"RBI's exchange rate tools tested amid rupee depreciation and capital outflows"
Managed Float
exchange rate regime where market sets the rate but the central bank intervenes to curb excessive volatility
FCNR(B) Deposits
Foreign Currency Non-Resident (Bank) deposits that attract diaspora dollar inflows, with principal and interest payable in foreign currency
India's exchange rate management operates within a managed float regime — the rupee's value is primarily determined by market forces, but the Reserve Bank of India (RBI) intervenes periodically to curb excessive volatility. This is distinct from a fixed peg (where the central bank defends a specific rate) or a fully free float (where the market alone determines the rate). The legal basis for the RBI's forex operations lies in the Foreign Exchange Management Act (FEMA), 1999, which replaced the earlier FERA, 1973, shifting the philosophy from control to management of foreign exchange.
The RBI's monetary policy mandate, anchored in Section 45ZA of the RBI Act, 1934, formally prioritises CPI-based inflation targeting at 4% (±2%). However, exchange rate stability is an implicit secondary concern because currency depreciation feeds into import costs, raising domestic inflation — particularly for fuel and edible oils — and complicating the inflation-targeting mandate. The tension between defending the rupee and maintaining adequate forex reserves has historically shaped India's policy responses during episodes like the taper tantrum of 2013, the 2018 current account stress, and the present episode of dollar strengthening.
The exchange rate is primarily driven by net capital flows, especially Foreign Portfolio Investment (FPI) flows, which are highly sensitive to interest rate differentials between India and the United States. When the US Federal Reserve raises rates or signals tightening, the yield differential narrows, making Indian assets relatively less attractive. Global risk aversion then compounds this: investors repatriate capital to perceived safe havens, putting downward pressure on the rupee and depleting India's foreign exchange reserves.
The RBI has a toolkit of instruments to manage this. First, direct forex market intervention — buying or selling dollars in the spot market to smooth volatility. Second, forward contracts — the RBI can sell dollars forward, locking in future supply; however, a large net forward-selling position signals market expectations of continued rupee weakness. Third, FCNR(B) deposit schemes — Foreign Currency Non-Resident (Bank) deposits allow the RBI to attract dollar inflows from the Indian diaspora by offering attractive interest rates, with the RBI bearing the hedging cost. …
Which one of the following is not the most likely measure the Government/Reserve Bank of India takes to stop the slide of Indian rupee?
If the RBI decides to adopt an expansionist monetary policy, which of the following would it not do?
1.Cut and optimize the Statutory Liquidity Ratio
2.Increase the Marginal Standing Facility Rate
3.Cut the Bank Rate and Repo Rate
Select the correct answer using the code given below:
In India, as the 'Lender of Last Resort', the function of the central bank in its usual course normally includes which of the following?
1.Lending to trade and industry bodies when they fail to obtain credit from other sources
2.Providing liquidity to the banks having a temporary crisis
3.Lending to governments to finance budgetary deficits
Select the correct answer using the code given below.
With reference to India's exchange rate management, consider the following statements:
1.India follows a managed float regime where the RBI intervenes to curb excessive volatility but does not defend a fixed rate.
2.The Foreign Exchange Management Act (FEMA), 1999 replaced FERA, 1973, shifting the approach from 'control' to 'management' of foreign exchange.
3.Under the Fully Accessible Route (FAR), foreign portfolio investors can invest in all categories of Indian government securities without any limit.
Which of the statements given above are correct?
Consider the following statements about Foreign Currency Non-Resident — Bank (FCNR-B) deposits:
1.The principal and interest on FCNR-B deposits are payable in foreign currency, creating a future liability on India's foreign exchange reserves.
2.In the 2013 FCNR-B scheme, the RBI bore the hedging cost to make the scheme attractive to foreign investors.
3.The 2013 FCNR-B scheme raised approximately $26 billion over its full duration.
Which of the statements given above are correct?
The 'impossible trinity' or Mundell-Fleming trilemma in international economics states that a country cannot simultaneously maintain which of the following three objectives?
Assertion (A): The RBI's large net forward-selling position in dollars since October 2023 has been interpreted by markets as a bearish signal for the rupee.
Reason (R): Forward contracts to sell dollars commit the RBI to delivering foreign currency at a future date, implying an expectation that the rupee will weaken and dollar supply will be needed.
Which one of the following is correct in respect of the above?
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