Official Answer Key & Detailed Solution
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Correct Answer: Option (A) — 1 only
Concept & Option Breakdown
Standard Reference VerifiedStatement 1 is correct: Avoiding dependence on short-term foreign borrowings reduces vulnerability to external shocks and sudden capital outflows (flight to safety) during global liquidity crunches.
Statement 2 is incorrect: Increasing foreign bank penetration enhances contagion channels from parent international banks facing distress abroad to the domestic economy.
Statement 3 is incorrect: Full capital account convertibility allows unrestricted cross-border capital mobility, which can exacerbate sharp capital flight during global financial panics.
In a global crisis, greater financial openness (full capital account convertibility, more foreign banks) transmits external shocks faster. Restricting short-term external debt acts as a buffer.
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