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ANSWERS & EXPLANATIONS
G.S. PRE. (2025) MINI TEST – 5505

Q 1.A
• Fiscal policy is the economic policy of the government that is concerned with (a) taxation (b) public
expenditure and (c) public borrowing. The government uses fiscal policy to control the rising prices or
deal with the situation of deflation.
• At the time of inflation, the government increases taxes for dropping private spending. If direct taxes
on profits increase, the total disposable income would reduce. As a result, the total spending of individuals
decreases, which, in turn, reduces the money supply in the market. Hence statement 2 is correct.
• Along with taxation policy, the government must reduce public expenditure and public borrowing to
control excess demand. Reduction in public expenditure and public borrowing reduces the supply of
money thereby reducing inflation. Hence statement 1 is correct.
• Increasing interest rates in the economy to control inflation is a monetary policy tool and it is done by the
Monetary Policy Committee of RBI. Hence statement 3 is not correct.

Q 2.B
• When the economy has both Current Account Deficit and Fiscal Deficit, it is said to be facing the twin
deficit. Hence option (b) is the correct answer.
• Both deficits often reinforce each other.
• The current account measures the flow of goods, services and investments into and out of the country.
There is a deficit in Current Account if the value of the goods and services imported exceeds the value of
those exported. It comprises of following components:
o Trade of goods,
o Services, and
o Net earnings on overseas investments and net transfer of payments over a period of time, such
as remittances.
• Hence, Current Account = Trade gap + Net current transfers + Net income abroad
• It can be reduced by boosting exports and curbing non-essential imports such as gold, mobiles, and
electronics.
• A fiscal deficit is a shortfall in a government's income compared with its spending. It is usually measured
as percentage of GDP.
• As per CGA data, for the Financial Year 2020 India's fiscal deficit widened to 4.59% of gross domestic
product (GDP) for the previous fiscal, overshooting the government's revised target of 3.8%.(May 2020)

Q 3.A
• Revenue Receipts are receipts which do not have a direct impact on the assets and liabilities of the
government. It consists of the money earned by the government through tax (such as excise duty, income
tax) and non-tax sources (such as dividend income, profits, interest receipts).
• Capital Receipts indicate the receipts which lead to a decrease in assets or an increase in liabilities of
the government.
• The main items of capital receipts are loans raised by the government from the public which are
called market borrowings, borrowing by the government from the Reserve Bank and commercial
banks and other financial institutions through the sale of treasury bills, loans received from
foreign governments and international organisations.
• Other components of capital receipts include
o Recoveries of loans granted by the central government.
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o Small savings (Post-Office Savings Accounts, National Savings Certificates, etc),

o Provident funds
o Net receipts obtained from the Divestment of PSUs.

o Hence option (a) is the correct answer.

Q 4.A
• In order to meet the extra expenditure beyond the income, government may resort to borrowings.
• Borrowing requirement of the government includes interest obligations on the accumulated debt.
• To obtain an estimate of borrowing on account of current expenditures exceeding revenues, we need to
deduct these interest obligations on accumulated debt from the total deficit of the government, which
gives the Primary deficit of the government. Primary deficit is measured to know the amount of
borrowing that the government can utilize, excluding the interest payments. Hence, statement 1 is
correct.
• It is simply the fiscal deficit minus the interest payments. Hence statement 2 is not correct.
• Primary deficit = Fiscal deficit – net interest liabilities
• Net interest liabilities consist of interest payments minus interest receipts by the government on net
domestic lending.
• A decrease in primary deficit shows progress towards fiscal health. Hence, when the primary deficit is
zero, the fiscal deficit becomes equal to the interest payment. This means that the government has resorted
to borrowings just to pay off the interest payments. Further, nothing is added to the existing loan.

Q 5.A
• A proportional tax is a taxing mechanism in which the taxing authority charges the same rate of tax
from each taxpayer, irrespective of income. This means that lower class, or middle class, or upper-class
people pay at the same rate of tax. Hence statement 1 is correct.
• Since the tax is charged at a flat rate for everyone, whether earning higher income or lower income, it is
also called a flat tax.
• A proportional tax is based on the theory that since everybody is equal, taxes should also be charged the
same way.
• A progressive tax is a tax in which the tax rate increases as the taxable amount increases. This sort
of system is meant to affect higher-income people more than low- or middle-class earners to reflect the
presumption that they can afford to pay more.
• The redistribution objective is sought to be achieved through progressive income taxation( not
proportional taxation), in which higher the income, higher is the tax rate. Hence, statement 2 is not
correct.

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Q 6.D
• Option (d) is the correct answer: Ricardian equivalence was a theory put forward by David Ricardo in
the early 19th century and later was elaborated upon by Harvard professor Robert Barro. For this reason,
Ricardian equivalence is also known as the Barro-Ricardo equivalence proposition.
• It is an economic theory that argues that attempts to stimulate an economy by increasing debt-
financed government spending are doomed to fail because the demand remains unchanged.
• This is because consumers anticipate the future so if they receive a tax cut financed by government
borrowing they anticipate future taxes will rise. Therefore, their lifetime income remains unchanged and
so consumer spending remains unchanged.
• It is called ‘equivalence’ because it argues that taxation and borrowing are equivalent means of financing
expenditure. When the government increases spending by borrowing today, which will be repaid by taxes
in the future, it will have the same impact on the economy as an increase in government expenditure that
is financed by a tax increase today.
• The paradox of thrift: It is an economic theory which stipulates that personal savings are a net drag on
the economy during a recession. It assumes that an increase in autonomous saving leads to a decrease in
aggregate demand and thus a decrease in gross output which will, in turn, lower total saving.
• The Solow Growth Model is an exogenous model of economic growth that analyzes changes in the level
of output in an economy over time as a result of changes in the population growth rate, the savings rate,
and the rate of technological progress.
• Kuznets' inverted-U hypothesis implies that economic growth worsens income inequality first and
improves it later at a higher stage of economic development.

Q 7.B
• Effective Revenue deficit is a term introduced in the Union Budget 2011-12
• While revenue deficit is the difference between revenue receipts and revenue expenditure, the earlier
accounting system includes all grants from the Union Government to the state governments/Union
territories/other bodies as revenue expenditure, even if they are used to create assets.
• Such assets created by the sub-national governments/bodies are owned by them and not by the Union
Government. Nevertheless, they do result in the creation of durable assets.
• According to the Finance Ministry, such revenue expenditures contribute to the growth in the
economy and therefore, should not be treated as unproductive in nature.
• In the Union Budget (2011-12) a methodology has been introduced to capture the ‘effective revenue
deficit’, which excludes those revenue expenditures (or transfers) in the form of grants for the
creation of capital assets.
• In short, Effective Revenue Deficit is the difference between revenue deficit and grants for creation
of capital assets.
• However, the 14th Finance Commission observed that the concept of effective revenue deficit is not
recognized in the standard government accounting process. Under the Constitution, there are only two
categories of expenditure- expenditure on the revenue account and other expenditures which is
broadly expressed as capital expenditure. Hence, according to the Commission, the artificial carving
out of the revenue account deficit into an effective revenue deficit to bring out that portion of grants which
is intended to create capital assets at the recipient level leads to an accounting problem and raises the
moral hazard issue of creative budgeting.
• Hence, option(b) is the correct answer.

