"RBI Raises Rates Citing Inflation Risks from Supply Shocks"
GS Paper 3: Indian Economy, Monetary Policy, Inflation Targeting, and RBI's Role.
Prelims:
Mains:
Flexible Inflation Targeting
a framework where the central bank targets a fixed inflation number but retains some flexibility around it.
Repo Rate
the rate at which the RBI lends short-term funds to banks; the MPC's primary tool for managing inflation and growth.
India's monetary policy follows a framework called flexible inflation targeting. Section 45ZA of the RBI Act, 1934 requires the Central Government to set an inflation target every five years, in consultation with the RBI. The current target is 4% CPI inflation, with a tolerance band of plus or minus 2 percent. Inflation between 2% and 6% is acceptable. If inflation stays outside this band for three consecutive quarters, the RBI must explain the failure to the government and submit a plan with a timeline to correct it.
The Monetary Policy Committee (MPC) has six members. Three come from the RBI and three are external experts appointed by the government. The MPC meets periodically to set the repo rate, which is the rate at which the RBI lends short-term funds to banks against government securities. This rate is the RBI's primary tool to balance growth and inflation. A cut in the repo rate signals an easy money policy. A rise signals tightening. The RBI also adjusts the Marginal Standing Facility (MSF) Rate, the Standing Deposit Facility (SDF) rate, and the Bank Rate alongside the repo rate. When all these move together in the same direction, it confirms the overall policy stance.
Beyond the repo rate, the RBI manages liquidity through the Cash Reserve Ratio (CRR), the Statutory Liquidity Ratio (SLR), and Open Market Operations (OMO). OMO means buying or selling government securities. The RBI sells securities to pull excess cash out of the banking system when inflation is high. It buys securities to add liquidity when needed. Cutting the SLR, which is the minimum share of deposits banks must hold in approved liquid assets, also injects liquidity into the system.
Inflation in India can come from two broad directions. Demand-pull inflation occurs when too much money chases too few goods. This typically happens during periods of strong economic growth. Cost-push inflation occurs when rising input costs push up prices without any increase in demand. Common examples include a spike in crude oil prices or a weak monsoon that damages food output.
This distinction matters for policy. The repo rate works mainly by controlling demand. Making loans costlier reduces borrowing and spending, which cools demand-pull pressures. However, rate tools are far less effective against cost-push inflation. …
With reference to the Indian economy, consider the following statements:
1.If the inflation is too high, Reserve Bank of India (RBI) is likely to buy government securities.
2.If the rupee is rapidly depreciating, RBI is likely to sell dollars in the market.
3.If interest rates in the USA or European Union were to fall, that is likely to induce RBI to buy dollars.
Which of the statements given above are correct?
An increase in the Bank Rate generally indicates that the
If the RBI decides to adopt an expansionist monetary policy, which of the following would it not do?
1.Cut and optimize the Statutory Liquidity Ratio
2.Increase the Marginal Standing Facility Rate
3.Cut the Bank Rate and Repo Rate
Select the correct answer using the code given below:
Consider the following statements about India's inflation-targeting framework: 1. Section 45ZA of the RBI Act, 1934 requires the Central Government to notify the inflation target once every five years in consultation with the RBI. 2. The current inflation target is 4%, with a tolerance band of plus or minus 2%. 3. If the inflation target is missed for three consecutive quarters, the RBI must explain the failure and the remedial timeline to the government. Which of the statements given above is/are correct?
Consider the following statements about the Reserve Bank of India's typical policy response to macroeconomic conditions: 1. When inflation is persistently high, the RBI typically sells government securities to reduce money supply. 2. When the rupee depreciates rapidly, the RBI typically sells dollars in the foreign exchange market. 3. When interest rates in the US or EU fall sharply, the RBI typically buys dollars to prevent excessive rupee appreciation. How many of the above statements are correct?
An increase in the Bank Rate by the Reserve Bank of India generally indicates that the central bank is following a:
Match List-I (Monetary Policy Tool) with List-II (Immediate Effect on Liquidity) and select the correct answer using the code given below:
List-I:
A.Increase in Repo Rate
B.Cut in Cash Reserve Ratio (CRR)
C.Sale of government securities via Open Market Operations
D.Increase in Marginal Standing Facility (MSF) Rate
List-II:
1.Increases liquidity in the banking system
2.Discourages banks from borrowing against collateral, reducing liquidity
3.Makes borrowing costlier, reducing credit demand
4.Withdraws cash directly from the banking system
India's domestic requirement of edible oil is met through imports to what approximate extent?
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