With reference to the Indian economy, consider the following statements:

1. If the inflation is too high, Reserve Bank of India (RBI) is likely to buy government securities.

2. If the rupee is rapidly depreciating, RBI is likely to sell dollars in the market.

3. If interest rates in the USA or European Union were to fall, that is likely to induce RBI to buy dollars.

Which of the statements given above are correct?

The correct option is 2 and 3 only.

To understand why statements 2 and 3 are correct, let us analyze each statement individually:

Analysis of Statement 1:
If the inflation is too high, the Reserve Bank of India (RBI) aims to reduce the money supply in the economy to curb demand and lower prices. Buying government securities injects money (liquidity) into the banking system, which increases inflation further. To control inflation, the RBI is likely to sell government securities, thereby absorbing liquidity from the market. Hence, Statement 1 is incorrect.

Analysis of Statement 2:
If the Indian rupee is rapidly depreciating against the US dollar, it means there is excess demand for dollars relative to their supply. To stabilize the rupee and check depreciation, the RBI intervenes in the foreign exchange market by selling dollars from its foreign exchange reserves. This increase in the supply of dollars strengthens the rupee. Hence, Statement 2 is correct.

Analysis of Statement 3:
If interest rates in the USA or the European Union fall, foreign investors will look for higher returns, leading to increased capital inflows (dollars) into India. This sudden influx of dollars causes the rupee to appreciate rapidly, which can hurt India's export competitiveness. To prevent sharp appreciation and manage volatility, the RBI buys the excess dollars from the market and adds them to its reserves, releasing rupees instead. Hence, Statement 3 is correct.