Consider the following statements:
- 1.Tight monetary policy of US Federal Reserve could lead to capital flight.
- 2.Capital flight may increase the interest cost of firms with existing External Commercial Borrowings (ECBs).
- 3.Devaluation of domestic currency decreases the currency risk associated with ECBs.
Which of the statements given above are correct?
Why UPSC dropped it · explanation
UPSC dropped this question from evaluation in its final answer key.
UPSC dropped this question from evaluation in its final answer key. The facts it tests: tighter US monetary policy can pull capital out of emerging economies (statement 1), and a weaker domestic currency raises, not lowers, the currency risk on foreign-currency borrowing (statement 3 is wrong).
- ✓ 1. When the US Federal Reserve tightens, spillovers to emerging market economies can trigger capital outflows and currency depreciation, as the RBI's Financial Stability Report of June 2022 noted.
- • 2. Arguable, which is probably why the question was dropped. Capital flight weakens the rupee and raises risk premia, so servicing dollar loans costs more in rupee terms; whether the interest cost itself rises depends on whether the loan carries a floating rate.
- ✗ 3. Most ECBs are in US dollars, so a fall in the rupee raises the rupee cost of interest and principal. That increases the currency risk unless the borrower has hedged; about 56 per cent of ECB loans were hedged in 2022.
Remember · Fed tightening can trigger capital flight from emerging markets; a weaker rupee makes unhedged dollar borrowing (ECB) costlier to repay, so currency risk rises.
Sources
- Reserve Bank of India, Financial Stability Report, June 2022 ↗ “The evolving outlook is particularly challenging for emerging market economies (EMEs) that face rising indebtedness, currency depreciations, capital outflows and reserve losses … Nearly 80 per cent of the ECB are denominated in US dollars and 5 per cent each are denominated in Euro and Japanese yen. A predominant component (56 per cent) of ECB loans are hedged”
Question and answer: UPSC's official GS Paper I (2022, Series A) — paper ↗ · answer key ↗. Explanation: Minimalist IAS, checked 30 Sept 2026 (how we verify). ·