Which one of the following is not the most likely measure the Government/ RBI takes to stop the slide of Indian rupee?
Contents14
- ACurbing imports of non-essential goods-and promoting exports
- BEncouraging Indian borrowers to issue rupee denominated Masala Bonds
- CEasing conditions relating to external commercial borrowing
- DFollowing an expansionary monetary policy
Show answer
Answer: (D) Following an expansionary monetary policy
The correct answer is (D) — Following an expansionary monetary policy.
To stop the rupee from falling, the government/RBI would typically:
- curb unnecessary imports (A)
- encourage rupee-denominated bonds like Masala Bonds to reduce dollar demand (B)
- ease external commercial borrowing to bring in more foreign currency (C)
However, an expansionary monetary policy (increasing money supply, lowering interest rates) would WEAKEN the rupee further because lower interest rates make India less attractive for foreign investors, leading to capital outflow.
Tip:
Expansionary policy = more money supply = weaker currency.
This is the opposite of what you'd do to save the rupee.
When the rupee weakens, RBI uses measures that bring more dollars into India or reduce dollar demand - expansionary monetary policy does the opposite by making India less attractive to foreign investors.
The rupee faced significant pressure in 2018-2019 due to rising crude oil prices and US Fed rate hikes, making currency management a key policy focus that year.
The question tests whether students can identify the one policy that worsens currency depreciation rather than helps it.
Currency Depreciation Prevention Measures
Indian Economy stop the slide of Indian rupee Government RBI
How Government & RBI Prevent Rupee Depreciation
Import curbs and export promotion reduce dollar demand
Masala Bonds bring foreign investment in rupees, not dollars
Expansionary monetary policy weakens currency further
Easier ECB conditions attract more foreign currency inflows
When the rupee falls against the dollar, the government and RBI use multiple tools to reduce dollar demand and increase dollar supply in the market. The key is managing the balance between imports, exports, and foreign investment flows.
Rupee Defense Measures
Measure | How It Works | Impact on Rupee |
|---|---|---|
Import Curbs | Reduce demand for dollars to buy foreign goods | Strengthens rupee |
Export Promotion | Increase dollar inflows from foreign buyers | Strengthens rupee |
Masala Bonds | Foreign investors buy bonds in rupees, not dollars | Reduces dollar demand |
Easier ECB Rules | Companies borrow more dollars from abroad | Increases dollar supply |
Contractionary Policy | Higher interest rates attract foreign investment | Strengthens rupee |
Expansionary Policy | Lower rates → capital outflow → more dollar demand | Weakens rupee |
Why These Work
Trade balance: Less imports + More exports = Less dollars leaving + More dollars coming
Capital flows: Higher interest rates make India attractive to foreign investors
Currency substitution: Masala Bonds let foreigners invest without buying dollars first
Supply-demand: All measures either reduce dollar demand or increase dollar supply
Trap: Expansionary policy sounds like 'expansion is good' — but it expands money supply, weakening currency
Confusion: ECB easing brings dollars IN (good), but monetary easing sends dollars OUT (bad)
Remember: Lower interest rates = Foreign money leaves India = Rupee falls
Masala Bonds
Indian Economy Masala Bonds rupee denominated
Masala Bonds: Rupee-Denominated Offshore Bonds
Rupee-denominated bonds issued by Indian entities in foreign markets
Currency risk shifts from issuer to investor
Reduces dollar demand in Indian forex market
SEBI and RBI jointly regulate these bonds
Masala Bonds are rupee-denominated bonds issued by Indian companies in international markets. Unlike regular foreign bonds where Indian companies borrow in dollars, here foreigners lend in rupees — shifting currency risk to the investor.