Q 8.C
• Option(c) is the correct answer: Mezzanine financing is defined as a financial instrument which is a
mix of debt & equity finance.
• It is a debt capital that can be converted by the lender to an ownership or equity interest in the
company.
• Mezzanine finance is listed as an asset on the company’s balance sheet. As it is treated as equity in a
company’s balance sheet, it allows the company to access other traditional sources of finance.
• In the hierarchy of creditors, mezzanine finance is subordinate to senior debt but ranks higher than
equity. The return on mezzanine finance is higher in relation to debt finance but lower than equity
finance.
• It is also available quickly to the borrower with little or no collateral.

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• The concept of mezzanine financing is just catching up in India. Mezzanine financing is used mainly for
small and medium enterprises, infrastructure and real estate. ICICI Venture's Mezzanine Fund was the
first fund in India to focus on mezzanine finance opportunities.

Q 9.A
• Goods and Services Tax (GST) refers to the single unified tax created by amalgamating a large number of
Central and State taxes presently applicable in India. The 101st Constitution Amendment Act of
September 2016 made in this regard, inserted a definition of GST in Article 366 of the constitution by
inserting a sub-clause 12A.
• As per that, GST means any tax on supply of goods, or services, or both, except taxes on supply of the
alcoholic liquor for human consumption.
• GST is a single tax on the supply of goods and services, right from the manufacturer to the consumer.
Credits of input taxes paid at each stage will be available in the subsequent stage of value addition,
which makes GST essentially a tax only on value addition at each stage. Hence, statement 1 is
correct.
• GST is a destination-based tax as against the previous concept of origin based tax. i.e, tax is imposed
at the point of consumption. Hence, statement 2 is correct.
• It is a dual GST with the Centre and the States simultaneously levying it on a common base. The
GST, to be levied by the Centre would be called Central GST (CGST) and that to be levied by the States
would be called State GST (SGST). This is to protect the fiscal federalism of this country as both the
levels of government have the constitutional mandate to levy and collect specific taxes. SGST would be
applicable only if both the buyer and seller are located within the state. Hence, statement 3 is
correct.
• The Centre would levy and collect the Integrated Goods and Services Tax (IGST) on all inter-State
supply of goods and services. Tax will be shared between the Central andState Government.
• A Goods & Services Tax Council which is a joint forum of the Centre and the States. It would
function under the Chairmanship of the Union Finance Minister and will have Ministers in charge
of Finance/Revenue or Minister nominated by each of the States & UTs with Legislatures.

Q 10.D
• Tax Expenditures, as the word might indicate, does not relate to the expenditures incurred by the
Government in the collection of taxes.
• Rather it refers to the opportunity cost of taxing at concessional rates, or the opportunity cost of
giving exemptions, deductions, rebates, deferrals credits etc. to the taxpayers. Hence option (d) is the
correct answer.
• Tax expenditures indicate how much more revenue could have been collected by the Government if
not for such measures. In other words, it shows the extent of indirect subsidy enjoyed by the
taxpayers in the country.
• Tax expenditures or revenue is forgone are sanctioned in the tax laws.
• They indicate the potential revenue gain that would be realized by removing exemptions, deductions, and
such similar measures.

Q 11.C
• A deficit is an amount by which the expenditures in a budget exceed the income. A Government Deficit is
the amount of money in the set budget by which the government expenditure exceeds the government
income amount. This deficit provides an indication of the financial health of the economy. To reduce the
deficit or the gap between the expenditures and income, the government may take several steps.
• Steps to reduce deficits of government include raising taxes to increase the tax revenues, divesting
from nonessential services, disinvestment in public sector enterprise, rationalizing subsidies to
reduce expenditures, etc.,
• Hence option(c) is the correct answer.
• The government may also resort to borrowings to finance its deficits.
• Deficit financing is defined as “borrowings from the Reserve Bank of India against the issue of Treasury
Bills and running down of accumulated cash balances”.When the government borrows from the Reserve
Bank of India, it merely transfers its securities to the Bank. On the basis of these securities the bank issues
more currency and puts them into circulation on behalf of the government. This amounts to the creation of
money. The rationale for Deficit Financing is that sometimes the government fails to mobilize adequate
resources. In this situation, the option of deficit financing is required to meet fiscal deficit targets. If the
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option of deficit financing is not utilized the government ends up compromising on growth targets. So, it
is a way of financing the deficit, not reducing the deficit.

Q 12.C
•
Direct Tax Indirect Tax
Incidence and impact of tax fall on the same Incidence and Impact of tax fall on two
person. Hence, statement 1 is correct. different persons
It is levied on the income. Eg – Income tax, Corporate
It is levied on goods and services. Eg- GST etc.
tax etc. Hence statement 3 is not correct.
It is regressive in nature i.e. all persons (rich
It is progressive in nature- higher taxes are levied on and poor) will bear the same taxes on goods and
persons earning higher income services, irrespective of their capability to
pay. Hence, statement 2 is correct.

Q 13.B
• National Investment Fund (NIF) was established to receive disinvestment proceeds of central public
sector enterprises and to invest the same to generate earnings without depleting the corpus. Hence,
statement 2 is correct.
• The earnings of the Fund were to be used for selected Central social welfare Schemes & capital
investment requirements of profitable and revivable PSUs. This fund was kept outside the consolidated
fund of India.
• The fund became operational in 2005.
• Entire disinvestment proceeds are to be credited to the existing ‘Public Account’ under the head NIF and
they would remain there until withdrawn/invested for the approved purpose. The allocations out of the
NIF will be decided in the annual Government Budget.
• National Investment and Infrastructure Fund is India’s first infrastructure specific investment fund. This is
different from the National Investment Fund. The objective of NIIF would be to maximize economic
impact mainly through infrastructure development in commercially viable projects, both greenfield and
brownfield, including stalled projects. Hence, statement 1 is not correct.
• The corpus of NIIF is Rs. 40,000 Crores. The government can provide up to 20000 crores per annum into
these funds. Government's contribution/share in the corpus will be 49% in each entity set up as an
alternate Investment Fund (AIF) and will neither be increased beyond nor allowed to fall below, 49%. The
whole of 49% would be contributed by the Government directly. Rest is open for contribution from
others.

Q 14.D
• Option 1 is correct: In the short run an important factor in determining exchange rate movements
is the interest rate differential i.e. the difference between interest rates between countries. There are
huge funds owned by banks, multinational corporations and wealthy individuals which move around the
world in search of the highest interest rates. If we assume that government bonds in country A pay 8
percent rate of interest whereas equally safe bonds in country B yield 10 percent, the interest rate
differential is 2 percent. Investors from country A will be attracted by the high interest rates in country B
and will buy the currency of country B selling their own currency.
• Option 2 is correct: Exchange rates in the market depend not only on the demand and supply of
exports and imports, and investment in assets, but also on foreign exchange speculation where
foreign exchange is demanded for the possible gains from appreciation of the currency. Money in
any country is an asset. If Indians believe that the British pound is going to increase in value relative to
the rupee, they will want to hold pounds. This expectation would increase the demand for pounds and
cause the rupee-pound exchange rate to increase in the present, making the beliefs self-fulfilling.
• Option 3 is correct: When income increases, consumer spending increases. Spending on imported
goods is also likely to increase. When imports increase, the demand curve for foreign exchange
shifts to the right (i.e. demand of foreign currency increases).There is a depreciation of the domestic
currency. If there is an increase in income abroad as well, domestic exports will rise and the supply curve
of foreign exchange shifts outward. On balance, the domestic currency may or may not depreciate. What
happens will depend on whether exports are growing faster than imports. In general, other things
remaining equal, a country whose aggregate demand grows faster than the rest of the world’s normally
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finds its currency depreciating because its imports grow faster than its exports. Its demand curve for
foreign currency shifts faster than its supply curve.

