Static Quiz 27 May 2026 (Indian Economy)

Q1. Consider the following statements regarding exchange rate regimes:

1. Under a fixed exchange rate regime, the value of the domestic currency is determined entirely by market demand and supply.
2. India presently follows a managed floating exchange rate system.
3. In a managed float system, the central bank may intervene in the foreign exchange market to reduce volatility.

Which of the statements given above is/are correct?

A) 2 and 3 only
B) 1 and 2 only
C) 3 only
D) 1, 2 and 3

Answer: A) 2 and 3 only

Explanation:

• Statement 1: Incorrect
  • In a fixed exchange rate system, the exchange rate is officially pegged to another currency, gold, or a basket of currencies.
  • The central bank actively intervenes in the foreign exchange market to maintain the predetermined value.
  • Therefore, exchange rates are not determined entirely by demand and supply.
  • Example:
    • Under the Bretton Woods system, many currencies were pegged to the US Dollar.
    • China historically maintained tight control over the Yuan exchange rate.
• Statement 2: Correct
  • India follows a Managed Floating Exchange Rate System (Dirty Float).
  • In this system:
    • Exchange rate is largely market-determined.
    • RBI intervenes occasionally to prevent excessive volatility, speculative attacks, or disorderly market movements.
  • India shifted towards market-determined exchange rates after the 1991 Balance of Payments crisis.
• Statement 3: Correct
  • In managed float systems, central banks use tools such as:
    • Buying/selling foreign currency
    • Interest rate changes
    • Open market operations
  • Objective:
    • Prevent excessive depreciation/appreciation
    • Ensure macroeconomic stability
    • Protect external sector confidence
• Hence, Statements 2 and 3 are correct.

Q2. Which one of the following situations would most likely lead to depreciation of the Indian Rupee?

A) Large inflow of Foreign Direct Investment into India
B) Sustained rise in India’s exports relative to imports
C) Sharp increase in crude oil import bill
D) Significant increase in India’s foreign exchange reserves due to capital inflows

Answer: C) Sharp increase in crude oil import bill

Explanation:

• India is one of the world’s largest crude oil importers.
• Oil imports are denominated primarily in US Dollars.
• When crude oil prices rise sharply:
  • India’s import bill increases.
  • Demand for dollars rises significantly.
  • Higher dollar demand weakens the Rupee.

Why other options are incorrect?

• Option A: Incorrect
  • FDI inflows bring foreign currency into India.
  • Increased dollar supply strengthens Rupee.
• Option B: Incorrect
  • Higher exports increase foreign exchange earnings.
  • Exporters convert dollars into Rupees, increasing dollar supply and supporting Rupee appreciation.
• Option D: Incorrect
  • Higher forex reserves generally indicate stronger capital inflows and external sector stability.
  • This usually supports currency strength.

Q3. With reference to the Real Effective Exchange Rate (REER), consider the following statements:

1. REER adjusts the nominal exchange rate for inflation differentials between countries.
2. A rise in REER necessarily indicates improvement in export competitiveness.
3. REER is calculated against a basket of currencies.

Which of the statements given above is/are correct?

A) 1 and 3 only
B) 2 only
C) 1 only
D) 1, 2 and 3

Answer: A) 1 and 3 only

Explanation:

Understanding REER

• REER = Weighted average of a country’s currency relative to a basket of currencies adjusted for inflation differentials.
• It measures external competitiveness.

Statement 1: Correct

• REER adjusts Nominal Effective Exchange Rate (NEER) using relative inflation rates.

REER=NEER×Foreign Price LevelDomestic Price Level

• Thus, it reflects real purchasing power and competitiveness.

Statement 2: Incorrect

• Higher REER often indicates:
  • Domestic currency appreciation in real terms.
  • Reduced export competitiveness because domestic goods become relatively expensive globally.
• Therefore, rise in REER does not necessarily improve competitiveness.

Statement 3: Correct

• REER uses weighted basket of major trading partner currencies.
• RBI publishes:
  • 6-currency REER
  • 40-currency REER

Prelims Pointer

• NEER = Nominal index without inflation adjustment.
• REER = Inflation-adjusted competitiveness indicator.

Q4. Consider the following effects of depreciation of the domestic currency:

1. Imports become costlier.
2. External debt servicing burden may increase.
3. Export competitiveness may improve.

Which of the above are correct?

A) 1 and 2 only
B) 2 and 3 only
C) 1 and 3 only
D) 1, 2 and 3

Answer: D) 1, 2 and 3

Explanation:

Statement 1: Correct — Imports become costlier

• Depreciation means:
  • More Rupees are needed to buy one Dollar.
• Example:
  • ₹80/$ → ₹90/$
• Imported goods like:
  • Crude oil
  • Electronics
  • Fertilisers
    become more expensive.
• This can trigger imported inflation.

Statement 2: Correct — External debt burden rises

• India’s external debt is partly denominated in foreign currencies.
• After depreciation:
  • Government and firms need more Rupees to repay same amount of Dollar-denominated debt.
• Example:
  • $1 billion debt at ₹80/$ = ₹8000 crore
  • At ₹90/$ = ₹9000 crore

Statement 3: Correct — Exports may become competitive

• Indian goods become cheaper for foreign buyers.
• This can:
  • Increase export demand
  • Improve trade balance

Important Caveat

• Export gains depend on:
  • Global demand conditions
  • Elasticity of exports
  • Import content in exports

Q5. Which of the following can help the Reserve Bank of India prevent excessive depreciation of the Rupee?

1. Selling foreign exchange reserves
2. Increasing policy interest rates
3. Liberalising outward remittances

Select the correct answer using the code below:

A) 1 and 2 only
B) 2 and 3 only
C) 1 only
D) 1, 2 and 3

Answer: A) 1 and 2 only

Explanation:

Statement 1: Correct — Selling forex reserves

• RBI can sell US Dollars from its forex reserves.
• This:
  • Increases dollar supply in forex market.
  • Reduces pressure on Rupee depreciation.
• This is one of the most direct tools used during currency volatility.

Statement 2: Correct — Increasing interest rates

• Higher interest rates:
  • Attract foreign portfolio investment (FPI).
  • Encourage capital inflows.
  • Increase demand for Rupee assets.
• Consequently, Rupee may strengthen.

Statement 3: Incorrect — Liberalising outward remittances

• Outward remittances increase capital outflows.
• More residents buying dollars:
  • Raises forex demand.
  • Weakens domestic currency further.