Masala vs Regular Foreign Bonds
Feature | Masala Bonds | Regular Foreign Bonds |
|---|---|---|
Currency | Indian Rupee | Foreign currency (USD, EUR) |
Currency Risk | Borne by foreign investor | Borne by Indian borrower |
Forex Impact | Reduces dollar demand | Increases dollar demand |
Regulation | SEBI + RBI | Overseas regulators |
First Issue | HDFC (2014) | Various since 1990s |
Benefits for Rupee Stability
No forex conversion: Foreign investors buy rupee bonds directly, no dollar-rupee exchange needed
Reduced volatility: Less pressure on rupee during repayment as no currency conversion required
Diversification: Gives Indian companies alternative to dollar borrowing
Name origin: Called 'Masala' because rupee bonds have the 'flavor of India'
Don't confuse: Masala Bonds help rupee; Dollar bonds create rupee pressure
Regulation: Both SEBI (securities) and RBI (forex) have roles
External Commercial Borrowing (ECB)
Indian Economy external commercial borrowing
External Commercial Borrowing: Foreign Currency Loans
Foreign currency loans by Indian companies from overseas lenders
Automatic route up to certain limits, approval route beyond
Easing ECB conditions brings more dollars to India
RBI sets limits, interest rates, and end-use guidelines
ECB allows Indian companies to borrow foreign currency (mainly USD, EUR) from overseas banks, institutions, or capital markets. RBI regulates these borrowings through limits and end-use restrictions.
ECB Routes & Limits
Route | Limit | Approval | Key Features |
|---|---|---|---|
Automatic Route | Up to USD 750 million per year | No RBI approval needed | Faster, less paperwork |
Approval Route | Above USD 750 million | RBI approval required | Case-by-case evaluation |
Startups | Up to USD 3 million | Automatic | Special concession |
Infrastructure | Higher limits | Approval route | Priority sector treatment |
How Easing ECB Helps Rupee
Higher limits: More companies can borrow foreign currency, increasing dollar inflows
Relaxed end-use: Companies can use ECB for more purposes, making it attractive
Lower interest rate caps: Cheaper foreign borrowing encourages more ECB uptake
Simplified procedures: Faster approvals mean quicker dollar inflows
End-Use Restrictions
Allowed: Capital expenditure, infrastructure, R&D, working capital
Not allowed: Investment in stock markets, real estate, lending to others
Working capital: Limited to 25% of average working capital or USD 20 million
Easing vs Tightening: Easier ECB brings dollars IN (helps rupee), tighter ECB reduces inflows
Automatic route limit: Remember USD 750 million per financial year
End-use matters: ECB cannot be used for speculation or financial investments
Expansionary Monetary Policy Effects
Indian Economy expansionary monetary policy
Why Expansionary Policy Weakens Currency
Lower interest rates make domestic investments less attractive
Capital outflow increases as foreign investors seek higher returns elsewhere
More money supply creates inflationary pressure, weakening currency
Contractionary policy does the opposite — strengthens currency
Expansionary monetary policy means RBI increases money supply and reduces interest rates to boost economic growth. However, this makes the rupee weaker against other currencies through multiple channels.
How Expansion Weakens Rupee
%%{init: {"flowchart": {"wrappingWidth": 460}}}%%
flowchart TD
s1["`**RBI cuts interest rates**
Repo rate, reverse repo rate reduced`"]
s2["`**Lower returns on Indian investments**
FDs, bonds give less interest`"]
s3["`**Foreign investors pull money out**
Seek higher returns in other countries`"]
s4["`**Capital outflow increases**
More dollars leaving India`"]
s5["`**Dollar demand rises**
Indians need dollars to invest abroad too`"]
s6["`**Rupee depreciates**
More rupees needed to buy each dollar`"]
s1 --> s2
s2 --> s3
s3 --> s4
s4 --> s5
s5 --> s6Expansionary vs Contractionary Impact
Policy Type | Interest Rates | Capital Flows | Currency Effect |
|---|---|---|---|
Expansionary | Decrease | Outflow (FII exit) | Weakens rupee |
Contractionary | Increase | Inflow (FII entry) | Strengthens rupee |
Additional Weakening Factors
Inflation risk: More money supply can trigger inflation, reducing rupee's purchasing power
Interest rate differential: Gap between Indian and US rates narrows, making dollar more attractive
Carry trade unwinding: Investors stop borrowing cheap rupees to invest in higher-yielding currencies
Counter-intuitive: Expansion sounds positive but weakens currency — opposite of currency defense
Growth vs Currency: Expansion helps growth but hurts exchange rate — policy trade-off
Remember: To defend rupee, RBI would raise rates, not lower them