Q 15.A
• The nominal exchange rate is the price of one unit of foreign currency in terms of the domestic
currency. The nominal exchange rate (NER) is the relative price of currencies of two countries. For
example, if the exchange rate is £ 1 = Rs 100, then a British can exchange one pound for Hundred Rupees
in the world market. Hence statement 2 is not correct.
• The real exchange rate is the relative price of foreign goods in terms of domestic goods. It is equal to the
nominal exchange rate times the foreign price level divided by the domestic price level. The real exchange
rate (RER) refers to the relative price of goods of Britain and India. The real exchange rate is expressed
as: Hence statement 1 is not correct.
• The real exchange rate (RER) is a very useful measure of the competitiveness of an economy. It tells us
whether the prices of goods and services at home are higher or lower than their prices abroad. If domestic
prices are lower, then we can expect healthy exports and a trade surplus. It thus, measures the
international competitiveness of a country in international trade. When the real exchange rate is equal to
one, the two countries are said to be in purchasing power parity. Hence statement 3 is correct.

Q 16.A
• The balance of payments (BoP) records the transactions in goods, services and assets between residents of
a country with the rest of the world. There are two main accounts in the BoP – the current account and the
capital account. The current account records exports and imports in goods and services and transfer
payments.
• Trade-in services are denoted as invisible trade (because they are not seen to cross national borders).
Services trade includes both factor and non-factor income. Factor income includes net international
earnings on factors of production (like labor, land, and capital). Non-factor income is the net sale of
service products like shipping, banking, tourism, software services, etc.
• Transfer payments are receipts which the residents of a country receive ‘for free’, without having to make
any present or future payments in return. They consist of remittances, gifts and grants. They could be
official or private. The balance of exports and imports of goods is referred to as the trade balance. Adding
trade in services and net transfers to the trade balance, we get the current account balance. The capital
account records all international purchases and sales of assets such as money, stocks, bonds, etc.

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Q 17.A
• Statement 1 is correct: Currency convertibility refers to the freedom to convert the domestic
currency into other internationally accepted currencies and vice versa at the market-determined
exchange rate.
• Current account convertibility means freedom to convert domestic currency into foreign currency and vice
versa to execute trade in goods and invisibles. On the other hand, capital account convertibility implies
freedom of currency conversion related to capital inflows and outflows.
• Compared to current account convertibility, capital account convertibility is a complex issue because of
the peculiar feature of capital account transactions. An important one is the high frequency and volume of
international capital movements across borders which may produce many macroeconomic effects in host
countries like India. The Committee on Capital Account Convertibility (CAC)(1997, Chairman Dr S S
Tarapore) in its report has given a working definition for the CAC which is :“CAC refers to the freedom
to convert local financial assets into foreign financial assets and vice versa at market-determined rates of
exchange. It is associated with changes of ownership in foreign/domestic financial assets and liabilities
and embodies the creation and liquidation of claims on, or by, the rest of the world.”
• Statement 2 is not correct: In India, there is full current account convertibility since August 20,
1993. A series of measures were launched then to liberalise exchange controls and the exchange rate
system was shifted to market- determined exchange rates since March 1993. After that, on August 20,
1993, the RBI announced that that the rupee became fully convertible on current account. There is partial
capital account convertibility in India.
• Partial convertibility can be defined as to convert Indian currency (up to specific extent) in the currency of
other countries. So that the flow of foreign investment in terms of Foreign Institutional Investment (FII)
and foreign Direct Investment (FDI). In 1991-92 the GOI adopted a dual exchange rate system under
which the official rate of exchange was controlled and the market rate (or the black-market rate) of
exchange was free to move or fluctuate according to forces of supply and demand. All of India’s foreign
exchange remittances—earned through export of goods or services or through inward remittances—were
allowed to be converted in the following manner:
o 60% of the export earnings could be converted at the market-determined rate; this amount could be
used freely for current account transactions and payments (i.e., for import of goods, for travel and for
remittances abroad).
o The balance 40% of the earnings should be sold to RBI through authorised dealers at the official rate
of exchange; this amount of foreign exchange would be made available by RBI for financing
preferred imports, bulk imports, etc.
• The system of dual exchange rate of the rupee enabled the exporters to convert (at least) 60% of their
export earnings at the market rate of exchange which was much higher than the official exchange rate.
The GOI expected that this would provide adequate incentive to exporters and increase foreign exchange
earnings.

Q 18.B
Treasury Bills
• Government Security (G-Sec) is a tradeable instrument issued by the Central Government or the State
Governments. It acknowledges the Government’s debt obligation.
• In India, the Central Government issues both, treasury bills and bonds or dated securities while the
State Governments issue only bonds or dated securities, which are called the State Development Loans
(SDLs). Hence statement 2 is correct.
• Treasury bills or T-bills, which are money market instruments, are short term debt instruments
issued by the Government of India and are presently issued in three tenors, namely, 91 days, 182 days
and 364 days. Hence statement 3 is not correct. Treasury bills are zero-coupon securities and pay no
interest. Instead, they are issued at a discount and redeemed at the face value at maturity. Hence
statement 1 is correct and statement 3 is not correct.

Q 19.C
• If the expenditure of the government exceeds its income, the government is said to have incurred a fiscal
deficit. This deficit financing has to be done either by borrowing from the market or monetisation of
deficit through RBI.
• Monetisation of Deficit: It involves the financing of such extra expenses with money, instead of debt
to be repaid at some future dates. So, it is a form of non-debt financing. As a result, under

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monetization, there is no increase in net (not gross) public debt. Hence statement 1 and 2 are not
correct. It can occur only through one of two modalities:
o Direct Monetization
o Indirect Monetization
• Direct Monetization (DM): Under this method, RBI prints new currency and purchases government
bonds directly from the primary market (from the government) using this currency. As a result, this
supports the spending needs of the government.
• Indirect monetization (IM): In this method, deficits are monetized as the government issues bonds in the
primary market and the RBI purchases an equivalent amount of government bonds from the secondary
market in the form of Open Market Operations (OMO).
• Monetisation of deficit was in practice in India till 1997, whereby the central bank automatically
monetised government deficit through the issuance of ad-hoc treasury bills.
• In 1994 and 1997, two agreements were signed between the government and RBI to completely phase out
funding through ad-hoc treasury bills.
• Later on, with the enactment of Fiscal Responsibility and Budget Management (FRBM) Act, 2003,
RBI was completely barred from subscribing to the primary issuances of the government. It was
agreed that henceforth, the RBI would operate only in the secondary market through the OMO
(open market operations) route. Hence statement 3 is correct.

