Directions (1-10): Read the following passage carefully and answer the questions given below them. Certain words/phrases have been printed in bold to help you locate them while answering some of the questions.
The Indian rupee touched a 14-month low last week. Most analysts expect it to continue to depreciate in the near term. There are multiple reasons for the fall in the rupee. For instance, the condition in the international financial market is tightening with yields on 10-year US government bonds touching 3%. This is one of the reasons foreign investors sold Indian stocks and bonds worth about $2 billion in April. Further, global crude oil prices have gone up by over 10% since the beginning of the year and are expected to remain elevated in the foreseeable future. Crude prices have gone up by over 40% over the last one year and are putting pressure on India’s current account deficit, which is expected to have expanded from about $15 billion in FY17 to about $50 billion in FY18. Higher crude prices are also affecting bond prices, which in any case were under pressure due to the higher expected supply of government bonds. Higher crude prices, weakness in rupee, and rising bond yields have complicated policy choices for the Reserve Bank of India (RBI).
The central bank received bids for only a fraction of bonds on offer recently due to weak investor interest. However, if the central bank decides to manage bond yields through market intervention, as it is also responsible for executing the government borrowing programme, it might end up hurting its own policy objectives in other areas, such as currency management and containing inflation. If the RBI intervenes in the market heavily, it will infuse liquidity into the system, which can affect outcomes on the inflation front and put further pressure on the rupee. If the central bank defends the rupee by selling foreign exchange, it could end up draining liquidity from the system, which will put pressure on bond prices and make government borrowing more difficult. The latest minutes of the monetary policy committee (MPC) meeting suggest that the committee might raise rates sooner than expected. While higher policy rates—apart from anchoring inflationary expectations—could be handy in attracting foreign debt capital, it will increase the cost of money and make government borrowing more difficult.
So, what should the RBI do in the present circumstances? It has decided to ease tenure restrictions for foreign investors in both government and corporate bonds. Theoretically, greater flexibility, leading to higher capital inflow in the bond market, will not only reduce pressure on yields but will also help support the rupee. However, greater dependence on short-term foreign debt is inherently risky and can further complicate currency management in the short-to-medium term, as interest rates in the international market are expected to go up. Therefore, it is extremely important that the central bank doesn’t act in haste. All policy options should be carefully examined. In the currency market, the RBI would do well to stick to the stated policy of not targeting any level and should avoid throwing foreign currency from its reserves, or aggressively opening up foreign investment in debt. It should only intervene to avoid excessive volatility. The latest real effective exchange rate data shows that the rupee is overvalued and a healthy correction should help exports. Also, the depreciation of the rupee will serve as an automatic stabilizer. Not allowing the currency to depreciate at a time when the current account deficit is increasing will only create problems in the future. The RBI did well by accumulating large reserves in recent years, which will give confidence to market participants and help avoid excessive volatility.
The central bank should also stay away from managing yields. The government should accept that higher borrowings will increase the cost of money in the market. This will also underline the importance of fiscal discipline and is in line with the long-term idea of reducing financial repression. In terms of rate action, the latest monetary policy statement highlighted the upside risks to the RBI’s revised inflation forecast. However, the MPC would be well-advised to maintain a pause for now and wait for actual information on things, such as the increase in the minimum support price. Further, the monsoon is expected to be normal this year which will help contain inflation and inflationary expectations. Also, a rate hike at this stage could disproportionately raise the cost of money and affect economic growth, which is otherwise expected to strengthen. Rising international crude prices are putting pressure on India’s macroeconomic indicators and have complicated policy choices for the RBI. However, as we have argued in this space in the past, policymakers—including the central bank—should avoid doing too many things at this stage.
Q.1 What are the reasons highlighted in the passage that are responsible for complication of policy choices for the RBI?
(I) Rise in bond yields.
(II) Weakening of the Indian Rupee.
(III) Rise in price of crude oil.
(a) Only (I)
(b) Both (II) and (III)
(c) Both (I) and (III)
(d) All of the Above
(e) None of the above
Q.2 Which of the following are correct in context to the passage?
(I) Global crude oil prices have gone up by over 10% since the beginning of the year and are expected to remain elevated in the future.
(II) The condition in the international financial market is tightening with yields on 10-year US government bonds touching 3%.
(III) Crude prices have gone up by over 40% over the last one year and are putting pressure on India’s current account deficit.
(a) Only (I)
(b) Only (II)
(c) Only (III)
(d) Both (I) and (II)
(e) All are correct.
Q.3 According to the passage, what will be the effects of selling foreign exchange?e passage, what
(a) Bond yield will increase,
(b) Reduce pressure on bond prices.
(c) Government borrowing will become difficult.
(d) both (b) and (c)
(e) both (a) and (b)
Q.4 As per the passage, what has the RBI decided in the present circumstances to support the rupee?
(a) To ease tenure restrictions for foreign investors in both government and corporate bonds.
(b) To reduce the import of crude oil.
(c) To sell foreign exchange.
(d) Both (a) and (b)
(e) Both (b) and (c)
Q.5 Which of the following could be a suitable title for the passage?
(a) The target to reduce inflation
(b) The Dilemma of the Foreign Investors
(c) The right policy path for the Indian central bank
(d) Relation of inflation and bond yield
(e) None of the above
Q.6 Which of the following statements is/are incorrect?
(I) The Indian rupee is expected to continue to depreciate in the near term.
(II) The committee is expected to raise rates sooner than expected as per latest MPC meeting minutes.
(III) RBIs step of accumulating large reserves in recent years was not effective.
(a) Only (a)
(b) Only (b)
(c) Only (c)
(d) Both (a) and (b)
(e) Both (b) and (c)
Q.7 Choose the word which is MOST SMILAR to the word given in passage.
Q.8 Choose the word which is MOST SMILAR to the word given in passage.
(e) None of the Above
Q.9 Choose the word which is most opposite to the following word given in bold in the passage
Q.10 Choose the word which is most opposite to the following word given in bold in the passage