Monetary Policy — Set 7

Correct Answer: C. The SDF rate during surplus liquidity periods

• **The SDF rate during surplus liquidity periods** = when the banking system has excess liquidity, banks park more funds with RBI than they borrow, making the SDF rate the actual floor that guides overnight market rates. • **SDF (Standing Deposit Facility)** — introduced April 2022 at repo minus 25 bps; banks deposit excess cash with RBI without collateral; it replaced the fixed reverse repo as the operative floor rate. • When system is in surplus, the SDF rate becomes the 'effective' policy rate because that is where real transactions cluster — the policy repo rate acts only as a signalling rate. • 💡 Fixed at 4% is wrong — repo rate is not stuck at any single value and changes with each MPC decision; Weighted average of Repo and Reverse Repo is wrong — no such blended rate concept is used operationally; Rate at which most liquidity is traded is wrong — that describes a consequence, not the definition of effective repo rate.

Correct Answer: D. April

• **April** = India's financial year runs from April 1 to March 31, so the first bi-monthly MPC review is held in early April — typically the first week. • **Six bi-monthly meetings per year** — MPC meets roughly every two months; the April meeting sets the tone for the year's inflation and growth projections. • The April meeting is closely watched because it reflects post-Union Budget economic assessment and the first full-year outlook. • 💡 June is wrong — it is the second bi-monthly meeting of the year; March is wrong — it is the last meeting of the outgoing financial year; January is wrong — it falls in the middle of the financial year, not the beginning.

Correct Answer: C. The profit made by the central bank by

• **The profit made by the central bank by issuing currency** = Seigniorage is the difference between the face value of money and the cost to produce it — printing a ₹500 note costs only a few rupees, yet it commands ₹500 in purchasing power. • **Revenue for the government** — RBI transfers its surplus (which includes seigniorage) to the central government annually; this is why currency issuance is a profitable sovereign function. • Seigniorage matters for monetary policy because excessive reliance on it (printing money to fund deficits) leads to inflation — the FRBM Act 2003 restricts RBI from directly subscribing to primary government bonds to prevent this. • 💡 Ancient coin is wrong — it is a modern macroeconomic concept, not a numismatic term; RBI officials' salary is wrong — completely unrelated to currency issuance profit; Tax on senior citizens is wrong — seigniorage has nothing to do with taxation of individuals.

Correct Answer: A. It depends on the availability of a

• **It depends on the availability of a well-developed securities market** = OMO works by RBI buying or selling government securities; if the bond market is shallow or illiquid, RBI cannot transact at scale without causing extreme price volatility. • **Market depth is critical** — in a thin market, even a modest RBI purchase can push bond prices sharply up (yields down), distorting the yield curve rather than smoothly injecting liquidity. • India has a reasonably developed G-Sec market, which is why OMO has become RBI's primary durable liquidity tool alongside G-SAP (Govt Securities Acquisition Programme). • 💡 Increases government tax immediately is wrong — OMO affects liquidity, not tax revenue; Illegal in India is wrong — OMO is a standard, regularly used RBI instrument; Cannot be used by RBI is wrong — RBI uses OMOs routinely, especially post-demonetisation and during COVID.

Correct Answer: C. Cash Reserve Ratio

• **Cash Reserve Ratio (CRR)** = CRR is a direct instrument because RBI mandates banks to maintain a fixed percentage of their net demand and time liabilities (NDTL) as cash with RBI — banks have no choice; compliance is statutory. • **Direct vs. indirect** — direct instruments (CRR, SLR) work through statutory mandates; indirect instruments (Repo Rate, OMO, SDF) work through market mechanisms and price signals. • Currently CRR is 4%; RBI uses CRR cuts to inject durable liquidity quickly — a 50 bps cut releases approximately ₹1.1 lakh crore into the banking system. • 💡 Repo Rate is wrong — it is an indirect instrument; banks are not forced to borrow at repo; it influences market rates through incentives; OMO is wrong — it is market-based and indirect; SDF is wrong — it is also an indirect, market-based liquidity absorption tool.

