🧷 Authentic Classroom Explanation by IAS Monk

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📌 The 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 ?

(a) 1 and 2 only
(b) 2 and 3 only
(c) 1 and 3 only
(d) 1, 2 and 3

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✅ Correct Answer: (b) 2 and 3 only

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🧠 Classroom Explanation

• Statement 1 is NOT correct
  • When inflation is too high, RBI aims to contract liquidity.
  • It does so by selling government securities through Open Market Operations (OMOs), thereby absorbing excess money from the system.
  • Buying government securities would inject liquidity and worsen inflation.
• Statement 2 is correct
  • Rapid rupee depreciation reflects excess demand for foreign currency.
  • RBI sells dollars in the forex market to increase dollar supply and create demand for rupees, thereby stabilising the exchange rate.
• Statement 3 is correct
  • A fall in interest rates in the US/EU reduces returns there.
  • This encourages capital inflows into India, increasing demand for rupees and causing appreciation pressure.
  • To prevent excessive appreciation, RBI buys dollars and injects rupees into the system.

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🔍 Curiosity Raiser

Why does RBI sometimes fight inflation and accumulate foreign reserves at the same time?

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🧘 IAS Monk Whisper

Central banks speak softly,
but move oceans of money.