Monetary Policy — Set 6

Correct Answer: D. Store of value

• **Store of Value** = inflation erodes the purchasing power of money over time — ₹100 saved today buys fewer goods next year if prices rise; this directly undermines money's ability to preserve value. • **Why other functions are less affected** — money continues to work as a medium of exchange (transactions still happen) and as a unit of account (prices are still quoted in rupees) even during moderate inflation. • Hyperinflation can eventually destroy all functions, but under normal inflation, 'store of value' is the first and most directly impaired function. • 💡 'Medium of exchange' is wrong — people still use money for daily transactions even with moderate inflation; 'Standard of deferred payment' is wrong — loans are still repaid in money, though lenders lose in real terms; 'Measure of value' is wrong — prices are still measured in rupees; it is the stored value of those rupees that shrinks.

Correct Answer: A. Penalizing or banning a bank from

• **Direct Action** = a qualitative (selective) credit control tool where RBI takes punitive measures — such as imposing fines, refusing rediscounting facilities, or restricting certain banking operations — against a bank that wilfully violates RBI directives. • **Last resort tool** — RBI first uses Moral Suasion (persuasion) and Credit Rationing (limits); Direct Action is invoked only when a bank persistently defies RBI guidelines on lending practices. • Examples include denying a non-compliant bank access to the LAF window or imposing penalties under the Banking Regulation Act. • 💡 'Physical protest by RBI staff' is wrong — Direct Action is a regulatory enforcement measure by RBI management against banks, not a protest; 'Distributing cash to the public' is wrong — RBI distributes currency through banks, and this has nothing to do with credit control; 'Buying shares in a bank' is wrong — that would be an equity investment, not a monetary policy action.

Correct Answer: A. Four years

• **Four years, non-renewable** — external members of the MPC are appointed for a single term of 4 years and are not eligible for reappointment; this prevents entrenchment and ensures fresh perspectives. • **Appointment process** — selected by a Search-cum-Selection Committee headed by the Cabinet Secretary; they must be economists or experts in the field of economics, banking, or finance. • The 4-year fixed term also protects external members from political pressure, since they cannot be removed except for specific cause. • 💡 'Six years' is wrong — 6 years is the term for some constitutional appointments (e.g., UPSC members), not MPC external members; 'Three years' is wrong — no provision for a 3-year MPC term exists in the RBI Act; 'Five years' is wrong — 5-year terms apply to elected governments, not MPC members.

Correct Answer: C. It is mandatory under the Banking Regulation

• **Mandatory under Section 24 of the Banking Regulation Act, 1949** — every scheduled commercial bank must maintain SLR in the form of gold, cash, or approved government securities; failure attracts penal interest charged by RBI. • **Currently ~18% of NDTL** — unlike CRR (kept as cash with RBI), SLR assets can be held by the bank itself in approved liquid instruments; banks can also use these securities to borrow under the LAF. • 'Statutory' simply means 'required by law' (statute); it cannot be waived, made optional, or altered by Parliament monthly — only RBI can change the ratio within limits of the Act. • 💡 'Optional for new banks' is wrong — SLR is mandatory for all scheduled commercial banks from day one of operations; 'Only for government banks' is wrong — private sector banks (HDFC, ICICI, etc.) must also comply; 'Set by Parliament every month' is wrong — Parliament enacted the law but RBI sets the ratio; it is not revised monthly.

Correct Answer: B. Total of currency held by

• **High Powered Money (M0 / Monetary Base)** = currency notes and coins held by the public + cash reserves (CRR balances) held by commercial banks with RBI; it is the 'base' on which the banking system creates a larger money supply through credit (money multiplier effect). • **Why 'high powered'** — each rupee of M0 held by banks can support multiple rupees of deposits/loans through the credit creation process; hence it is 'more powerful' than ordinary deposits. • M0 is directly controlled by RBI; it is also called 'Reserve Money' and is the narrowest measure of money supply in India. • 💡 'Foreign currency notes' is wrong — foreign currency is not part of India's domestic monetary base; 'Credit card balance' is wrong — credit card limits are bank-created credit, not part of the monetary base (M0); 'Gold in temples' is wrong — privately held gold is not part of the money supply regardless of quantity.

