Read the following report on Indian economy and answer the questions at the end.

[This is only intended to be a specimen]

Indian bonds signal July interest rate rise is on the cards

July 13 (Reuters) - Investors in Indian federal bonds are pricing in a quarter percentage point increase in the short-term interest rate this month, concerned surging domestic demand and costlier oil may boost inflation, analysts said !he yield curve has steepened in the past t"o "ee#s, "ith the spread bet"een the one-year and 1$-year bond "idening to 1%% basis points from 11$, indicating long-term inflationary e&pectations are building in the economy !he '($$-billion economy, )sia*s third largest, is e&pected to maintain gro"th of ( percent in the current fiscal year that ends in +arch ,$$-, having averaged ( ( percent in the past t"o years ./iven the underlying momentum of demand in the economy is strong, it is probable that a rise in oil prices "ill be passed on in product and services prices to a significant e&tent,. said 0an1eet 0ingh, economist at I2I2I 0ecurities .In such an environment, policy ma#ers "ould be biased to"ard raising interest rates to contain inflationary e&pectations . 3vidence pointing to increased inflationary pressures seems to be stac#ing up International oil prices hit a fresh record above '-, a barrel last "ee# and India*s industrial output gro"th is running at its fastest pace in nine years 3arly concerns that the June-0eptember monsoon "ould be "ea# -- prompting analysts in June to say the central ban# "ould not raise rates at its July ,- revie" -- have been "iped a"ay on gro"ing signs the rainy season "ill, in fact, be normal ) normal monsoon "ould underpin rural incomes and cement economic gro"th e&pectations 4il prices have gained more than 1$ percent since the central ban# last raised the shortterm rate ,5 basis points to 5 $ percent in )pril -- a move that "as also aimed at containing oil-fired inflation !he rate, #no"n as the reverse repo rate, is used to price short-term loans !he ban# rate, used to price longer-term loans, has been at - $ percent since )pril ,$$3 )nalysts say policy ma#ers are li#ely to "ait to see ho" the monsoon "or#s out before considering a rise in that rate in 4ctober India*s 1-year treasury bill is yielding 5 6$ percent "hile the 1$-year bond has been returning around ( ,% percent this "ee#, the highest in , months INF !TI"N #R$$% 7uel comprises 1% , percent of the "holesale price inde& (89I), India*s most closely "atched inflation gauge, so this is li#ely to be a significant factor in central ban# deliberations !he central ban# estimates every dollar increase in crude, the country*s biggest import, pushes the 89I up 3$ basis points !he "holesale inflation rate is currently around % percent, do"n from 5 percent in )pril, but analysts say the fall "ill prove temporary .)s the base effects recede and domestic demand pressures intensify, inflation is li#ely to creep bac# up to nearer - percent to"ards the end of financial year ,$$5:$-,. 0tandard 2hartered ;an# said in a research report this "ee#

It e&pects inflation to average 5 percent to 5 5 percent in the financial year to the end of ne&t +arch .8e maintain our vie" that the tightening cycle in India is not over yet,. the ban# said &TR"N' (!T!) TI'*T$R I+,I(IT+ay*s industrial output rose a si<<ling 1$ 6 percent from a year earlier, pic#ing up sharply from )pril*s gro"th Industrial output accounts for a quarter of India*s gross domestic product and the data tallies "ith a surge in demand for ban# loans, "hich "ere about 3$ percent higher in June than a year earlier, as companies invest in capacity to meet demand !he pace of activity is li#ely to continue if the monsoon is normal this year =ealthy crops "ould boost rural incomes and demand, a #ey factor in economic gro"th since nearly t"o thirds of India*s one billion population live on the land )nalysts say the central ban# has also reined in high liquidity, possibly to manage inflation, by refraining from rupee intervention and allo"ing the currency to be nearly 1$ percent overvalued on a trade-"eighted basis, "hich is unusual but "hich helps curb oil-led inflation >eutsche ;an# said in a report this "ee# gro"th in the central ban#*s net foreign e&change assets, the foreign currencies it holds and built through intervention, has no" slo"ed to 6 3 percent year-on-year from 1- percent in early +ay, as the central ban# has stayed a"ay from intervening )nalysts say "hile a drop of nearly 3$$-billion rupees ('- ? billion) of e&cess funds in the ban#ing system since early +ay is a sign of tighter conditions, the central ban#*s ne&t step "ould be raising domestic rates to rein in inflation e&pectations

a)

What are the monetary policy instruments that are referred to in this report? Explain how they may be used to tackle the economic problem faced by the country as evident in the report. What has been the policy of RBI re ardin exchan e rates durin the period under review? What is the apparent reason for that course of action? Examine the link between inflation! interest rates! bond prices and yield with reference to the context iven in the report. Explain what is expected happen to the rate of rowth of dp and why.

b)

c) d)