar reasons (c) is wrong. (d) is the most rational and critical inference as portfolio investments definitely impacts emerging economies in certain cases so there is a risk.
Note : Portfolio investments: Portfolio investments are passive investments, as they do not entail active management or control of the issuing company. Rather, the purpose of the investment is solely financial gain. This is in contrast to foreign direct investment (FDI), which allows an investor to exercise a certain degree of managerial control over a company. For international transactions, equity investments where the owner holds less than 10% of a company's shares are classified as portfolio investments. These transactions are also referred to as "portfolio flows" and are recorded in the financial account of a country's balance of payments.Portfolio investments include transactions in equity securities, such as common stock, and debt securities, such as banknotes, bonds, and debentures.
Quantitative Easing: Quantitative easing (QE) is a type of monetary policy used by central banks to stimulate the economy when standard monetary policy has become ineffective. A central bank implements quantitative easing by buying financial assets from commercial banks and other financial institutions, thus raising the prices of those financial assets and lowering their yield, while simultaneously increasing the money supply. This differs from the more usual policy of buying or selling short-term government bonds to keep interbank interest rates at a specified target value.
Quantitative easing can help ensure that inflation does not fall below a target. Risks include the policy being more effective than intended in acting against deflation (leading to higher inflation in the longer term, due to increased money supply), or not being effective enough if banks do not lend out the additional reserves.

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