Correct Answer: A. Tight Monetary Policy

• **Tight Monetary Policy** = a contractionary approach where RBI raises repo rate, increases CRR/SLR, sells government securities (OMO), and uses other tools to reduce money supply — making credit expensive and slowing spending to control inflation. • **Also called 'Hawkish' policy** — in market parlance, a central bank that prioritises inflation control over growth is 'hawkish'; tight policy is the hawkish stance in action. • Outcomes: higher loan EMIs, reduced consumer spending, slower GDP growth, lower inflation — the intended trade-off. • 💡 'Dovish Policy' is wrong — dovish means prioritising growth over inflation, i.e., lower rates (expansionary); 'Neutral Policy' is wrong — neutral stance means the policy is neither stimulating nor contracting the economy; 'Loose Monetary Policy' is wrong — loose (expansionary) policy cuts rates and injects money, the exact opposite of tightening.

Correct Answer: C. They must be published on the 14th day after

• **Published on the 14th day after the meeting** — as per Section 45ZL of the RBI Act, RBI must publish the minutes of each MPC meeting on the 14th day following the conclusion of that meeting. • **What the minutes contain** — the resolution (policy decision), how each member voted, and each member's written statement explaining the rationale for their vote; this ensures full transparency and accountability. • This 14-day window gives members time to write and submit their individual statements before publication. • 💡 'Only for the Finance Minister' is wrong — MPC minutes are public documents available to all; 'Published after ten years' is wrong — classified government documents may be released after years, but MPC minutes are released promptly at 14 days; 'Secret forever' is wrong — mandatory transparency is a cornerstone of the FIT framework to maintain RBI credibility.

Correct Answer: B. Interest rates are likely to fall

• **Interest rates are likely to fall** — when banks have more funds than they can deploy profitably, they compete for borrowers by lowering lending rates; overnight call money rates also drop toward the SDF floor as banks park surplus funds with RBI. • **Inflationary risk** — excess liquidity, if sustained, can increase aggregate demand and push inflation higher (the opposite of option A); RBI manages this through SDF, OMO sales, or CRR hikes. • Excess liquidity typically arises from large government spending, forex inflows, or after RBI's liquidity injection measures (LTROs, etc.). • 💡 'Inflation is likely to decrease' is wrong — excess liquidity tends to boost spending and raise prices over time, not reduce them; 'Banks stop giving loans' is wrong — with surplus funds, banks actively try to lend more; 'Banks go bankrupt immediately' is wrong — excess liquidity means banks have too much money, the opposite of insolvency.

Correct Answer: C. It varies as per MPC decisions

• **The corridor width varies** — the LAF corridor (MSF rate minus SDF rate) is not fixed by statute; RBI adjusts it based on prevailing liquidity conditions and monetary policy objectives decided by MPC. • **Historical changes** — the corridor was 100 bps (2011–14), then narrowed to 50 bps, and has been adjusted multiple times; after introducing SDF in 2022, the corridor is MSF (+25 bps above repo) to SDF (−25 bps below repo) = 50 bps total, but this is a policy choice, not a rule. • A wider corridor gives more flexibility but less market certainty; a narrower corridor anchors overnight rates more tightly near the repo rate. • 💡 '100 basis points' is wrong — this was a historical width, not a fixed target; '25 basis points' is wrong — 25 bps is the margin of MSF or SDF from repo individually, not the total corridor; '50 basis points' is wrong — while the current effective corridor is ~50 bps, it is a policy decision and not a guaranteed fixed width, making option C the most accurate answer.

Correct Answer: C. Market Stabilization

• **Market Stabilization Scheme (MSS)** = created in 2004 specifically to sterilise the excess rupee liquidity generated when RBI buys foreign currency (dollars) to prevent the rupee from appreciating excessively due to large capital inflows. • **Mechanism** — when RBI buys $1 billion, it releases ~₹8,000 crore into the banking system; MSS allows RBI to issue T-Bills/bonds to drain this excess rupee liquidity, keeping inflation in check. • MSS funds are kept in a separate sterilisation account and cannot be used by the government for spending — this is its key design feature to prevent fiscal-monetary conflicts. • 💡 'Moral Suasion' is wrong — it is a persuasion tool for bank lending behaviour, not a sterilisation instrument for forex flows; 'Bank Rate' is wrong — Bank Rate controls the cost of credit, not foreign capital inflows; 'Credit Rationing' is wrong — it restricts credit to specific sectors domestically and has no mechanism to absorb rupee liquidity from forex inflows.