IAI Actuarial Core Principles · Business Economics · Balance of payments and exchange rates
Which development would most likely cause a sustained depreciation of the rupee under a floating exchange rate, ceteris paribus?
A persistent widening of the current account deficit without enough capital inflow to finance it causes sustained rupee depreciation. Importers sell rupees to buy foreign currency while little foreign demand for rupees offsets this. The other options increase demand for rupees or improve competitiveness.
- AA rise in global demand for Indian software exports
- BImproved expectations of Indian economic growth attracting foreign direct investment
- CA persistent increase in the current account deficit financed by weaker capital inflowsCorrect
- DA fall in Indian inflation relative to trading partners
- A rise in the RBI's foreign exchange reserves from purchases of dollars
Explanation
A widening current account deficit means more rupees are supplied to buy foreign currency, and if capital inflows are weaker the demand for rupees does not offset it, so the rupee falls. Software exports, FDI and lower relative inflation raise demand for rupees. RBI dollar purchases would weaken the rupee only in the short term and are intervention, not a fundamental driver.
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