RBI forex operations

Explanation

Both statements correctly describe RBI's exchange-rate management approach. First, the RBI's stated policy is to curb excessive volatility — not to peg or fix the rupee at a target level. This is the standard distinction in central-bank forex operations between a 'managed float' (intervening only to smooth volatility) and a 'fixed exchange rate' regime (defending a specific rate). Second, a dedicated dollar window for oil marketing companies — where oil importers source their dollar requirements through designated channels rather than the open spot market — is a recognised tool for reducing concentrated dollar demand that can push the rupee down. By channelling large, predictable oil-import dollar purchases away from the open market, the RBI reduces the immediate demand pressure on the rupee in the spot market without directly fixing its price.

Explanation

All three statements correctly describe distinct RBI forex management tools and their underlying logic. First, a risk reserve requirement — where lenders must set aside a percentage of the rupee equivalent for forex derivative transactions above a threshold — directly raises the cost of entering such contracts, making speculative hedging less attractive while also affecting genuine hedgers; this is a classic macro-prudential tool applied to the derivatives market. Second, capping the notional value of 'naked' or unbacked derivative positions (those without an underlying import, export, or capital-account exposure) is a well-established structural intervention that targets purely speculative currency bets; it is conceptually different from spot-market dollar sales because it does not deploy reserves but instead restricts the size of permissible positions. Third, routing large state-owned oil refiners' dollar purchases through a separate arrangement (taking them 'out of the market') reduces the demand signal in the onshore forward and spot markets; the country's physical import need is unchanged, but the concentrated daily demand that would otherwise move market rates is insulated from public price discovery — a demand-management tool rather than a supply-side reserves-injection tool. Together, the three statements map the breadth of the RBI's currency-defence toolkit: price-based disincentives (reserve requirement), position-based restrictions (naked derivative limits), and demand-segregation (oil importer exclusion).

Explanation

Statement 1 is correct. Under FEMA, interest payments on external commercial borrowings are classified as current account transactions (since they are periodic remittances, not principal flows). However, they arise from an underlying capital account transaction (the ECB itself). This dual character is a recognised feature of FEMA's current vs capital account distinction, and RBI's directions explicitly acknowledge it when carving out exemptions — hedges of such payments by users are excluded from certain reserve requirements precisely because of this capital-account origin, even though the payment itself is current-account in nature. Statement 2 is incorrect. RBI's regulatory architecture keeps different reserve obligations strictly separate. A new reserve requirement imposed on forex derivatives (such as a Foreign Exchange Risk Reserve) is maintained in the authorised dealer's current account with RBI as a distinct obligation and cannot be counted toward the bank's CRR requirement, nor can it be counted as high-quality liquid assets under the liquidity coverage ratio framework. The daily minimum balance in the bank's RBI account must independently satisfy CRR, any new forex derivative reserve, and other applicable cash reserve obligations — they are additive, not fungible. Statement 3 is correct. FEMA draws a fundamental distinction between current account and capital account transactions, and RBI's regulatory instruments for currency derivatives map directly onto this distinction. A derivative used to hedge a current account transaction may attract different reserve or reporting requirements compared with one used to hedge a capital account transaction. This differential treatment is intrinsic to how FEMA empowers RBI to regulate currency derivatives — RBI can calibrate requirements based on the nature of the underlying exposure, so the current/capital account classification of the hedged transaction materially affects the regulatory burden on the derivative.

Explanation

Statement 1 is correct. A managed float (also called a 'dirty float') is the regime India operates under: the rupee's value is set primarily by supply and demand in the forex market, but the RBI intervenes periodically to curb excessive volatility. This is distinct from a fixed peg (where the rate is administratively set) and a pure float (where the central bank never intervenes). Statement 2 is correct. The IMF's standard advice — consistent with its Article IV consultations and published guidance — is that exchange rate flexibility acts as a shock absorber for external shocks such as oil price surges or capital flow reversals, and that reserve-based intervention is less effective beyond the short term. The IMF recommends letting the exchange rate move first and using reserves only as a secondary, smoothing tool. Statement 3 is incorrect. When the RBI sells dollars (foreign currency) to defend the rupee, it receives rupees in exchange from the market. This means rupees flow OUT of the banking system back to the RBI, thereby reducing — not increasing — domestic rupee liquidity. This is a classic sterilisation concern: large-scale dollar sales tighten domestic liquidity, which may prompt the RBI to conduct offsetting open market operations.

