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IAI Actuarial Core Principles · Business Economics · Impact of macroeconomic policies on businesses

Under a floating exchange rate regime, the Reserve Bank of India's monetary policy is tightened, raising domestic interest rates while foreign rates are unchanged. Other things equal, which sequence best describes the effect on an Indian exporter?

Capital inflows rise, the rupee appreciates and exporters lose price competitiveness. Higher Indian interest rates attract foreign investors, increasing demand for rupees, which pushes up the exchange rate and makes exports more expensive in foreign currency terms.

  1. ACapital inflows rise, the rupee appreciates, and exporters become less price competitive abroadCorrect
  2. BCapital outflows rise, the rupee depreciates, and exporters become more competitive
  3. CCapital inflows rise, the rupee depreciates, and exporters become more competitive
  4. DThe rupee is unaffected because floating rates ignore interest differentials
  5. Capital outflows rise, the rupee appreciates, and exporters become less competitive

Explanation

Higher domestic rates attract foreign capital, raising demand for rupees and causing appreciation. A stronger rupee makes Indian goods dearer in foreign currency, reducing export competitiveness. The other sequences have the wrong direction of capital flow or exchange rate.

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