UPSC Essentials | Mains answer practice — GS 3 : Questions on RBI interventions in controlling the Indian rupee and impacts of the oil spill (Week 66)

General points on the structure of the answers

Introduction

— The introduction of the answer is essential and should be restricted to 3-5 lines. Remember, a one-liner is not a standard introduction.

— It may consist of basic information by giving some definitions from the trusted source and authentic facts.

Body

— It is the central part of the answer and one should understand the demand of the question to provide rich content.

— The answer must be preferably written as a mix of points and short paragraphs rather than using long paragraphs or just points.

— Using facts from authentic government sources makes your answer more comprehensive. Analysis is important based on the demand of the question, but do not over analyse.

QUESTION 1: Discuss the potential adverse consequences of the Reserve Bank of India’s (RBI) interventions in controlling the value of the Indian rupee.

Note: This is not a model answer. It only provides you with thought process which you may incorporate into the answers.

Introduction:

— The Indian rupee has a managed floating exchange rate regime, which implies that the central bank intervenes in the foreign currency market to buy or sell dollars in order to keep the rupee’s value stable.

— In recent times, however, the RBI appears to be using its regulatory authorities to gain more control over the currency.

Body:

You may incorporate some of the following points in the body of your answer:

— Currency volatility is not a market failure, but rather the currency’s movement in reaction to demand and supply dynamics.

— The employment of regulatory authorities for currency management creates uncertainty in the central bank’s currency policy while also raising the cost of doing business in RBI-regulated sectors.

— Rajeswari Sengupta and Bhargavi Zaveri Shah outline three such regulatory approaches and the challenges that come with them.

— Prohibiting speculative trades on exchanges: This exacerbates the difficulties of taking rupee exposure in India. In 2008, the RBI allowed Indian exchanges to launch a currency derivatives segment. At that time, the RBI’s guidelines on currency Futures and Options allowed Indian residents to participate in this market “to hedge an exposure to foreign exchange rate risk or otherwise”. While the RBI continued to prescribe the product design, position limits, and trading hours, the general trend was towards opening up this market.

— These regulations explicitly allowed taking positions in rupee-linked currency derivatives up to $100 million across all exchanges, “without having to establish existence of underlying exposure”.

— Regulating offshore trading platforms: The RBI proposed to regulate offshore electronic trading platforms (ETPs), which facilitate rupee-linked derivative transactions. Published on its website in April 2024, this proposal seeks to empower the RBI to oversee the offshore currency forwards market, commonly called the non-deliverable forwards (NDF) market.

— The NDF market lets anyone deal in the rupee without having to physically deliver the currency, lowering the cost of trading. The rupee NDF market has risen significantly in recent years, and is now estimated to be over three times the size of the onshore market. This has raised fears among the RBI that the offshore market, over which it has no direct jurisdiction or control, may be playing an important role in deciding the rupee’s value. The current regulation plan requires ETPs to register with the RBI and gives very comprehensive authorities on the central bank, such as the ability to refuse registration, collect information, designate “eligible instruments” that Indian residents may trade in, and impose additional terms and conditions.

— RBI’s instructions to banks: Earlier this month, when the rupee-dollar exchange rate depreciated close to the 84 mark in the spot market, the RBI is reported to have orally instructed some large commercial banks to not add to their existing trading positions against the rupee. This step seems to have been taken to stem further rupee depreciation.

— On August 16, the RBI advised banks that conduct commerce with the United Arab Emirates to partially settle their trade payments in rupees rather than dollars. This means that banks should change rupees directly to dirhams and vice versa, without first converting them to dollars. One goal of this action appears to be to lessen dollar dependence in international trade. However, settling transactions in rupees helps buffer the currency from the impact of dollar outflows, reducing the magnitude of rupee depreciation against the dollar.

Conclusion:

— The RBI should not attempt to regulate the rupee’s volatility by indiscriminately expanding its regulatory powers. Regulations define the regulations of the game.

— Unlike market operations in which central banks purchase and sell currency in foreign exchange markets, changes to the rules of the game can have a longer-term, negative impact on the incentives and costs of doing business in the country.

