Interest rates in India rise while those abroad stay the same, and there are no restrictions on buying Indian bonds. Foreign investors now demand more rupees. As with a rightward shift of the demand curve in a goods market (supply unchanged), the value of the rupee will most likely:
Answer & explanation
Correct answer: option 4
The correct answer is Option (4) → rise, that is, the rupee will appreciate
Higher interest rates in India draw foreign funds. Foreign investors buy rupees to buy Indian bonds, so the demand for rupees rises.
As in a goods market, more demand with supply unchanged raises the price. The price of the rupee rises: the rupee appreciates.
Option (3) mixes this up with the demand for money at home, which falls with a higher interest rate. Here the demand is for rupees as a currency.
This question uses Market Equilibrium and Open Economy Macroeconomics together.
NCERT (2026-27): “Interest Rates and the Exchange Rate … Thus, a rise in the interest rates at home often leads to an appreciation of the domestic currency. Here, the implicit assumption is that no restrictions exist in buying bonds issued by foreign governments.” Market Equilibrium (Introductory Microeconomics): “5.1.1 Market Equilibrium: Fixed Number of Firms … Now suppose the market demand curve shifts rightward to DD2 with supply curve remaining unchanged at SS0, as shown in panel (a). This shift indicates that at any price the quantity demanded is more than before. … In response to this excess demand some individuals will be willing to pay higher price and the price would tend to rise. …” |