Correct Option (A): (Question Dropped by UPSC)
Statement 1 is correct. A tight monetary policy by the US Federal Reserve involves increasing interest rates. Higher interest rates in the US make dollar-denominated assets more attractive to global investors seeking higher returns. This can lead to a reallocation of capital from emerging economies, where returns might become relatively less attractive, back to the US, resulting in capital flight from these economies.
Statement 2 is correct. Capital flight often leads to a depreciation of the domestic currency. For firms with existing External Commercial Borrowings (ECBs), which are typically denominated in foreign currencies (e.g., US Dollar), a depreciated domestic currency means that more units of the domestic currency are required to repay the same amount of foreign currency principal and interest. This effectively increases the servicing cost (including interest and principal) of these ECBs when measured in domestic currency terms.
Incorrect Options:
Statement 3 is incorrect. Devaluation of a domestic currency means that its value decreases relative to foreign currencies. For firms with ECBs, which are typically denominated in foreign currency, a devaluation implies that more units of the domestic currency are needed to repay the same amount of foreign currency debt. This increases the burden of repayment and, consequently, enhances the currency risk associated with ECBs, rather than decreasing it.
Options 2, 3, and 4 include statement 3 as correct, which is factually inaccurate.