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 below is/are correct?
Detailed Explanation:
Answer: Option 2 — 2 and 3 only
This question tests the understanding of RBI's monetary policy tools and foreign exchange market operations. Statement 1 is incorrect as RBI sells (not buys) securities during high inflation, while statements 2 and 3 correctly describe RBI's forex interventions.
❌ Statement 1 – Incorrect: When inflation is too high, RBI sells government securities through Open Market Operations (OMO) to absorb excess liquidity from the market, not buy them. Buying securities would inject more money and worsen inflation.
✅ Statement 2 – Correct: When the rupee depreciates rapidly, RBI intervenes by selling dollars from its forex reserves, increasing dollar supply in the market to stabilize the exchange rate and support the rupee.
✅ Statement 3 – Correct: Lower interest rates in USA/EU make Indian markets more attractive for foreign investment, causing dollar inflows and rupee appreciation. RBI buys these excess dollars to prevent excessive rupee strengthening that could harm exports.
📝 Short Notes: RBI's Monetary and Forex Operations
| Economic Situation | RBI Action | Purpose |
|---|---|---|
| High Inflation | Sells government securities (OMO) | Absorb excess liquidity, reduce money supply |
| Low Inflation/Recession | Buys government securities (OMO) | Inject liquidity, increase money supply |
| Rupee Depreciation | Sells foreign currency (usually dollars) | Increase forex supply, stabilize rupee |
| Rupee Appreciation | Buys foreign currency (dollars) | Prevent excessive strengthening, protect exports |
| Capital Inflows (low foreign rates) | Buys dollars to build reserves | Manage exchange rate, prevent rapid appreciation |
- Open Market Operations (OMO): Buying/selling of government securities to regulate liquidity and money supply in the economy
- Foreign Exchange Intervention: RBI's buying/selling of foreign currency to manage exchange rate volatility
- Sterilization: When RBI buys dollars, it simultaneously sells securities to neutralize the rupee liquidity created
- Forex Reserves: Maintained to ensure external stability, meet import requirements, and manage exchange rate
Question 4 of 17 Monetary Policy
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