Nikaalo Prelims Spotlight || External Sectors of India

Dear Aspirants,

This Spotlight is a part of our Mission Nikaalo Prelims-2023.

You can check the broad timetable of Nikaalo Prelims here

Session Details

YouTube LIVE with Parth sir – 1 PM  – Prelims Spotlight Session

Evening 04 PM  – Daily Mini Tests

Telegram LIVE with Sukanya ma’am – 06 PM  – Current Affairs Session

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15th Mar 2023

External Sectors of India 

All economic activities of an economy which take place in foreign currency fall in the external sector such as balanced of payment, export, import, foreign investment, external debt, current account, capital account, exchange rates etc.


Foreign exchange reserves are assets denominated in a foreign currency that are held on reserve by a central bank. These may include foreign currencies, bonds, treasury bills and other government securities.


Forex Reserves Consist of:


• Bank deposits

• Gold

• Special drawing rights (SDRS)

• Reserve tranche position (RTP)

• Foreign currency assets (FCA)

• Government securities



• SDR is an international reserve asset, created by the IMF in 1969.

• Value of the SDR is based on a basket of five currencies- Dollar, Euro, Renminbi, Yen, and Pound Sterling.

• It is neither a currency nor a claim on the IMF. Rather, it is a potential claim on the freely usable currencies of IMF members.


Exchange rate is Price at which one currency is converted into or exchanged for another currency.

Various Exchange rates mechanism:





Complete intervention of Authority (government or central bank) in determination of the currency exchange rate.

Market forces(demand and supply) determine the value of currency

No role of authority

Exchange rate is largely determined by market forces.

In crisis, central banks may intervene to stabilize the exchange rate



Nominal Effective Exchange Rate (NEER)

Real Effective Exchange Rate (REER)

Weighted average of bilateral nominal exchange rates of the home currency in terms of foreign currencies

Weighted average of nominal exchange rates, adjusted for inflation.

It is the exchange rate of one currency against a basket of currencies, weighted according to trade with each country (not adjusted for inflation).

Is calculated on the basis of NEER.

Captures inflation differentials between country and its major trading partners and reflects the degree of external competitiveness


Currency convertibility is the ease with which the currency of a country can be freely converted into any other foreign currency or gold at market determined exchange rate.


Partial Convertibility:

• Portion allowed by the government which can be converted into foreign currency with least restrictions.

• Union Budget for 1992-93, introduced it on current account under Liberalized Exchange Rate Management System (LERMS)

• Also known as Dual exchange system.

• Presently partial convertibility still operational on capital account.

Full Convertibility:

• Freedom to convert domestic currency into any foreign currency and vice versa without any regulatory intervention.

• Dual exchange rate system got automatically abolished and LERMS was now based upon the open market exchange.

• In 1994, the Government of India declared full convertibility of Rupee on Current account.

Tarapore Committee I (1997) and II (2006):

• Constituted by the RBI for suggesting a roadmap on full convertibility of Rupee on Capital Account.


Advantages of capital account convertibility:

  • Availability of large funds
  • Reduction in cost of capital.
  • Greater financial competitiveness.
  • Increase in FII/FPI flow.


A systematic record of all economic transactions between the residents of one country with the residents of the other country in a financial year.

It consists of balance of trade, balance of current account and capital account.

Balance of trade: Difference between the monetary value of a nation’s exports and imports over a certain time period.

Balance of payments divides transactions in two accounts:

Current account

Capital account


Current Account




Services [+)


1. Dividend

2. Interest

3. Profit

Transfer [+]

1. Gift

2. Donation

3. Remittance

Capital account [+]

Investment [+]

1.Sovereign 2.Commercial

NRI account [+]

1. Gift

2.Donation 3.Remittance

Loan (+)






• Records imports and exports of visible and invisibles

• Short term implication transactions

• Covers only earnings and spending.

• Excludes any borrowings and lending.

• Shows capital expenditure and income for country

• Long term implication transactions

• Only includes borrowings and lending by a country


• Visible trade(Export and Import of goods-Merchandise transactions )

• Invisible trade(Export and Import of services)

• Unilateral transactions

• Direct Investment (FDI)

• Portfolio Investment (FPI)

• Loans / External commercial borrowing (ECB)

• Non-resident’s investment in Bank, Insurance, Pension schemes.

• RBI’s foreign exchange reserve

Deficit (CAD)

• If the value of the goods and services imported exceeds the value of those exported.

• Current Account deficit = Trade gap(export – import) + Net current transfers (foreign aid) + Net factor income (Interest, Dividend)

• When more money is flowing out of a country to acquire assets and rights abroad


• If the value of the goods and services exported exceeds the value of those imported.

• Money is flowing into the country, but these inflows reflect changes in the ownership of national assets by way of sale or borrowing.


• Current account convertibility relates to the removal of restrictions on payments relating to the international exchange of goals, services and factor incomes.

• Capital account convertibility refers to a liberalization of a country’s capital transactions such as loans and investment.

Current status

• Allowed Full convertibility

• Only Partial convertibility


Part of a country s debt which has been borrowed from foreign creditors which includes private commercial banks, international financial institutions such as the World Bank, International Monetary Fund (IMF), and sovereign governments.

Types of external debts:

Short term debt: Maturity period 1 year or less

Long term debt: Maturity period more than 1 year

Sovereign debt : Bonds issued by the national government in any foreign currency to generate funds to meet its financial expenses.


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