Monetary Policy & RBI Tools — Set 13

Correct Answer: B. Fall in general price level; harmful as it delays spending and increases debt burden

Deflation is a sustained fall in the general price level (negative inflation). While falling prices seem beneficial, deflation is considered harmful because: consumers delay purchases expecting further price falls (deflationary spiral), real debt burden increases for borrowers, investment falls, and unemployment rises. Japan's 'Lost Decade' (1990s-2000s) is a classic case of deflationary stagnation.

Correct Answer: B. Currency + demand deposits + time deposits with banks

M3 is the broad money supply measure that includes: M1 (currency with public + demand deposits with banks + other deposits with RBI) + Time deposits (fixed deposits) with commercial and cooperative banks. M3 is the most widely tracked money supply aggregate in India, used to monitor monetary conditions and inflationary pressures.

Correct Answer: B. FERA 1973

FEMA (Foreign Exchange Management Act), 1999, replaced FERA (Foreign Exchange Regulation Act), 1973. While FERA treated forex violations as criminal offences, FEMA treats them as civil offences. FEMA is administered by the RBI and the Enforcement Directorate. This shift signalled India's move towards current account convertibility and a more liberalised external sector.

Correct Answer: B. Rupee is freely convertible for trade in goods and services

Current Account Convertibility means the Indian rupee can be freely converted for transactions related to trade in goods and services, remittances, and income flows. India achieved full current account convertibility in 1994. Capital account convertibility (for investment flows) remains partial in India. Full capital account convertibility is under consideration but not yet implemented.

Correct Answer: B. Free capital flows, fixed exchange rate, and independent monetary policy cannot all coexist

The 'impossible trinity' (Mundell-Fleming trilemma) states that a country cannot simultaneously have: (1) free capital mobility, (2) fixed exchange rate, and (3) independent monetary policy. It must choose any two. India has chosen independent monetary policy and managed (but not fixed) exchange rate, with partial capital account convertibility.

Correct Answer: C. SDF Rate (floor) and MSF Rate (ceiling)

The LAF (Liquidity Adjustment Facility) corridor is bounded by the SDF (Standing Deposit Facility) rate as the floor and the MSF (Marginal Standing Facility) rate as the ceiling. The policy repo rate sits in the middle. Banks borrow at MSF when they need funds and park at SDF when they have excess liquidity, keeping market rates within this corridor.

Correct Answer: B. Structural = chronic, persistent shortfall; Frictional = temporary, episodic shortfall

Structural liquidity deficit refers to a chronic, persistent shortage of liquidity in the banking system caused by structural factors like government cash balances or persistent cash withdrawals. Frictional liquidity deficit is temporary, caused by episodic events like advance tax payments or end-of-quarter effects. RBI uses different tools for each: LAF for frictional, OMO for structural.

Correct Answer: B. 14 days

Under Section 45ZL of the RBI Act, the Monetary Policy Committee is required to publish the minutes of its meeting within 14 days of the meeting. The minutes include the resolution, voting record, and the statement of each member explaining the rationale for their vote. This transparency requirement enhances accountability and market communication.

Correct Answer: B. Providing assurance to market on secondary market purchases of G-Secs to manage yields

G-SAP (Government Securities Acquisition Programme), launched by RBI in April 2021, was an unconventional monetary policy tool where RBI pre-committed to buying a specific amount of government securities in the secondary market. This assured market participants that yields would be managed, reducing uncertainty during the COVID-19 economic stress period.

Correct Answer: B. Financial intermediation outside the regular banking system, not fully regulated

Shadow banking refers to credit intermediation activities conducted by non-bank financial entities (NBFCs, money market funds, hedge funds) that are outside traditional banking regulation. It is a monetary policy concern because shadow banks can amplify credit cycles, create systemic risks, and weaken monetary transmission. India's NBFC sector is part of the shadow banking landscape.