Q 20.A
• A J-curve is a trendline that shows an initial loss immediately followed by a dramatic gain.
• In a chart, this pattern of activity would follow the shape of a capital "J".
• The J-curve effect is often cited in economics to describe, for instance, the way that a country’s balance
of trade initially worsens following a devaluation of its currency, then quickly recovers and finally
surpasses its previous performance.
• In economics, the J-curve shows how a currency depreciation causes a severe worsening of a trade
imbalance followed by a substantial improvement. Hence, option (a) is the correct answer.
• The pattern is as follows:
o Immediately after a nation's currency is devalued, imports get more expensive and exports get
cheaper, creating a worsening trade deficit (or at least a smaller trade surplus).
o Shortly thereafter, the sales volume of the nation's exports begins to rise steadily, thanks to their
relatively cheap prices.
o At the same time, consumers at home begin to buy more locally-produced goods because they are
relatively affordable compared to imports.
o Over time, the trade balance between the nation and its partners bounces back and even exceeds pre-
devaluation times.

Q 21.B
• Foreign exchange reserves are assets held on reserve by a central bank in foreign currencies. These may
include foreign currencies, bonds, treasury bills, and other government securities.
• Foreign exchange reserves of RBI include – Foreign Currency Assets, Gold, SDR (Special Drawing
Right), Reserve Position in the IMF. As of 20 November 2020, RBI’s forex reserves stood at US$
575.290.
• Forex reserves increase when there is an increased inflow of foreign currencies. Increase in exports and an
increase in inbound international tourism will increase the inflow of foreign currencies. Hence options (a)
and (c ) will lead to an increase in forex reserves of a country.
• Foreign Direct Investment (FDI) is an investment in the equities of companies by foreign entities. Increase
in FDI will cause an increased inflow of foreign currencies. This, in turn, will increase in forex
reserves. Hence, option (d) will also lead to an increase in forex reserves.
• However, if the world trade increases, it may or may not favour exports from a country. Hence, option
(b) may not necessarily lead to increase in forex reserves.

Q 22.C
• One of the two main methods of conversion of GDP uses market exchange rates—the rate prevailing in
the foreign exchange market (using either the rate at the end of the period or an average over the period).
The other approach uses the purchasing power parity (PPP) exchange rate—the rate at which the currency
of one country would have to be converted into that of another country to buy the same amount of goods
and services in each country.
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• To facilitate price comparisons across countries, the International Comparisons Program (ICP) was
established by the United Nations and the University of Pennsylvania in 1968. PPPs generated by the ICP
are based on a global survey of prices. To understand PPP, let’s take a commonly used example, the price
of a hamburger. If a hamburger is selling in London for £2 and in New York for $4, this would imply a
PPP exchange rate of 1 pound to 2 U.S. dollars.
• PPP versus market rates
o Advantages of PPP: The main one is that PPP exchange rates are relatively stable over time. By
contrast, market rates are more volatile, and using them could produce quite large swings in
aggregate measures of growth even when growth rates in individual countries are stable. Hence,
statement 1 is correct.
o Another drawback of market-based rates is that they are relevant only for internationally traded goods.
Nontraded goods and services tend to be cheaper in low-income than in high-income countries. A
haircut in New York is more expensive than in Lima; the price of a taxi ride of the same distance is
higher in Paris than in Tunis; and a ticket to a cricket game costs more in London than in Lahore.
Indeed, because wages tend to be lower in poorer countries, and services are often relatively labor
intensive, the price of a haircut in Lima is likely to be cheaper than in New York even when the cost
of making tradable goods, such as machinery, is the same in both countries. Drawbacks of PPP: The
biggest one is that PPP is harder to measure than market-based rates.
o There is a large gap between market- and PPP-based rates in emerging market and developing
countries, for most of which the ratio of the market and PPP U.S. dollar exchange rate is between 2
and 4. But for advanced economies, the market and PPP rates tend to be much closer. As a result,
developing countries get a much higher weight in aggregations that use PPP exchange rates than they
do using market exchange rates. The weights of China and India in the world economy are far
greater using PPP exchange rates than market-based weights. Hence, statement 2 is correct.

Q 23.B
• FPI stands for those investors who hold a short term view of the company, in contrast to Foreign Direct
Investors (FDI).
• FPIs generally participate through the stock markets and get in and out of a particular stock at much faster
frequencies.
• Short term view is associated often with a lower stake in companies. Hence, globally FPIs are defined as
those who hold less than 10% in a company. Hence statement 1 is correct.
• FPIs are not allowed to invest in unlisted shares. However, all existing investments made by the FIIs/Sub-
accounts/QFIs are grandfathered.
• In respect of those securities, where FPIs are not allowed to invest no fresh purchase shall be allowed as
FPI. They can only sell their existing investments in such securities. Hence statement 2 is not correct.
• Capital account can be regarded as one of the primary components of the balance of payments of a nation.
• It gives a summary of the capital expenditure and income for a country. It includes the following: Foreign
Direct Investment (FDI), Foreign Portfolio Investment (FPI), Other investments, Reserve Account. Hence
statement 3 is correct.

Q 24.B
• A Participatory Note (PN or P-Note) in the Indian context, in essence, is a derivative instrument issued
in foreign jurisdictions, by a SEBI registered FII, against Indian securities—the Indian security
instrument may be equity, debt, derivatives or may even be an index.
• PNs are also known as Overseas Derivative Instruments, Equity Linked Notes, Capped Return Notes,
and Participating Return Notes, etc. Hence statement 1 is correct.
• It is considered a highly ‘safe and lucrative route’ to invest the ‘unaccounted’, ‘even illegal’ money into
the Indian security market for huge profits (during the booming period).
• Experts even imagined that it may be allowing the ‘black money’ of India (stashed away from India
through ‘hawala’ kind of illegal channels and deposited in the tax havens of the world in ‘Swiss Bank’
kind of financial institutions) to get invested back in the market. Again, ‘terrorist organizations’ might
have been using this route, too. Hence statement 2 is not correct.
• PNs are market instruments that are created and traded overseas. Hence, Indian regulators cannot ban the
issue of PNs. However, they can regulated, as SEBI does—when a PN is traded on an overseas exchange,
the regulator in that jurisdiction would be the authority to regulate that trade. Hence statement 3 is
correct.

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Q 25.A
• Fiscal policy refers to the use of government spending and tax policies to influence economic conditions,
especially macroeconomic conditions, including aggregate demand for goods and services, employment,
inflation, and economic growth.
• Fiscal policy helps to stabilize the economy during business cycles. The two important phases of business
cycles are boom and recession. A recession should not be allowed to grow into a deep recession.
Similarly, a boom should not explode bigger. Fiscal policy strategies of taxation and expenditure can go in
two ways in response to the business cycle: Countercyclical and procyclical.
• Counter-cyclical fiscal policy: It refers to strategy by the government to counter boom or recession
through fiscal measures. It works against the ongoing boom or recession trend; thus, trying to stabilize the
economy. Understandably, countercyclical fiscal policy works in two different direction during these two
phases.
o Recession: Recession is a business cycle situation where there is slowing demand and falling growth
in the economy. Here, the Government’s responsibility is to generate demand by fine-tuning taxation
and expenditure policies. Reducing taxes and increasing expenditure will help to create demand and
producing upswing in the economy.
o Boom: In the case of boom, economic activities will be on upswing. Amplifying the boom is
disastrous as it may create inflation and debt crisis and the government’s responsibility here is to
bring down the pace of economic activities. Increasing taxes and reducing public expenditure will
make boom mild. Thus, slowing down demand should be the nature of countercyclical fiscal policy
during boom. Hence only options 1 and 2 are correct.
• Procyclical fiscal policy: Itis the opposite of countercyclical. Here, fiscal policy goes in line with the
current mood of the business cycle; amplifying them. For example, during the time of boom, government
makes high expenditure and doesn’t hike taxes. Thus, boom grows further. Such a policy is dangerous and
tends to bring instability in the economy.
o Boom: total government spending as a percentage of GDP goes up and tax rates go down, increasing
government deficit.
o Recession: total government spending as a percentage of GDP goes down and tax rates go up,
decreasing government deficit.

