UPSC Prelims 2022 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. 
   
   

Which of the statements given above are correct?

Explanation:

• Open market operations, or OMOs, are the purchase and sale of government securities by Reserve Bank of India (RBI) on the Centre’s behalf to streamline money supply and interest rates. OMOs aim to control the supply of money or existing liquidity in the economy. In case of an inflationary situation, RBI adopts a contractionary monetary policy i.e., it sells government securities and absorbs the excess money from the financial flow. Amid a recessionary trend, RBI is keen to boost money supply in the market and ensure adequate credit availability for investment and production. So, it buys securities, increasing the money supply. So, statement 1 is not correct.
  
  
• Interest rate movements in a foreign economy can stimulate action on the part of RBI. If the Federal Reserve reduces money supply in the US, interest rates there will increase. This will reduce Financial Institutional Investments (FII) into India, because US debt investments would have become more attractive. The reduced demand for the rupee due to less interest on the part of global institutional investors, will cause the rupee to depreciate. In response, RBI can sell dollars from its reserves to prop up the Indian currency. On the other hand, if interest rates in the US or the EU were to fall, FIIs will ramp up investments in India. The resultant demand for rupees will cause the rupee to appreciate. In response, RBI will buy dollars and inject rupees into the system. So, statement 2 and statement 3 are correct.
  
  

Therefore, option (2) is the correct answer.

Subject: Economics| Inflation