Explanation

Statement 1 is incorrect. The RBI's stated policy is to curb excessive or disorderly volatility in the exchange rate — not to eliminate volatility altogether or to defend a specific exchange-rate level. This is a well-established distinction in Indian monetary policy: the RBI is a 'managed float' regime participant, not a fixed-rate defender. Conflating 'curbing excessive volatility' with 'targeting a fixed band' misrepresents the framework. Statement 2 is correct. The IMF itself — and standard economic doctrine — distinguishes between direct market intervention (buying/selling foreign exchange from reserves to influence the spot rate) and structural capital-account measures such as relaxing external commercial borrowing (ECB) rules or offering incentive rates on FCNR(B)/NRE deposits for Non-Resident Indians. The latter attract fresh dollar supply without depleting existing reserves and are broadly seen as complementary rather than substitutive to intervention. Statement 3 is correct. A dedicated dollar window for oil PSUs channels their large, recurring import-payment demand through a separate facility rather than the open interbank forex market, thereby preventing concentrated dollar buying from causing sharp, sudden depreciation pressure. This is a classic demand-management instrument in the RBI's forex toolkit and has been used on previous occasions (most notably during the 2013 taper tantrum) for the same purpose.

Explanation

India's exchange rate regime is officially a 'managed float' (also called a dirty float), meaning the RBI does not fix the rupee at a target level but intervenes in currency markets to smooth out excessive or disorderly fluctuations — this is correctly described in Pair 1. FCNR(B) — Foreign Currency Non-Resident (Bank) deposits — are a well-established RBI instrument used to attract dollar inflows from the Indian diaspora; they have been mobilised during periods of stress (notably 2013) as a special measure to shore up forex reserves, making Pair 2 correct. Pair 3 is incorrect because defending a specific exchange rate level as a standing policy commitment is not how the RBI operates under a managed float; the RBI's consistent stated policy is to prevent disorderly movements, not to peg the rupee to a particular value — which is also precisely the concern Rajan raises: that spending reserves to 'defend a level' contradicts India's historical approach.

Explanation

Statement 1 is correct. When the RBI sells foreign currency (e.g., dollars) in the market to defend the rupee, it receives rupees in return — this mops up rupee liquidity from the banking system. Sterilisation refers to the subsequent open-market operation (usually buying government securities) that the RBI conducts to inject rupee liquidity back, offsetting the contractionary effect. So selling reserves contracts domestic liquidity; sterilisation reverses that. Statement 2 is correct. A weaker currency raises the rupee cost of imports but simultaneously lowers the foreign-currency price of Indian exports, improving their price competitiveness in global markets. This is a standard principle of exchange rate economics — currency depreciation, if not fully offset by domestic inflation, expands the export sector's competitive position. Statement 3 is incorrect. India follows a 'flexible inflation targeting' (FIT) framework under which the RBI's primary mandate is to maintain CPI inflation within a target band — not to defend any specific exchange rate level. The RBI intervenes in forex markets only to manage undue volatility, not to fix the rupee at a predetermined value. Defending a hard exchange rate peg is inconsistent with India's current framework.

Explanation

Statement 1 is correct. When the RBI sells foreign currency (dollars) to support the rupee, it receives rupees in return, withdrawing those rupees from circulation. This reduces domestic banking-system liquidity, which may necessitate offsetting open-market operations — a well-recognised tension in forex intervention management. Statement 2 is incorrect and reflects a common misconception. India operates a managed-float (also called a 'dirty float') regime, NOT a fixed exchange rate or a target-zone/band system. Under a managed float, there is no pre-announced band or level that the central bank is legally obligated to defend; instead, the RBI intervenes at its discretion to contain excessive volatility and prevent disorderly market conditions. The RBI has no statutory obligation to hold any specific rate. Statement 3 is correct. A weaker currency does raise the domestic-currency cost of imports (aggravating the oil import bill) but simultaneously makes exports cheaper in foreign-currency terms, improving the competitiveness and volume potential of export sectors — this is the standard expenditure-switching effect of depreciation that is central to open-economy macroeconomics.