UPPSC 2024 Prelims GS Paper-I · Question 116 of 150

Correct — D, (A) is true, but (R) is false. The Assertion is the standard textbook definition. A flexible — or floating — exchange rate is one at which the external value of the national currency is settled in the foreign exchange market by the demand for and supply of foreign currency, with no official parity being defended. Its opposite is the fixed exchange rate, where the authorities announce a parity and buy or sell reserves to hold it, and where a deliberate downward change is called devaluation rather than depreciation. So (A) stands. The Reason contradicts the very definition the Assertion states. Under a flexible rate the demand for and supply of foreign currency come from the market — importers and exporters settling trade, foreign portfolio and direct investors moving capital in and out, Indians remitting money home, travellers, and firms servicing external debt. If a central bank were the body that determined that demand and supply, the rate would no longer be market-determined and the regime would not be flexible at all. A central bank certainly participates: the Reserve Bank of India buys and sells dollars in the market, so India's rupee floats within a managed float rather than a pure one. But participating in a market is not the same as determining it, and the question's phrasing — that demand and supply 'is being determined by the Central Bank' — is false as written. Hence (A) true, (R) false, which is option (d).

• (a)Both (A) and (R) are true and (R) is the correct explanation of (A). — This is the option a candidate picks who reads the two statements as agreeing because both mention demand and supply of foreign currency. They do not agree — they are in direct conflict. (A) says the market settles the rate; (R) says the central bank settles the market. Both cannot be true of the same regime, so (R) cannot be the explanation of (A).
• (b)(A) is false, but (R) is true. — Reverses the truth values. (A) is the accepted definition of a flexible exchange rate and appears in that form in every standard text. (R) is the false half: in a floating regime the demand and supply of foreign exchange arise from traders, investors, remitters and travellers, not from the central bank.
• (c)Both (A) and (R) are true, but (R) is not the correct explanation of (A). — Correctly senses that (R) does not explain (A), but still certifies (R) as true. It is not. Note the trap: (R) would be closer to describing a fixed or pegged regime, where the authority sets the parity and defends it with reserves — but the Assertion is expressly about the flexible rate, and against that background (R) is simply wrong.

An exchange rate is the price of one currency in terms of another, and the question of who sets that price divides the world's regimes. Under a fixed or pegged rate the government or central bank announces a parity and defends it by buying or selling foreign exchange from its reserves; a deliberate lowering of that parity is a devaluation and a deliberate raising is a revaluation. Under a flexible or floating rate no parity is announced and the price is cleared in the foreign exchange market; a fall in the currency's value is then called a depreciation and a rise an appreciation. Most countries, India included, sit between the two poles in a managed float — the rate is market-determined, but the central bank enters the market as a participant to smooth disorderly movements.

The way to attack an assertion-reason item is to judge each statement on its own before asking whether one explains the other, and here the two statements can be judged against each other. The Assertion defines a flexible rate as market-determined. The Reason then says the central bank determines that market. If you accept both, you have said that a rate is simultaneously market-set and authority-set, which is a contradiction — so at most one of them can be true, and the definition in the Assertion is the one that is textbook-correct. That alone eliminates options (a) and (c), and since (A) is plainly true, (b) goes too. The subtler point worth carrying into the exam hall is why (R) feels plausible: the Reserve Bank of India does buy and sell foreign currency, and a candidate who has read about intervention to steady the rupee may credit the statement. Intervention makes the central bank one more source of demand and supply, sometimes an influential one; it does not make it the determinant. Had the Reason said 'the central bank may intervene to moderate volatility', it would have been true — and still not an explanation of the Assertion.

• Flexible or floating exchange rate — the external value of the currency is determined in the foreign exchange market by demand for and supply of foreign currency; a fall is called depreciation and a rise appreciation.
• Fixed or pegged exchange rate — the authorities announce and defend a parity using reserves; a deliberate reduction is a devaluation and a deliberate increase a revaluation. Devaluation is therefore a policy act, depreciation a market outcome.
• In a floating regime the demand for foreign currency comes from importers, outward investors, travellers, students and borrowers servicing external debt; the supply comes from exporters, inward foreign investment, remittances and foreign borrowing. The central bank is a participant in that market, not its determinant.
• India runs a managed float: the rupee's rate is market-determined and the Reserve Bank of India intervenes in the foreign exchange market from time to time rather than announcing and defending a parity. India moved to a market-determined rate in the reforms of the early 1990s.

• Treating central-bank intervention as central-bank determination. The RBI trades in the foreign exchange market; that keeps India in a managed float, it does not make the rate administered.
• Using devaluation and depreciation interchangeably. Devaluation is a deliberate reduction of an announced parity under a fixed regime; depreciation is a market fall under a flexible one.
• Certifying a Reason as true merely because it sounds like something the central bank does. Judge each statement against the definition in the Assertion — here the two statements describe incompatible regimes.

UPPSC puts external-sector concepts into the assertion-reason frame and usually breaks the item on the Reason, as here; UPSC prefers the definition or the consequence — what convertibility implies, what NEER and REER movements mean, whether devaluation necessarily improves the trade balance. Both reward knowing the vocabulary exactly rather than approximately.

• practice — not a real PYQ

  Under a fixed exchange rate system, a deliberate reduction in the official value of the domestic currency by the government is called

  • (a)depreciation
  • (b)devaluation
  • (c)revaluation
  • (d)appreciation

  Answer(b) devaluation — a policy act under a fixed or pegged regime. A fall in the currency's value brought about by market forces under a flexible regime is depreciation; the opposite pair is revaluation (policy) and appreciation (market).

• practice — not a real PYQ

  Which one of the following best describes the exchange rate system followed by India at present?

  • (a)A fixed exchange rate pegged to the US dollar
  • (b)A managed float, in which the rate is market-determined and the central bank intervenes at times
  • (c)A pure gold standard
  • (d)A rate announced daily by the Ministry of Finance

  Answer(b) A managed float — the rupee's external value is determined in the foreign exchange market, while the Reserve Bank of India intervenes from time to time by buying or selling foreign currency rather than defending an announced parity.