Monetary Policy — Set 10

Correct Answer: D. RBI Governor asking banks to prioritize

• **RBI Governor asking banks to prioritize** = Moral Suasion is a qualitative tool where the RBI uses persuasion, meetings, and informal appeals — not legal force — to steer bank behavior toward desired credit policies. • **No legal compulsion** — unlike CRR or repo rate changes, Moral Suasion carries no penalty; it relies on banks' respect for the regulator and fear of reputational consequences. • RBI Governor meeting bank CEOs and requesting them to pass on rate cuts to customers is the textbook example of this tool. • 💡 Imposing a fine (A) is Direct Action — a punitive qualitative tool, not persuasion; Raising CRR (B) is a quantitative tool affecting all banks uniformly; Selling gold (C) is an OMO-type operation, also quantitative.

Correct Answer: B. It invites banks to park their excess cash at

• **It invites banks to park their excess cash at variable (auction-determined) rates** = VRRR is a fine-tuning liquidity absorption tool where RBI accepts funds from banks and the interest rate is set by competitive bidding, not fixed by RBI. • **Market-determined rate** — unlike the Standing Deposit Facility (SDF) which pays a fixed rate, VRRR rate is decided by banks' own bids, giving RBI more nuanced control over surplus liquidity. • RBI uses VRRR aggressively when excess liquidity is very high to prevent the call money rate (WACR) from falling too far below the repo rate. • 💡 Lending to banks at fixed rate (A) describes the repo window, not VRRR; giving money to public (C) and selling buildings (D) are completely irrelevant.

Correct Answer: A. M1

• **M1 (Narrow Money)** = most liquid measure — it includes currency held by the public plus demand deposits with banks, both of which can be used for transactions immediately without any conversion or waiting period. • **M1 ⊂ M2 ⊂ M3 ⊂ M4** — each successive measure adds less liquid components: M2 adds savings deposits, M3 (Broad Money) adds time deposits and is RBI's key policy target, M4 further adds Post Office deposits. • Liquidity decreases as you go from M1 → M4 because the added components take longer to convert to cash. • 💡 M3 is wrong — it is the broadest commonly tracked measure but includes time deposits that cannot be spent immediately; M2 and M4 are also less liquid than M1.

Correct Answer: A. To absorb liquidity from banks without

• **To absorb excess liquidity from banks without requiring collateral** = SDF, introduced in April 2022, allows RBI to suck out surplus cash from the banking system without giving government securities in return — unlike the old reverse repo. • **Collateral-free absorption** — previously, every rupee RBI absorbed via reverse repo required it to pledge a government bond; SDF removes this constraint, giving RBI unlimited absorption capacity. • SDF rate (currently floor of LAF corridor) is slightly lower than the repo rate, making it the overnight deposit rate for banks parked with RBI. • 💡 Long-term loans to banks (B) describes MSF/refinance facilities; regulating forex (C) is RBI's forex intervention function; savings accounts (D) are retail banking services.

Correct Answer: C. Being aggressive in controlling inflation

• **Hawkish = aggressively focused on controlling inflation**, even at the cost of slower economic growth — a hawkish central bank prefers higher interest rates to squeeze demand and bring down prices. • **Rate-hike bias** — a hawkish MPC stance signals likelihood of repo rate increases or at least no cuts; the opposite is 'Dovish' (growth-supportive, lower-rate bias). • When MPC members prioritize the 4% CPI target over GDP growth concerns, they are described as hawkish. • 💡 Focusing on growth only (B) describes a Dovish stance; reducing branches (A) and promoting birds (D) are nonsensical distractors.

Correct Answer: A. A policy intended to increase the rate

• **Reflation** = a deliberate policy to stimulate economic activity and gently raise price levels back toward their long-term trend after a recession or deflationary period — it is the opposite of deflation-fighting without causing runaway inflation. • **Tools used** — reflation typically uses lower interest rates, increased government spending, and sometimes money supply expansion to boost aggregate demand. • Reflation is different from inflation: inflation is an unwanted rise in prices; reflation is a controlled, targeted lift from abnormally low levels. • 💡 Fixing torn notes (B) is currency management by RBI's Issue Department; printing currency (C) alone is monetization, not reflation as a policy; stopping transactions (D) is completely unrelated.

Correct Answer: D. The primary operating target of the RBI's monetary policy

• **WACR = RBI's primary operating target** — it is the weighted average rate at which banks lend surplus funds to each other overnight in the inter-bank (call money) market. • **Policy transmission anchor** — RBI aims to keep WACR close to the repo rate (within the LAF corridor) by injecting or absorbing liquidity; if WACR drifts, it signals a transmission failure. • WACR is the most sensitive real-time indicator of banking system liquidity — excess liquidity pushes it toward SDF rate; deficit pushes it toward MSF rate. • 💡 MPC member salary (A) is irrelevant; government borrowing rate (B) describes the G-sec yield / T-bill rate; average of all rates (C) is a misconception — WACR is specific to the overnight call money market.

Correct Answer: C. Margin

• **Margin Requirements** = a qualitative (selective) monetary tool where RBI fixes the minimum margin a borrower must bring when taking a loan against specific assets (e.g., commodities, shares) — higher margin = lower loan-to-value = less speculative credit in that sector. • **Sector-specific action** — unlike CRR and repo rate which affect all banks and all sectors uniformly, margin requirements can be raised only for, say, real estate or gold loans to cool overheating in those specific markets. • RBI uses margin requirements alongside Selective Credit Controls (SCC) to curb speculative hoarding of sensitive commodities like food grains and oilseeds. • 💡 CRR (A) and SLR (B) are quantitative tools affecting the entire banking system; Repo Rate (B) raises borrowing cost economy-wide — none of these can target one sector alone.

Correct Answer: D. The hidden cost to holders of cash due

• **Inflation Tax** = not a real statutory tax — it is the hidden erosion of purchasing power that cash/currency holders suffer when inflation rises, because their money buys less over time while the government benefits by repaying its fixed debts with cheaper rupees. • **Who gains, who loses** — the government (debtor) gains as real debt burden falls; holders of fixed-value cash, savings accounts, and government bonds lose real value — effectively a transfer of wealth from savers to the state. • Countries that print money to finance deficits impose a heavy inflation tax on citizens, which is why RBI's price stability mandate exists. • 💡 A tax levied by RBI (A) is wrong — RBI does not levy taxes, it is not a tax authority; property tax (B) and interest tax (C) are statutory taxes collected by government — completely different concepts.

Correct Answer: C. Cash Reserve Ratio

• **Cash Reserve Ratio (CRR)** = the percentage of a bank's total net demand and time liabilities (NDTL) that must be kept as cash with the RBI — currently maintained as a balance in the bank's current account with RBI. • **Key facts** — RBI pays no interest on CRR balances; raising CRR reduces lendable funds (contracts money supply); the RBI can change CRR without giving any advance notice. • CRR is a quantitative tool — it affects every bank across all sectors equally, unlike qualitative tools which can target specific sectors. • 💡 Credit Rating Ratio (A) and Central Reserve Rate (B) are fabricated terms; Cash Ratio Reserve (D) reverses the word order but is not the official term — the correct full form is Cash Reserve Ratio.