Q 26.B
• Fiscal drag is an economic term whereby inflation or income growth moves taxpayers into higher
tax brackets. This in effect increases government tax revenue without actually increasing tax rates. The
increase in taxes reduces aggregate demand and consumer spending from taxpayers as a larger share of
their income now goes to taxes, which leads to deflationary policies, or drag, on the economy.
• Fiscal drag is essentially a slowing in the growth of the economy caused by a lack of spending as
increased taxation slows the demand for goods and services. When an economy is rapidly expanding,
inflation results in higher income and therefore individuals moving into higher tax brackets and
paying more of their income in taxes. This is particularly the case in economies with progressive taxes,
or tax brackets, which stipulate that the higher income an individual makes the higher the tax they pay and
thus they move into a higher tax bracket.
• Moving into a higher tax bracket and paying a larger portion of income in taxes, as mentioned prior,
results in an eventual slowing of the economy as there is now less income available for discretionary
spending.
• It is common to view fiscal drag as a natural economic stabilizer as it tends to keep demand stable and the
economy from overheating. This is generally viewed as a mild deflationary policy and a positive aspect to
fiscal drag.
• Hence option (b) is the correct answer.

Q 27.B
• Fiscal Responsibility and Budget Management (FRBM) became an Act in 2003. The objective of the Act
is to ensure inter-generational equity in fiscal management, long run macroeconomic stability, better
coordination between fiscal and monetary policy, and transparency in fiscal operation of the Government.
• FRBM Act provides a legal institutional framework for fiscal consolidation. It is now mandatory for the
Central government to take measures to reduce fiscal deficit, to eliminate revenue deficit and to generate
revenue surplus in the subsequent years. The Act binds not only the present government but also the
future Government to adhere to the path of fiscal consolidation.

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• The Government can move away from the path of fiscal consolidation in certain cases as oresribed by the
law or other exceptional grounds which Central Government may specify.
• The subsection 4 (2) of the Act says about various grounds on which the FRBM’s fiscal deficit target may
be exempted during a year.
o National security, act of war
o National calamity
o Collapse of agriculture severely affecting farm output and incomes
o Structural reforms in the economy with unanticipated fiscal implications
o Decline in real output growth of a quarter by at least three per cent points below its average of the
previous four quarters
• Hence option (b) is the correct answer.

Q 28.D
• Public debt management plays an important role in the macro-economic policy of a country. Productive
use of public debt contributes to the economic growth and welfare of society at large. At the same time,
public debt because of its size, if not managed well, could become a source of financial instability.
• Thus, establishing and executing a strategy for managing the Government's debt in order to raise the
required amount of funds at low cost over the medium to long-run, consistent with a prudent degree of
risk is essential.
• Objectives of the Debt Management Strategy (DMS):
o To mobilize borrowings at low cost over the medium to long-term subject to prudent levels of risk in
debt portfolio. Hence, statement 1 is correct.
o To maintain a stable and sustainable debt structure so as to ensure financial stability across time
periods. Hence, statement 2 is correct.
o To support the development of a well-functioning, vibrant, deep and liquid domestic bond market
which helps in pricing the Government debt efficiently. Hence, statement 3 is correct.
o To promote deep and liquid financial markets while providing benchmarks for pricing financial assets
and maintain consistency with other macro-economic policies including monetary policy.
• About 93 percent of the outstanding public debt of the Government of India is domestic and within this, a
very large part consists of marketable debt. Accordingly, the major focus of DMS is on the active element
of domestic debt of the Central Government, i.e., marketable debt. Government Small Savings Schemes,
which have started playing a major role in financing a significant portion of borrowing requirements of
Government, are also now covered under DMS.

Q 29.D
• A current account deficit occurs when the value of imports (of goods/services/inv. incomes) is greater
than the value of exports.
• Policies to reduce a current account deficit involve:
o Devaluation of the exchange rate (make exports cheaper – imports more expensive)
o Reduce domestic consumption and spending on imports (e.g. tight fiscal policy/higher taxes)
o Supply-side policies to improve the competitiveness of the domestic industry and exports.
• Devaluation of exchange rate: This involves reducing the value of the currency against others. (e.g.
selling pounds would cause the value of the Pound to fall). If there is a devaluation of the currency, the
price of imported goods increases, and therefore the quantity demanded of imports falls. Exports will
become cheaper, and there will be an increase in the number of exports. Hence only option 1 is not
correct.
• Tight monetary policy involves increasing interest rates. Higher interest rates will increase the cost of
debt and mortgage repayments and leave people with less money to spend. Therefore, this will reduce
their consumption of imports, improving the current account.
• Supply-side policies can improve the competitiveness of the economy and help make exports more
attractive. This can improve the current account position, but it may take considerable time to have an
effect. For example, if the government pursued a policy of privatization and deregulation it may help to
increase the efficiency of the economy because of the profit motive in the private sector. This increased
efficiency would translate into lower costs of production and more exports.

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Q 30.B
• Balance of trade (BOT) is the difference between the value of a country's exports and the value of a
country's imports for a given period. Balance of trade is the largest component of a country's balance of
payments (BOP). Sometimes the balance of trade between a country's goods and the balance of trade
between its services are distinguished as two separate figures. Thus the situation in the first state statement
may imply a balance of trade, but not a balance of payment equilibrium. Hence statement 1 is not
correct.
• The balance of payments (BOP) is a statement of all transactions made between entities in one
country and the rest of the world over a defined period of time, such as a quarter or a year.
• The balance of payments includes both the current account and capital account.
• The current account includes a nation's net trade in goods and services, its net earnings on cross-border
investments, and its net transfer payments.
• The capital account consists of a nation's transactions in financial instruments and central bank reserves.
• The sum of all transactions recorded in the balance of payments should be zero; however, exchange rate
fluctuations and differences in accounting practices may hinder this in practice.
• Sometimes the capital account is called the financial account, with a separate, usually very small,
capital account listed separately.
• The current account includes transactions in goods, services, investment income, and current transfers.
• The capital account, broadly defined, includes transactions in financial instruments and central bank
reserves. Narrowly defined, it includes only transactions in financial instruments. The current account is
included in calculations of national output, while the capital account is not. Hence statement 1 is not
correct.
• The sum of all transactions recorded in the balance of payments must be zero, as long as the capital
account is defined broadly. The reason is that every credit appearing in the current account has a
corresponding debit in the capital account, and vice-versa. If a country exports an item (a current
account transaction), it effectively imports foreign capital when that item is paid for (a capital
account transaction).
• Balance of payments equilibrium occurs when induced balance of payments transactions---those
engineered by the government to influence the nominal exchange rate---are zero. This implies that
autonomous receipts from exports and the sale of securities abroad equal autonomous payments for
imports and the purchase of securities from foreign residents. Since changes in the stock of official
reserves of foreign exchange are the method used by the authorities to fix or otherwise manipulate the
exchange rate, balance of payments equilibrium requires that the stock of foreign exchange reserves
be constant.
• Autonomous transactions: International economic transactions are called autonomous when
transactions are made due to some reason other than to bridge the gap in the balance of payments, that is
when they are independent of the state of BoP. One reason could be to earn a profit. These items are
called ‘above the line’ items in the BoP. The balance of payments is said to be in surplus (deficit) if
autonomous receipts are greater (less) than autonomous payments. Hence statement 2 is correct.
• Accommodating transactions (termed ‘below the line’ items), on the other hand, are determined by the
gap in the balance of payments, that is, whether there is a deficit or surplus in the balance of payments.
In other words, they are determined by the net consequences of autonomous transactions. Since the
official reserve transactions are made to bridge the gap in the BoP, they are seen as the accommodating
item in the BoP (all others being autonomous).

