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A depreciation of the Indian rupee against the US dollar is likely to

  1. A.Make Indian exports cheaper for foreign buyers and imports costlier
  2. B.Make Indian exports costlier for foreign buyers and imports cheaper
  3. C.Reduce the rupee cost of repaying dollar loans
  4. D.Have no effect on the price of imported crude oil

Correct answer

A. Make Indian exports cheaper for foreign buyers and imports costlier

Explanation

The correct answer is A. When the rupee depreciates, each dollar buys more rupees, so an Indian good priced in rupees costs a foreign buyer fewer dollars and exports become more competitive, while every imported item costs more rupees than before. Option B is wrong because it reverses this relationship; exports becoming costlier and imports cheaper is the effect of an appreciation. Option C is wrong because repaying a loan fixed in dollars takes more rupees after a depreciation, which is exactly why firms with external commercial borrowings suffer when the rupee weakens. Option D is wrong because crude oil is bought in dollars and forms a large part of India's import bill, so a weaker rupee raises the landed cost of oil, feeds into transport and manufacturing costs and adds to imported inflation. Remittances from workers abroad also fetch more rupees, which is a common additional statement in this question.

Read the full article: Foreign Exchange and Exchange Rate: Concepts and Policy

Practice Questions

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Q1.Indian EconomyAsked in: UPSC Civil Services · UPSC Civil Services Prelims 2022Hard

With reference to the Indian economy, consider the following statements: 1. An increase in the Nominal Effective Exchange Rate (NEER) indicates the appreciation of rupee. 2. An increase in the Real Effective Exchange Rate (REER) indicates an improvement in trade competitiveness. 3. An increasing trend in domestic inflation relative to inflation in other countries is likely to cause an increasing divergence between NEER and REER. Which of the above statements are correct?

  1. A.1 and 2 only
  2. B.2 and 3 only
  3. C.1 and 3 only
  4. D.1, 2 and 3
Show answer
Correct answer: C. 1 and 3 only

Statement 1 is right because the NEER is a trade weighted index of the rupee against a basket of partner currencies, so a rise in the index means the rupee has appreciated in nominal terms.

Q2.Indian EconomyAsked in: UPSC Civil Services · UPSC Civil Services Prelims 2022Hard

Consider the following statements: 1. Tight monetary policy of US Federal Reserve could lead to capital flight. 2. Capital flight may increase the interest cost of firms with existing External Commercial Borrowings (ECBs). 3. Devaluation of domestic currency decreases the currency risk associated with ECBs. Which of the statements given above are correct?

  1. A.1 and 2 only
  2. B.2 and 3 only
  3. C.1 and 3 only
  4. D.1, 2 and 3
Show answer
Correct answer: A. 1 and 2 only

Statement 1 is right because when the United States Federal Reserve tightens, returns there become attractive and portfolio money flows out of emerging markets, which is capital flight.

Q3.Indian EconomyAsked in: SSC CGL · 09 Sept, 2024, Shift 1Easy

What challenge does foreign investment often face in India?

  1. A.Excessive foreign competition
  2. B.Inconsistent regulatory environment
  3. C.Lack of skilled labour
  4. D.Lack of consumer base
Show answer
Correct answer: B. Inconsistent regulatory environment

Foreign investors bring in foreign exchange and look for predictable rules, and the difficulty most often listed for India is regulatory uncertainty: changing rules, clearances spread across departments and states, and disputes that take long to settle.

Q5.Indian EconomyMedium

In which year did India accept the obligations of Article VIII of the IMF, making the rupee fully convertible on the current account?

  1. A.1991
  2. B.1993
  3. C.1994
  4. D.1999
Show answer
Correct answer: C. 1994

India accepted the obligations of Article VIII of the Articles of Agreement of the International Monetary Fund in August 1994, which means the rupee can be exchanged freely for trade in goods and services, travel, education, remittances and interest payments.