Balance of Payments and Foreign Trade: Key Concepts

The correct answer is B, external sector. The balance of payments is the statement that records every economic transaction between the residents of a country and the rest of the world in a given period, which is precisely what the external sector of an economy means; it covers merchandise trade, services, income, transfers and capital flows. Option A is wrong because the agriculture sector is a producing sector within the domestic economy and is measured through output and national income accounts, not through the balance of payments. Option C is wrong because the government sector is tracked through the budget and the fiscal deficit, which are internal accounts. Option D is wrong because the private sector is likewise a domestic classification, covering households and firms, and appears in savings and investment data. The other three are all parts of the internal economy, while only the external sector looks outward.

The correct answer is C, Export Security. Export security is not a recognised category of trade barrier; it is not a device that restricts the movement of goods across a border. Option A is wrong as a choice because subsidies are treated as a barrier: by lowering the cost of domestic producers they make imported goods uncompetitive, and the World Trade Organization disciplines them for that reason. Option B is wrong because an embargo is the strongest of all barriers, an outright ban on trade with a particular country or in a particular good. Option D is wrong because tariff barriers, chiefly customs duty, are the classic barrier, raising the price of the imported good in the home market. Keep the two families apart: tariff barriers act on price, while non-tariff barriers such as quotas, embargoes, licensing and standards act on quantity or on entry itself.

The correct answer is D, tariffs and quotas. An inward-looking trade strategy, better known as import substitution, was the policy India followed from the Second Five Year Plan until 1991, and it rested on two instruments. A tariff is a tax on imports that makes the foreign good dearer, and a quota is a limit on the quantity that may be imported at all. Option A is wrong because subsidies help exporters or domestic producers but are not the paired instrument named in the textbook definition of protection. Option B is wrong for the same reason, and because it leaves out the tariff, which is the primary instrument. Option C is wrong because price controls are a domestic measure aimed at consumers and essential goods; they do not act at the border. Remember the textbook pairing: protection equals tariffs plus quotas.

The correct answer is B. Self-reliance, the goal set out in India's early plans, means building the capacity to produce at home what the country would otherwise have to buy abroad, so the true indicator is that imports of such goods are avoided. It is a statement about reducing dependence, not about ending trade. Option A is wrong because rising imports of goods the country can itself make is the opposite of self-reliance and shows growing dependence. Option C is wrong because a country cannot export in quantity what it does not produce, and in any case exports are a sign of competitiveness rather than of self-reliance. Option D is wrong because avoiding exports of goods that can be produced at home wastes earning capacity; self-reliance was never meant to mean shutting out foreign markets. The policy that followed from this idea was import substitution.

The correct answer is A, only exports and imports of goods. The balance of trade, also called the merchandise or visible balance, is the difference between the value of goods exported and goods imported; nothing else enters it. Option B is wrong because once services are added the figure becomes the balance on goods and services, a step towards the current account but not the balance of trade. Option C is wrong because the current and capital accounts together make up the whole balance of payments, of which the balance of trade is only one component. Option D is wrong because foreign investment, whether direct or portfolio, belongs to the capital account and never to the trade balance. This is the single most common confusion in the chapter, so fix the ladder in order: balance of trade, then current account, then balance of payments.

The correct answer is B, 1994. In August 1994 India accepted the obligations of Article VIII of the International Monetary Fund and made the rupee fully convertible on the current account, so that foreign exchange for trade, travel, education and remittances could be obtained freely at the market rate. Option A is wrong because 1991 is the year of the balance of payments crisis and of the two-step devaluation, not of convertibility. Option C is wrong because 1997 is the year of the first Tarapore Committee, which drew up a road map for capital account convertibility; that convertibility is still only partial. Option D is wrong because nothing of the kind happened in 2000. Keep the sequence in mind: crisis and devaluation in 1991, the dual exchange rate of 1992, unification in 1993 and current account convertibility in 1994.

The correct answer is B, the General Agreement on Tariffs and Trade. GATT was signed in 1947 as a provisional agreement on tariff reduction, and after the Uruguay Round it was replaced on 1 January 1995 by the World Trade Organization, a permanent body with headquarters at Geneva and a binding dispute settlement system. India is a founder member. Option A is wrong because the International Monetary Fund, created at Bretton Woods in 1944, deals with exchange rates and balance of payments support and continues to exist. Option C is wrong because UNCTAD, set up in 1964, is a United Nations body that speaks for developing countries on trade and development and was never replaced. Option D is wrong because the World Bank, also born at Bretton Woods, lends for development projects and is a separate institution. The WTO agreements to remember are TRIPS, TRIMS, GATS and the Agreement on Agriculture.

The correct answer is B, the Directorate General of Foreign Trade. The DGFT works under the Ministry of Commerce and Industry, and under the Foreign Trade (Development and Regulation) Act of 1992 it frames and administers the Foreign Trade Policy, issues the importer-exporter code without which no one may trade across the border, and runs the export promotion schemes. Option A is wrong because the Reserve Bank manages the foreign exchange side of trade under FEMA and holds the reserves, but it does not write trade policy. Option C is wrong because SEBI regulates the securities market and has nothing to do with imports and exports. Option D is wrong because NITI Aayog is a policy think tank that advises the government and has no regulatory power. Associated bodies worth remembering are the EXIM Bank of 1982 and the Export Credit Guarantee Corporation.

The correct answer is B, foreign direct investment. The capital account records transactions that change the ownership of assets and liabilities between residents and non-residents, and foreign direct investment, along with portfolio investment, external commercial borrowings and deposits of non-resident Indians, falls squarely in that group. Option A is wrong because the export of software services is an invisible item of the current account, one of India's biggest earners. Option C is wrong because remittances are unilateral transfers and are also part of the invisibles in the current account; they help cover India's trade deficit. Option D is wrong because the import of crude oil is a visible merchandise item and the single largest entry on the import side of the trade balance. The rule to remember is simple: goods, services, income and transfers go to the current account, while assets and liabilities go to the capital account.

The correct answer is B, 1991. By the middle of 1991 India's foreign exchange reserves had fallen to roughly a fortnight of imports, gold was pledged abroad to raise funds, the country borrowed from the International Monetary Fund and the rupee was devalued in two steps in July. The new industrial policy of 1991 followed, dismantling most industrial licensing and opening the economy. Option A is wrong because 1985 saw a limited liberalisation under Rajiv Gandhi but no crisis of this kind. Option C is wrong because 1997 is the year of the East Asian currency crisis, which India largely escaped, and of the first Tarapore Committee report. Option D is wrong because 2008 is the global financial crisis, in which India's growth slowed but its external position did not collapse. Remember 1991 together with devaluation, the IMF loan and the LPG reforms.