Q 31.C
• A currency swap is a transaction in which two parties exchange an equivalent amount of money with
each other but in different currencies. The parties are essentially loaning each other money and will
repay the amounts at a specified date and exchange rate. The purpose could be:
o to hedge exposure to exchange-rate risk,
o to speculate on the direction of a currency, or
o to reduce the cost of borrowing in a foreign currency.
• The parties involved in currency swaps are usually financial institutions, trading on their own or on behalf
of a non-financial corporation.
• Hence option (c) is the correct answer.

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Q 32.A
• The capital account, on a national level, represents the balance of payments for a country. The capital
account keeps track of the net change in a nation's assets and liabilities during a year. The capital
account's balance will inform economists whether the country is a net importer or net exporter of capital.
• Under the Capital Account of India, both equity and debt flows are covered.
• Debt flows comprise:
o commercial borrowings,
o external assistance,
o short-term trade credits
o Non-Resident Indian (NRI) deposits,
• Equity flows comprise:
o Foreign Direct Investment (FDI)
o Portfolio Investment.
• Hence all the options are correct.

Q 33.D
• The invisible balance or balance of trade on services is that part of the balance of trade that refers to
services and other products that do not result in the transfer of physical objects. Examples include
consulting services, shipping services, tourism, and patent license revenues.,
• Both transfers and service payment comes under the current account (invisible).
• Both have shown fluctuation in the last 5 years.

• Hence option (d) is the correct answer.

Q 34.C
• One of the differences between FDI and FII is that the latter necessarily has to be an institution while FDI
can come from an individual also. Hence option (a) is correct.
• Subsequent to changes in the law in 2014, since FDI is defined to be an investment beyond 10%, to some
extent it can be said that there is "lasting interest". However, FDI is also permissible in lower dozes in
unlisted entities. Hence option (b) is correct.
• In August 2020, the Indian government amended Foreign Direct Investment Policy, 2017 on commercial
coal mining policy making it approved only under the Government route. In 2019, the Central
Government, amended FDI Policy 2017, to permit 100% FDI under automatic route in coal mining
activities. Hence option (c) is not correct.
• Measures taken by the Government on the fronts of FDI policy reforms, investment facilitation and ease
of doing business have resulted in increased FDI inflows into the country.
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• FDI inflows in India stood at $45.15 bn in 2014-15 and have consistently increased since then. Moreover,
total FDI inflow grew by 55%, i.e. from US$ 231.37 bn in 2008-14 to $358.29 bn in 2014-20 and FDI
equity inflow also increased by 57% from $160.46 billion during 2008-14 to $252.42 bn (2014-20).FDI
inflows in India increased to $55.56 bn in 2015-16, $60.22 billion in 2016-17, $60.97 bn in 2017-18 and
the country registered its highest ever FDI inflow of $62.00 bn (provisional figure) during the last
Financial Year 2018-19. Moreover, India has attracted more than $74 bn investments across sectors
during 2019-20. Hence option (d) is correct.

Q 35.A
• The Herfindahl-Hirschman Index (HHI) is a common measure of market concentration and is used
to determine market competitiveness. Hence option (a) is the correct answer.
• It is calculated by squaring the market share of each firm competing in a market and then summing the
resulting numbers. It can range from close to zero to 10,000.
• A market with an HHI of less than 1,500 is considered to be a competitive marketplace, an HHI of 1,500
to 2,500 to be a moderately concentrated marketplace, and an HHI of 2,500 or greater to be a highly
concentrated marketplace.
• The closer a market is to a monopoly, the higher the market's concentration (and the lower its
competition). If, for example, there were only one firm in an industry, that firm would have 100% market
share, and the Herfindahl-Hirschman Index (HHI) would equal 10,000, indicating a monopoly. If there
were thousands of firms competing, each would have nearly 0% market share, and the HHI would be
close to zero, indicating nearly perfect competition. Thus, higher value of HHI implies less competitive
economy and vice versa.
• The primary disadvantage of the HHI stems from the fact that it is such a simple measure that it fails to
take into account the complexities of various markets.

Q 36.C
• An Advance Pricing Agreement (APA) is an agreement between a taxpayer and the tax authority
determining the Transfer Pricing methodology for pricing the tax payer’s international transactions for
future years. APA provisions were introduced in the Income-tax Act, 1961. An APA can be unilateral,
bilateral, or multilateral.
• Key benefits of APA:
o The certainty with respect to tax outcome of the tax payer’s international transactions, by agreeing in
advance the arm’s length pricing or pricing methodology (ies) to be applied to the tax payer’s
international transactions covered by the APA. Hence, statement 1 is correct.
o Reduction in the audit threat (minimize rigors of audit), and deliverance of a particular tax outcome
based on the terms of the agreement. The APA process is legally binding on both the parties for a
period of five consecutive years or less as agreed between the taxpayer and the CBDT. The regular
transfer pricing audit is carried on a year on year basis. APA provides certainty and reduces
litigation. Transparency and open-minded approach during negotiation, both by tax authorities and
taxpayers is the key to a successful APA. Non-negotiation process is involved in the regular transfer
pricing assessment. Hence, statement 2 is correct.
o Substantial reduction of compliance costs over the term of the APA.
o For tax authorities, an APA reduces the cost of administration and also frees scarce resources.
• Consequently, APAs provide a win-win situation for all the stakeholders involved.

Q 37.C
• The gain or profit from the sale of assets is classified as a capital gain. Short Term Capital Gains Tax
(STCG) is the tax levied on profits generated from the sale of an asset which is held for a government-
defined short period is called short-term capital gains tax. The short term period differs for various
items - for example it is 24 months or less in the case of immovable property such as land and
building and 12 months or less for equity, bonds, government securities etc. Hence, statement 1 is
not correct.
• The Securities Transaction Tax (STT) is a type of direct tax which is levied at the time of purchase and
sale of securities listed on stock exchanges in India. Securities are tradable investment instruments such as
shares, bonds, debentures, equity-oriented mutual funds (MFs) and so on and are issued either by
companies or by the Indian government. This tax was introduced in the Union Budget of 2004. The
Securities Transaction Tax (STT) was introduced in India in the Budget of 2004 to curb tax avoidance on
capital gains. On the other hand, Capital gains for securities is levied on the gains made from the sale of

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securities and not on the transaction as in the case of STT. However, both of them fall under the category
of direct taxes. Hence, statement 2 is not correct.
• Recently, the government announced the withdrawal of surcharge on long and short term capital
gains arising from transfer of equity shares.