Correct Answer: C. A stance that favors lower interest rates to

• **A stance that favors lower interest rates to support economic growth** = a dovish central bank prioritises boosting output and employment over fighting inflation — it is more tolerant of inflation remaining slightly above target. • **Opposite of hawkish** — a hawkish stance tightens policy (raises rates, reduces liquidity) to crush inflation; dovish loosens policy (cuts rates, adds liquidity) to stimulate demand. • The term comes from the dove symbolising peace — dovish policymakers 'go easy' on the economy; during COVID RBI adopted a dovish stance by cutting repo to a historic low of 4% and injecting massive liquidity. • 💡 Stopping printing notes is wrong — monetary stance is about interest rates and liquidity, not currency printing decisions; Ignores inflation completely is wrong — dovish means tolerating some inflation, not ignoring it entirely; Officials wearing white is wrong — this is not a monetary policy concept.

Correct Answer: C. The bank must pay a penalty to the RBI

• **The bank must pay a penalty to the RBI** = RBI levies penal interest on the amount of the CRR shortfall — this is charged at 3% above the Bank Rate for the days the shortfall persists. • **Bank Rate link** — the Bank Rate is currently 6.75% (repo + 25 bps); penalty for CRR shortfall is thus approximately 9.75% per annum on the deficit amount, making non-compliance very expensive. • CRR is maintained as a daily requirement (70% of required CRR must be maintained on each day); failure triggers automatic penalty without any grace period. • 💡 Bank gets a reward is wrong — CRR shortfall is a violation, not an achievement; Bank is closed immediately is wrong — immediate closure is reserved for far more severe regulatory failures; Manager is arrested is wrong — this is a civil monetary penalty, not a criminal matter.

Correct Answer: D. The Deputy Governor in charge of

• **The Deputy Governor in charge of monetary policy** = MPC has 6 members — 3 internal (from RBI) and 3 external (appointed by the government); the Deputy Governor heading the monetary policy department is a permanent internal member. • **Three internal members** — RBI Governor (Chairperson with casting vote), Deputy Governor (monetary policy), and one RBI officer nominated by the Central Board; these three vote alongside three external experts. • External members serve 4-year terms and cannot be reappointed — this design ensures both institutional continuity (internal) and independent perspective (external). • 💡 SEBI Chairman is wrong — SEBI is a separate regulator for securities markets and has no role in MPC; Chairman of SBI is wrong — commercial bankers are not part of MPC; Chief Economic Advisor is wrong — CEA is a government official, not an RBI internal member.

Correct Answer: A. 2012

• **2012** = The current CPI (Combined) series uses 2012 as the base year (2012 = 100); the Ministry of Statistics and Programme Implementation (MoSPI) adopted this base in 2015, replacing the earlier 2010 base. • **CPI (Combined) is the inflation benchmark** — RBI's flexible inflation target of 4% (with ±2% tolerance band) is measured using CPI (Combined), making this series critical for monetary policy decisions. • Base years are revised periodically to reflect changing consumption patterns — a household spending more on services than food today is better captured with a recent base year. • 💡 2001 is wrong — that was the base year for CPI (Urban/Rural) older series, not the current combined series; 2010 is wrong — it was a transitional base, replaced by 2012; 2016 is wrong — no CPI series uses 2016 as base year.

Correct Answer: A. Buying from anyone who is willing to

• **Buying from anyone who is willing to sell at the offered price** = 'Open market' means RBI transacts in the secondary market through competitive bidding — not restricted to specific counterparties; any eligible participant (banks, primary dealers) can participate. • **Contrast with other windows** — Repo and SDF are bilateral RBI-bank windows; OMO is conducted via auction in the broader government securities market, hence 'open'. • OMO purchases inject rupee liquidity (durable); OMO sales absorb rupee liquidity — the effect lasts until the securities mature or are re-sold, making OMO a durable (not overnight) tool. • 💡 Opening RBI vault for public is wrong — the public has no direct access to RBI's securities; Operating only during day time is wrong — 'open' refers to market access, not timing; Trading in an open field is wrong — it is a figurative expression about market access, not a physical location.