Module: | MODULE A: INTERNATIONAL BANKING
Q2: Evaluate the following statements regarding various exchange rate mechanisms utilized by different nations. Identify the incorrect statements.
Statement 1. Under a purely fixed exchange rate system, the central bank must continuously intervene by buying and selling foreign currency reserves to maintain the pegged exchange rate.
Statement 2. The Indian Rupee currently operates under a freely floating exchange rate mechanism where the Reserve Bank of India never intervenes, allowing purely market forces to dictate the daily rate.
Statement 3. In a managed floating exchange rate system, the rate is primarily determined by market demand and supply, but the central bank reserves the right to intervene to curb excessive volatility and speculative attacks.
Statement 2. The Indian Rupee currently operates under a freely floating exchange rate mechanism where the Reserve Bank of India never intervenes, allowing purely market forces to dictate the daily rate.
Statement 3. In a managed floating exchange rate system, the rate is primarily determined by market demand and supply, but the central bank reserves the right to intervene to curb excessive volatility and speculative attacks.
✅ Correct Answer: B
🎯 Quick Answer:
Statement II is the only incorrect statement, making Option B the right choice.
Concept Definition: Exchange rate mechanisms define how a country manages its currency in respect to foreign currencies.Statement II is the only incorrect statement, making Option B the right choice.
Structural Breakdown: Statement I is logically sound.
In a fixed system, the rate is set by the government.
To keep it there, the central bank must act as the buyer or seller of last resort, absorbing any excess supply or demand using its foreign exchange reserves.
Statement II is fundamentally incorrect.
India does not operate on a purely free float.
The Indian Rupee operates under a managed float system.
While daily rates are determined by the market, the Reserve Bank of India actively monitors and intervenes to smooth out extreme volatility and prevent disorderly market conditions.
Statement III is correct and accurately describes the managed float system, which is the exact system utilized by the Reserve Bank of India today.
Causal Reasoning: Pure free floats are rare in emerging economies because extreme currency volatility can destroy import pricing stability and disrupt foreign debt repayment schedules.