Monetary Policy & RBI Tools — Set 6

Correct Answer: B. Neutralising the monetary impact of capital flows through OMOs

Sterilisation refers to the process by which RBI neutralises the expansionary monetary impact of large capital inflows (foreign investment). When RBI buys foreign currency to prevent rupee appreciation, it injects rupees into the system. To sterilise this, RBI sells government securities through OMO to absorb the excess liquidity.

Correct Answer: B. MV = PT

The Quantity Theory of Money is expressed as MV = PT, also known as the Fisher Equation (after Irving Fisher). Here M is money supply, V is velocity of money, P is price level, and T is volume of transactions. It implies that an increase in money supply (M) leads to a proportional increase in price level (P), assuming V and T are constant.

Correct Answer: C. Monetary Policy Committee of RBI

The Monetary Policy Committee (MPC) of the Reserve Bank of India is the statutory body that sets the policy repo rate. Since 2016, this decision has been moved from the RBI Governor alone to the six-member MPC. The Ministry of Finance sets fiscal policy but has no authority over the repo rate.

Correct Answer: B. RBI is open to cutting rates to support growth

An accommodative monetary policy stance signals that the central bank is inclined to cut interest rates or inject liquidity to support economic growth. During downturns, RBI adopts an accommodative stance to reduce borrowing costs and stimulate investment and consumption. The policy stance is typically described as accommodative, neutral, or hawkish (tightening).

Correct Answer: B. RBI is focused on controlling inflation through tighter policy

A 'hawkish' monetary policy stance indicates that the central bank is focused on controlling inflation, even if it means slowing economic growth. A hawkish central bank is likely to raise interest rates, increase CRR, or absorb liquidity through OMO sales. The opposite stance, focused on growth, is called 'dovish' or accommodative.

Correct Answer: B. Temporary overdraft facility provided by RBI to government

Ways and Means Advances (WMA) are temporary short-term credit facilities provided by the RBI to the Central and State governments to bridge temporary mismatches between their receipts and expenditures. The limit for WMA is set by RBI in consultation with the Government. WMA must be repaid within 90 days.

Correct Answer: C. High inflation combined with slow/stagnant economic growth

Stagflation refers to an economic situation where there is simultaneously high inflation, low or negative economic growth (stagnation), and typically high unemployment. It is particularly challenging for monetary policy because the usual measures to control inflation (raising rates) can further dampen growth. The 1970s oil shocks caused widespread stagflation globally.

Correct Answer: B. Repurchase Option/Agreement

The term 'repo' stands for Repurchase Agreement or Repurchase Option. In a repo transaction, a bank sells government securities to RBI with an agreement to repurchase them the next day at a slightly higher price. The difference in price represents the interest, which is the repo rate. This collateralised borrowing mechanism is central to day-to-day liquidity management.

Correct Answer: B. 4%

The Cash Reserve Ratio (CRR) is currently 4% of Net Demand and Time Liabilities (NDTL). RBI has progressively reduced CRR from its historical high of 15% to the current level to unlock credit for the economy. The RBI has the authority to vary CRR between 3% and 20% as per the RBI Act.

Correct Answer: B. Banking Regulation Act 1949

The Statutory Liquidity Ratio (SLR) was introduced under Section 24 of the Banking Regulation Act, 1949. It requires all scheduled commercial banks to maintain a minimum percentage of their NDTL in liquid assets. Currently set at 18%, SLR has been used historically both as a prudential tool and as a way to fund government borrowing.