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IAI Actuarial Core Principles · Business Economics · Balance of payments and exchange rates

Under a freely floating exchange rate system, the Indian rupee is most likely to depreciate against the US dollar if:

The rupee is most likely to depreciate when Indian residents buy more imports and US assets, because this raises the demand for dollars and increases the supply of rupees on the foreign exchange market. The other events increase demand for rupees and would strengthen it.

  1. AForeign investors increase their purchases of Indian government bonds
  2. BIndian exporters see a sharp rise in overseas orders
  3. CIndian residents increase their demand for imported goods and US assets, raising the demand for dollarsCorrect
  4. DThe Reserve Bank of India raises its policy rate while US rates stay unchanged
  5. Global demand for Indian software services rises

Explanation

A depreciation of the rupee occurs when the demand for dollars rises relative to the supply of dollars. Higher Indian demand for imports and US assets requires buying dollars with rupees, which pushes the rupee down. The other options all raise demand for rupees and so tend to appreciate it.

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