Q. With reference to the Indian economy, consider the following statements:
1. If the inflation is too high, Reserve Bank of India (RBI) is likely to buy government securities.
2. If the rupee is rapidly depreciating, RBI is likely to sell dollars in the market.
3. 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?
a) 1 and 2 only
b) 2 and 3 only
c) 1 and 3 only
d) 1, 2 and 3
Correct Answer: b) 2 and 3 only
Question from UPSC Prelims 2022 GS Paper
Explanation :
Role of the Reserve Bank of India in the Indian Economy
The Reserve Bank of India (RBI) plays a pivotal role in managing the Indian economy, especially in terms of controlling inflation, stabilizing the currency, and influencing capital flows. Here we analyze three statements concerning the actions the RBI might take under different economic scenarios.
1. RBI’s Response to High Inflation
Contrary to the statement that the RBI is likely to buy government securities when inflation is too high, the central bank’s typical response is to sell these securities. Through open market operations (OMOs), selling government securities helps to absorb liquidity from the market, which is essential in reducing the money supply and combating high inflation.
2. RBI’s Strategy Against Rupee Depreciation
The statement that the RBI is likely to sell dollars in the market if the rupee is rapidly depreciating is accurate. By selling dollars, the RBI increases the supply of the US currency while simultaneously boosting demand for the rupee, which can help to stabilize its value against other currencies.
3. RBI’s Actions in Response to Foreign Interest Rate Changes
The RBI may indeed buy dollars if interest rates in the USA or European Union were to fall. Lower interest rates in these economies could lead to increased capital flows into India, causing the rupee to appreciate. To maintain export competitiveness and prevent excessive currency strength, the RBI might intervene by purchasing dollars, thereby increasing its foreign exchange reserves.
In conclusion, the correct assessment of the RBI’s likely actions is “2 and 3 only.” The RBI would sell government securities to fight inflation and sell dollars to support a depreciating rupee, while it might buy dollars in response to an influx of foreign capital due to lower interest rates in the USA or EU.