Q 38.C
• Foreign Investment means any investment made by a person resident outside India on a repatriable basis
in capital instruments of an Indian company or to the capital of an LLP.
• Foreign Direct Investment (FDI) is the investment through capital instruments by a person resident
outside India
o in an unlisted Indian company; or
o in 10 percent or more of the post issue paid-up equity capital on a fully diluted basis of a listed
Indian company.
• Foreign Portfolio Investment is any investment made by a person resident outside India in capital
instruments where such investment is
o less than 10 percent of the post issue paid-up equity capital on a fully diluted basis of a listed Indian
company or
o less than 10 percent of the paid up value of each series of capital instruments of a listed Indian
company
• Once the investment is classified as FDI (basis total holding), if the FDI holding comes back to <10%,
even then the holdings be classified as FDI i.e. once an FDI always an FDI.

Q 39.D
• The balance of payments (BoP) records the transactions in goods, services, and assets between residents
of a country with the rest of the world. It consists of Current and Capital accounts. The current account
records exports and imports in goods and services and transfer payments. The capital account records all
international purchases and sales of assets such as money, stocks, bonds, etc. A country that has a deficit
in its current account (spending more abroad than it receives from sales to the rest of the world) must
finance it by selling assets or by borrowing abroad. Thus, any current account deficit is of necessity
financed by a net capital inflow.
• Forex reserves can increase even in case of current account deficit if the capital inflows during that period
are greater than the current account deficit. For example, in April-September 2005-06, the current account
deficit of US$13 billion was financed by a capital inflow of US$19.5 billion, the extra capital inflow of
US$ 6.5 billion being added to our stock of foreign exchange. Reserves of foreign exchange are
accumulated when a country has an overall balance of payments surplus. Hence statement 2 is not
correct.
• Alternatively, the country could engage in official reserve transactions, running down its reserves of
foreign exchange, in the case of a deficit by selling foreign currency in the foreign exchange market. The
decrease in official reserves is called the overall balance of payments deficit.
• India's forex reserves comprise foreign currency assets (FCAs), gold reserves, special drawing rights
(SDRs) and India's reserve position with the International Monetary Fund (IMF). Hence statement 1 is
not correct.

Q 40.C
• In flexible exchange rates (also known as floating exchange rates), the exchange rate is determined by the
forces of market demand and supply. If the demand for foreign exchange goes up, the domestic currency
(rupee) depreciates since it has become less expensive in terms of foreign currency. By contrast, the
currency appreciates when it becomes more expensive in terms of foreign currency.
• Interest rate differential is important in determining exchange rate movements. There are huge funds
owned by banks, multinational corporations and wealthy individuals who move around the world in
search of the highest interest rates. If we assume that government bonds in country A pay 8 percent rate of
interest whereas equally safe bonds in country B yield 10 percent, the interest rate differential is 2 percent.
Investors from country A will be attracted by the high-interest rates in country B and will buy the
currency of country B selling their own currency. At the same time, investors in country B will also find
investing in their own country more attractive and will, therefore, demand less of country A’s currency.
This means that the demand for country A’s currency will decrease while that of country B's currency will
increase. Therefore, country A's currency depreciates whereas that of country B's currency appreciates.

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Thus, a rise in the interest rates at home often leads to an appreciation of the domestic currency which will
increase in the exchange rate of the domestic currency. Hence, statement 1 is correct.
• If a country's imports grow faster than exports, the capital inflows from exports will not be sufficient to
pay for the imports. This will lead to an increase in demand for foreign currency. Therefore the domestic
currency depreciates. Hence statement 2 is correct.

Q 41.B
• In India, total Central Government Liabilities constitutes the following three categories:
o Internal Debt
o External Debt
o Public Account Liabilities
• However, Public Debt in India includes only Internal and External Debt incurred by the Central
Government. Hence statement 1 is not correct.
• Internal debt of the Central Government constituted 83.4 per cent of public debt for 2019. Hence
statement 2 is correct.

Q 42.A
• Pigovian tax is a special tax that is often levied on companies that pollute the environment or create
excess social costs, called negative externalities, through business practices. In a true market economy, a
Pigovian tax is the most efficient and effective way to correct negative externalities. Tax on diesel, tax on
tobacco products and alcohol are examples of Pigouvian Tax.

Q 43.C
• Devaluating a currency is decided by the government issuing the currency, and unlike depreciation, is not
the result of non-governmental activities.
• Increased Aggregate Demand (AD) - Exports become cheaper and more competitive to foreign buyers.
Higher exports relative to imports can increase aggregate demand as increased consumer spending on
domestic goods and services.
• Inflation is more likely to occur because imports are more expensive causing cost push inflation, AD is
increasing causing demand pull inflation and with exports becoming cheaper manufacturers may have less
incentive to cut costs and become more efficient. Therefore over time, costs may increase.
• Improvement in the current account balance. With exports more competitive and imports more
expensive, we may see higher exports and lower imports, which will reduce the current account deficit.
• Hence option (c) is the correct answer.

Q 44.C
• Fixed Rate or Fixed Float: Under this system, Central bank decides the official exchange rate. A set
price will be determined against a major world currency (usually the U.S. dollar, but also other major
currencies such as the euro, the yen, or a basket of currencies). In order to maintain the local exchange
rate, the central bank buys and sells its own currency on the foreign exchange market in return for the
currency to which it is pegged.
• Flexible Rate or Free Float: When the exchange rate is decided by the market force (demand and supply
of currency), it is called the flexible exchange rate.

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• Managed floating exchange rate: It is a combination of flexible exchange rate system and fixed rate
system. Under this, central banks sometimes intervene by selling foreign currencies in the exchange to
stabilise the domestic currency, this is called as dirty floating. Hence option (c) is the correct answer.

Q 45.A
• Futures are financial contracts obligating the buyer to purchase an asset or the seller to sell an asset, such
as a physical commodity or a financial instrument, at a predetermined future date and price. Futures
contracts detail the quality and quantity of the underlying asset; they are standardized to facilitate trading
on a futures exchange. Some futures contracts may call for physical delivery of the asset, while others are
settled in cash. Hence, statement 1 is correct. A futures exchange or futures market is a central
financial exchange where people can trade standardized futures contracts
• A forward contract is also a customized contract between two parties to buy or sell an asset at a specified
price on a future date. Unlike Futures Contracts, Forward contracts do not trade on a centralized exchange
and are therefore regarded as over-the-counter (OTC) instruments. Hence, statement 2 is not correct.

