Inflow of foreign investments in India lead to Increase in Current Account Deficit CAD in the short ...........

Indian Economic System(HAS) Others

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Inflow of foreign investments in India lead to

Increase in Current Account Deficit (CAD) in the short-term
Crowding out in financial markets in the short-term

Which of the above is/are correct?

1 only

2 only

Both 1 and 2

None

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Explanation:

Statement 1: It actually bridges the CAD in the short-run. In the long-run, however, India has to pay more due to an outgo of both the principle and earned returns on investment in the long run.

Statement 2: Crowding out happens due to shortage of funds and a hike in interest rates following the shortage. This usually happens when government borrows in large quantities from markets. But, increase foreign exchange influx would actually help reduce crowding out by increasing the fund flow and lowering the interest rates.