Paper II

Story hook

On the morning of 2 February 1992, Finance Minister Manmohan Singh rose in Parliament to deliver his second Budget. Buried in paragraph 86 was a single sentence that would reshape the next three decades of India's external sector: "I propose to introduce a system of partial convertibility of the rupee under which exporters and others receiving inward foreign exchange remittances will be permitted to sell 60% of their proceeds at the market- determined rate and the remaining 40% at the official rate." This Liberalised Exchange Rate Management System (LERMS) was a dual exchange rate — neither the pegged ₹19.5/USD of pre-1991 nor the free float that would come later. It was the bridge.

The system lasted fourteen months. On 3 March 1993, the dual rate was abolished and India moved to a unified market- determined exchange rate. On 20 August 1994, Singh accepted Article VIII of the IMF Articles of Agreement — full current account convertibility. India had crossed from a closed foreign exchange regime to an open one in three short steps. The capital account remained partly closed — deliberately. This gradualism would prove decisive: when the Asian Financial Crisis swept through Thailand (July 1997), Indonesia (October), South Korea (December), reducing their currencies by 60-80%, India emerged with the rupee depreciating only 12% and growth continuing.

Twenty-five years later, in September 2022, RBI was forced to defend the rupee against a different storm: the Federal Reserve's aggressive interest-rate tightening had triggered capital outflows from emerging markets. India's forex reserves fell from $642 billion in October 2021 to $524 billion in October 2022 — a $118 billion defence over a year. The rupee slid from ₹73/USD to ₹83/USD. Critics asked whether RBI had mortgaged sovereign reserves to defend a falling currency. Shaktikanta Das (RBI Governor) argued the forex intermediation theory — that the RBI was managing volatility, not pegging. By March 2024 reserves had recovered to $648 billion — a new high.

Now consider the January 2025 scene. President-elect Donald Trump 2.0, days away from his second inauguration, declared that the BRICS bloc must abandon any plan for a non-dollar trade currency or face 100% tariffs. Within weeks of taking office on 20 January 2025, his "reciprocal tariff doctrine" crystallised: any country whose tariffs on US goods exceed US tariffs on the same product would face matching duties. India's average MFN tariff of 17.5% (vs US average of ~3.4%) put Indian exports squarely in the crosshairs. By April 2025 "Liberation Day" — Trump's 2 April 2025 sweeping tariff announcement — India faced a 27% reciprocal tariff (later recalibrated). The arc of India's external sector management — from the 1991 collapse at $1.1 billion to the 2024 peak at $648 billion to the 2025 tariff confrontation — is the story this file tells. The external sector is no longer about a closed inward-looking republic but about an open, networked economy navigating geo-economic fragmentation, energy transition, technology decoupling, and a fraying multilateral trading order.

Why this matters for UPSC

This unit is highly weighted in Economics Optional Paper II, yielding 20-25 marks annually across BoP composition, FDI policy, trade-policy reforms, and exchange-rate management. The 2014-2024 question pattern shows examiners emphasise: (a) conceptual rigour on BoP accounting identities; (b) named critiques of trade strategy (Rangarajan, Tarapore, Subramanian); (c) comparative empirics (India vs Vietnam vs China export trajectory); (d) 2022-25 macroeconomic stress (Fed tightening, oil shocks, rupee defence, Trump 2.0 tariffs). Interview boards probe candidates' grasp of WTO disputes, FTA strategy (RCEP exit, India-UK FTA 2024-25, India-EU progress), the trade-deficit-vs- FDI-surplus dynamic, the rupee-internationalisation roadmap, and the EU CBAM carbon-border challenge.

Beyond exam strategy, this is also the most politically consequential unit. The BoP question — what India can buy from the world, what India must sell to pay for it, how rupees and dollars exchange, what investments cross borders — is woven into every major political fault line: agricultural protection (RCEP exit), strategic autonomy (Russia oil, Iran sanctions navigation), technology sovereignty (semiconductor FDI, electronics PLI), climate justice (CBAM dispute), and even welfare politics (gold imports, fertiliser subsidy, food price volatility). A candidate who has internalised the external sector toolkit can analyse any contemporary economic policy debate with structural depth.