Q 46.B
• Zero-based budgeting (ZBB) is a method of budgeting in which all expenses must be justified for
each new period. The process of zero-based budgeting starts from a "zero base," and every scheme
within the budget is analyzed for its needs and costs. Budgets are then built around what is needed for the
upcoming period, regardless of whether each budget is higher or lower than the previous one. The
primary purpose of zero-based budgeting is termination of activities which have become irrelevant.
• Advantages of Zero-Based Budgeting
o It leads to efficiency. It works on rational principles leading to efficient allocation of resources
(department-wise).
o It brings accuracy. In traditional budgeting some arbitrary changes are made to the previous year’s
budget. But in the ZBB framework every department relooks at each and every item of the clash flow
and accordingly compute its operating costs. It gives a clear idea of the costs involved against the
desired performance. It also assists in cost reduction to a limited extent.
o It minimizes redundant activities.
o It has other benefits such as flexible budgets, focused operations, lower costs and more disciplined
execution.
• Disadvantages of Zero-based Budgeting:
o It is time-consuming. It is a very time-intensive exercise to do every year as against incremental
budgeting which is a far easier method.
o It is also very resource-intensive in nature. In order to make entire budget from the scratch additional
numbers of employees are needed.
• Outcome Budgeting:
• It is the practice of developing budgets based on the relationship between funding and expected results. It
enhances visibility into how government policies translate into spending and focuses on the outcomes of a
funded activity i.e. the quality or effectiveness of services provided. It aims to align programmes and
services with prioritised government outcomes.
• Incremental Budgeting: An incremental budget is a budget prepared using a previous period's budget or
actual performance as a basis with incremental amounts added for the new budget period.

Q 47.B
• A negotiable instrument is a signed document that promises a sum of payment to a specified person or the
assignee. In other words, it is a transferable, signed document that promises to pay the bearer a sum of
money at a future date or on-demand. The payee, who is the person receiving the payment, must be named
or otherwise indicated on the instrument.
• In India, the negotiable instrument are regulated by Negotiable Instrument Act, 1881 as amended from
time to time. The different types of negotiable instruments recognized by the act include -:
o Promissory note: An instrument in writing containing an unconditional undertaking, signed by the
maker, to pay a certain sum of money only to or to the order of a certain person or to the bearer of the
instrument. There are two parties, i.e. drawer and payee.
o Bill of exchange (demand draft): It is a written instrument showing the indebtedness of a buyer
towards the seller of goods. There are three parties, i.e. drawer, drawee and payee. Example- a student
paying a college fee through demand draft. Here, Student is drawer, Bank is drawee and College is the
payee.

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o Cheque: It is an order by the account holder of the bank directing his banker to pay on demand the
specified amount, to or to the order of the person named therein or to the bearer.
o Currency Note: It is a legal tender which gives the holder the right to receive the value of its
denomination on exchange. So “holding” determines the entitlement. Even if somebody steals the
currency he/she becomes the holder and so entitled to the rights. On the other hand, a negotiable
instrument is a document which guarantees a specific some of money to the payee whose name is
mentioned in the instrument itself.
• Hence only options 1, 2 and 4 are correct.

Q 48.A
• CIC or Credit Information Company is an independent third party institution that collects financial data
regarding loans, credit cards and more about individuals and shares it with its members. Banks, Non-
Banking Financial institutions are usually the customers of Credit Information Companies. The Credit
Card Company collects financial information about all these individuals and forms a credit report based
on their financial history. This credit report plays a very important role as it helps banks and other
financial institutions determine the creditworthiness of an individual applying for a loan or credit card
with them. Hence statement 1 is correct.
• Whenever an individual approaches a bank/financial institution to avail loans, the bank will be concerned
about the repayment capacity of the individual. The repayment capacity can be traced from the loan
repayment history of the individual.
• At present, four credit information companies are given a certificate of registration by the Reserve Bank
of India. These companies are Credit Information Bureau (India) Limited (CIBIL), Equifax Credit
Information Services Private Limited, Experian Credit Information Company of India Private Limited and
CRIF High Mark Credit Information Services Private Limited.
• For the regulation of credit information activities, there is the Credit Information Companies (Regulation)
Act, 2005 (CICRA) which is binding for the Credit information companies as well as for financial
institutions. The CICRA was enacted to regulate the businesses of the CICs. Hence statement 2 is not
correct.

Q 49.B
• The yield of a bond is the effective rate of return that it earns. But the rate of return is not fixed — it
changes with the price of the bond. A yield curve is a graphical representation of yields for bonds over
different time horizons. Typically, the term is used for government bonds — which come with the same
sovereign guarantee.
• In a healthy economy, bondholders typically demand to be paid more — or receive a higher “yield” — on
longer-term bonds than they do for short-term bonds. That’s because longer term bonds require people to
lock their money up for a greater period of time — and investors want to be compensated for that risk. In
contrast, bonds that require investors to make shorter time commitments say for three months, don’t
require as much sacrifice and usually pay less.

• Statement 1 is not correct: An inverted Bond yield curve happens when the yield on a longer tenure
bond becomes less than the yield for a shorter tenure bond.

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• Statement 2 is correct: A yield inversion typically portends a recession. It shows that investors expect
the future growth to fall sharply; in other words, the demand for money would be much lower than what it
is today and hence the yields are also lower.
• The Bond yield curve has inverted before every U.S. recession since 1955, although it sometimes happens
months or years before the recession starts. Because of that link, substantial and long-lasting inversions of
the yield curve are largely viewed as a strong predictor that a downturn is on the way.

Q 50.B
• Tax revenue is charged on income earned by an individual or an entity (direct tax) and on the value of
transaction of goods and services (indirect tax). On the other hand, non-tax revenue is charged against
services provided by the government. It also includes interest charged on loans advanced by the
government for various purposes
• Non-tax revenue includes-
o Interest: It comprises of interest of loans given to states and union territories for reasons like non-plan
schemes (e.g. flood control) and planned schemes with maturity period of 20 years such as
modernisation of police forces and also interest on loans advanced to Public Sector Enterprises
(PSEs), Port Trusts and other statutory bodies etc.
o Dividends and profits: This includes dividends and profits from PSEs as well as the transfer of
surplus from Reserve Bank of India (RBI).Petroleum license: This includes fees to get the exclusive
right for exploration in a particular region. Such fees may be in the form of royalty, share of the profit
earned from contact areas during a specific period, Petroleum Exploration License (PEL) fee or
Production Level Payment (PLP).
o Power supply fees: This includes fees received by Central Electricity Authority from the supply of
power under the Electricity (Supply) Act.
o Fees for Communication Services: This mainly includes the license fees from telecom operators
on account of spectrum usage charges that licensed Telecom Service Providers pay to the
Department of Telecom (DoT).
o Broadcasting fees: It includes license fee paid by DTH operators, commercial TV services,
commercial FM radio services etc.
o Road, Bridges usage fees: This includes receipts through toll plazas on account of the usage of
national highways, permanent bridges etc.
o Examination fees: This includes fees paid by applicants of competitive examinations conducted by
the Union Public Service Commission (UPSC) and Staff Selection Commission (SSC) to fill up
vacancies in government offices.
o Fee for police services: This includes fee received for supplying central police forces to state
governments and other parties like Central Industrial Police Force (CISF) to industries etc.
o Sale of stationery, gazettes etc: This includes receipts under ‘Stationery and Printing’ relating to the
sale of stationery, gazettes, government publications, etc.
o Fee for Administrative Services: This includes fees received for providing services like audit
services, issuance of passport, visa etc.
o Receipts relating to Defence Services: This relates to services provided through Canteen Stores
Department (CSD).
• Disinvestment receipts form a part of the Non-debt capital receipts.

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