(Source: Why RBI’s attempts to control the Rupee can have adverse consequences by Rajeswari Sengupta and Bhargavi Zaveri Shah)

Points to Ponder

What is foreign exchange?

Role of RBI in monetary policy

Functions of RBI

Related Previous Year Questions

Foreign Direct Investment (FDI) in the defence sector is now set to be liberalized. What influence this is expected to have on Indian defence and economy in the short and long run? (2014)

Justify the need for FDI for the development of the Indian economy. Why there is gap between MoUs signed and actual FDIs? Suggest remedial steps to be taken for increasing actual FDIs in India. (2016)

QUESTION 2: Discuss the environmental and socio-economic impacts of the oil spill. Give some recent examples.

Note: This is not a model answer. It only provides you with thought process which you may incorporate into the answers.

Introduction:

— Accidents involving oil tankers, drilling rigs, pipelines, or refineries, can be triggered by natural disasters, human error, or equipment failure.

— The environmental consequences are influenced by factors such as the type of oil, the volume of the spill, weather conditions, and proximity to sensitive ecosystems.

Body:

You may incorporate some of the following points in the body of your answer:

How do oil spills impact the environment?

— The long-term impacts of oil spills are extensive, affecting marine ecosystems, habitats, and local economies. These spills can wipe out animal populations, with toxic substances accumulating in the food chain and posing significant risks to higher-level predators, including humans. This bioaccumulation can result in long-term health problems and a reduction in biodiversity, disrupting entire ecosystems.

— When oil spills into water, it rapidly spreads. Due to its lighter density compared to water, it forms a layer that obstructs sunlight and disrupts photosynthesis in marine plants and phytoplankton, which are crucial for oxygen production. The microscopic algae are consumed by fish and other marine animals, and form the base of multiple food chains.

— Marine animals, especially those near the surface, face immediate dangers from toxic exposure. With oil coating the feathers of birds, they may lose their insulation abilities, leading to hypothermia and drowning.

— Coastal ecosystems: These ecosystems such as mangroves, coral reefs, and marshlands, are especially at risk, as oil can suffocate these habitats and kill vital plants and animals. Recovery can take decades, with some species facing the threat of extinction.

— Effect on economy: The economic fallout is significant for communities dependent on fishing and tourism. The cleanup effort is often costly and lengthy, diverting resources from other critical areas.

Recent examples:

— Philippines: Typhoon Gaemi has wreaked havoc across Taiwan, the Philippines and parts of southeastern China. The resultant heavy rains also led to the sinking of the oil tanker MT Terra Nova, laden with 1.4 million litres of oil, in Manila Bay.

— Peru: In 2022, the government declared a 90-day “environmental emergency” in damaged coastal territories, after an oil spill that saw 6,000 barrels of crude oil pour into the sea.

Conclusion:

— Fur and feathers soaked in oil can negatively impact an animal’s capacity to control their body temperature. Additionally, it may alter an animal’s natural buoyancy, leading to drowning. Moreover, birds are likely to swallow the oil due to their propensity for self-preening, which could harm both their organs and digestive systems.

— Burns, eye irritation, and neurological problems can all result from inhaling fumes from more volatile petroleum products like kerosene or jet fuel.

(Source: Ship carrying 1.4 million litres of oil sinks near Philippines: How oil spills impact the environment, http://www.noaa.gov, http://www.weforum.org)

Points to Ponder

How do oil spill affect marine populations

How do oil spills affect terrestrial populations

Related Previous Year Questions

What is oil pollution? What are its impacts on the marine ecosystem? In what way is oil pollution particularly harmful for a country like India? (2023)

Explain the causes and effects of coastal erosion in India. What are the available coastal management techniques for combating the hazard? (2022)

Previous Mains Answer Practice

UPSC Essentials: Mains answer practice — GS 1 (Week 65)

UPSC Essentials: Mains answer practice — GS 1 (Week 64)

UPSC Essentials: Mains answer practice — GS 2 (Week 64)

UPSC Essentials: Mains answer practice — GS 2 (Week 65)

UPSC Essentials: Mains answer practice — GS 3 (Week 65)

UPSC Essentials: Mains answer practice — GS 3 (Week 64)

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