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?

[UPSC Civil Services Exam – 2022 Prelims]

(a) 1 and 2 only

(b) 2 and 3 only

(c) 1 and 3 only

(d) 1, 2 and 3

Answer: (b)        

Explanation:

• If the inflation is high RBI tries to reduce the liquidity of the market, by selling Government securities to the public via open market operation. Hence, Statement 1 is not correct.
• In a free-floating exchange rate regime, depreciation takes place when the demand for the dollar is more than the supply. Hence, RBI is likely to sell dollars in the economy to increase the supply of the dollar. Hence, Statement 2 is correct.
• To reduce the supply of dollars in the economy, RBI will like to buy the dollars from the market. Hence, Statement 3 is correct.