With reference to the Indian economy, consider the following statements:
- If the inflation is too high, Reserve Bank of India (RBI) is likely to buy government securities.
- If the rupee is rapidly depreciating, RBI is likely to sell dollars in the market.
- If interest rates in the USA or European Union were to fall, that is likely to induce RBI to buy dollars.
Which of the statements given above are correct ?
1 and 2 only
2 and 3 only
1 and 3 only
1, 2 and 3
Answer is Wrong!
Answer is Right!
This question was previously asked in
UPSC IAS – 2022
Statement 2 is correct. If the rupee is rapidly depreciating, it means its value is falling relative to foreign currencies (like the US dollar). This is often due to high demand for foreign currency or low supply. To counter this, RBI can intervene in the foreign exchange market by selling dollars from its foreign exchange reserves. This increases the supply of dollars, which helps to stabilize the rupee’s value or reduce the rate of depreciation.
Statement 3 is correct. If interest rates in the USA or European Union fall, financial investments in those regions may become less attractive compared to India, assuming India offers relatively better returns. This encourages foreign investors to move capital to India, increasing capital inflows (e.g., FII/FPI investments). These inflows are often denominated in foreign currency (like USD) and converted to rupees, leading to increased supply of foreign currency in the domestic market. This would put pressure on the rupee to appreciate. To prevent excessive or rapid appreciation and maintain exchange rate stability, RBI may buy dollars (and sell rupees) from the market, thereby absorbing the excess foreign currency supply.