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Indian EconomyMedium

When the Reserve Bank raises the repo rate to control inflation, the likely immediate effect is that

  1. A.Credit becomes costlier and the growth of money supply slows
  2. B.Credit becomes cheaper and borrowing rises
  3. C.The fiscal deficit of the central government falls automatically
  4. D.The statutory liquidity ratio rises in the same proportion

Correct answer

A. Credit becomes costlier and the growth of money supply slows

Explanation

The correct answer is A. A higher repo rate raises the cost at which banks borrow from the Reserve Bank, so they raise their own lending rates. Loans become dearer, households and firms borrow and spend less, the growth of credit and of money supply slows, and the pressure of demand on prices eases. This is called a dear money or contractionary policy.

Option B states the effect of a cut in the repo rate, the easy money policy used to support growth when inflation is low. Option C is wrong because the fiscal deficit is decided by the government's own taxing and spending; indeed dearer credit raises the government's interest bill. Option D is wrong because the statutory liquidity ratio is a separate instrument under the Banking Regulation Act and does not move automatically with the policy rate.

Read the full article: RBI and Monetary Policy: Functions, MPC and Credit Control

Practice Questions

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Q2.Indian EconomyEasy

The Reserve Bank of India was nationalised with effect from

  1. A.1 April 1935
  2. B.1 January 1949
  3. C.15 August 1947
  4. D.19 July 1969
Show answer
Correct answer: B. 1 January 1949

The Bank began as a shareholders' institution, and the Reserve Bank (Transfer to Public Ownership) Act, 1948 transferred its shares to the central government with effect from the first day of 1949, since when it has been fully owned by the Government of India.

Q3.Indian EconomyEasy

The repo rate is the rate at which

  1. A.Commercial banks park their surplus funds with the Reserve Bank
  2. B.The Reserve Bank lends short term funds to commercial banks against government securities
  3. C.A bank lends to its most creditworthy customers
  4. D.The government borrows from the open market
Show answer
Correct answer: B. The Reserve Bank lends short term funds to commercial banks against government securities

In a repurchase agreement a bank sells government securities to the Reserve Bank and agrees to buy them back the next day at a fixed price; the difference is the interest, and the rate is the repo rate.

Q4.Indian EconomyEasy

How many members does the Monetary Policy Committee of India have?

  1. A.Four
  2. B.Five
  3. C.Six
  4. D.Seven
Show answer
Correct answer: C. Six

Three of them come from the Reserve Bank, the Governor as chairperson, the Deputy Governor in charge of monetary policy and an officer of the Bank nominated by the Central Board, and three are appointed by the central government from among persons of ability and integrity with knowledge of economics…

Q5.Indian EconomyHard

The Monetary Policy Committee was given statutory basis by amending the Reserve Bank of India Act through which law?

  1. A.The Finance Act, 2016
  2. B.The Banking Regulation Act, 1949
  3. C.The Fiscal Responsibility and Budget Management Act, 2003
  4. D.The Foreign Exchange Management Act, 1999
Show answer
Correct answer: A. The Finance Act, 2016

It amended the Reserve Bank of India Act, 1934 to insert the provisions on the inflation target and on the Monetary Policy Committee, so that the policy rate is now set by a committee and not by the Governor alone, and the framework of flexible inflation targeting became law.