India follows a managed floating system. The rupee is falling fast against the dollar, and the RBI sells dollars from its reserves to moderate the fall. Which of the following is correct?
Answer & explanation
Correct answer: option 4
The correct answer is Option (4) → Official reserve transactions are not zero, and the RBI’s foreign exchange reserves fall.
Under managed floating, the central bank steps in to moderate big movements. When the RBI sells dollars, it uses up its reserves, so its reserves fall and official reserve transactions are not zero.
Option (1) Official reserve transactions are zero, since the market alone sets the rate under this system. — Incorrect. That describes a completely flexible system; here the RBI intervenes.
Option (2) The rupee is devalued, since the RBI has acted to change the exchange rate. — Incorrect. Devaluation is a government action under a fixed rate. Here the RBI only slows a market fall.
Option (3) The RBI’s foreign exchange reserves rise, since it gets rupees in return for dollars. — Incorrect. Rupees are not foreign exchange. Giving out dollars lowers the reserves.
Option (4) Official reserve transactions are not zero, and the RBI’s foreign exchange reserves fall. — Correct. Selling dollars is an official reserve sale.
NCERT (2026-27): “6.2.4 Managed Floating … Under this system, also called dirty floating, central banks intervene to buy and sell foreign currencies in an attempt to moderate exchange rate movements whenever they feel that such actions are appropriate. Official reserve transactions are, therefore, not equal to zero.” “6.1.3 Balance of Payments Surplus and Deficit … Alternatively, the country could use its reserves of foreign exchange in order to balance any deficit in its balance of payments. The reserve bank sells foreign exchange when there is a deficit. This is called official reserve sale. The decrease (increase) in official reserves is called the overall balance of payments deficit (surplus). …” |