Question 

 

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.

 

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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

 

Answer

 

The correct answer is B. 2 and 3 only.

 

1. If inflation is too high, the Reserve Bank of India (RBI) is likely to raise interest rates or take other monetary policy measures to cool down the economy and reduce inflation. Buying government securities would have the opposite effect of increasing the money supply, and therefore would not be used as a tool to control inflation.

 

2. If the rupee is rapidly depreciating, the RBI may sell dollars in the market to try to stabilize the currency. This would help to decrease the demand for foreign currencies and increase the demand for the rupee, thereby helping to reduce the rate of depreciation.

 

3. If interest rates in the USA or European Union were to fall, that would tend to decrease the value of the dollar and euro relative to other currencies. This would make investing in these currencies less attractive, which would decrease the demand for these currencies, causing their exchange rates with the rupee to decrease. To counter this, RBI may buy the dollars to keep its value balance.