Question

Read the passage below and answer the questions that follow.

Monetary Policy Committee (MPC) of RBI unanimously voted for a pause after six cumulative hikes in the bench Repo Rate cumulatively by 2.5 per cent (250 basic points) in the April, 2023 Review of Monetary Policy as inflation showed some signs of moderation. Members of MPC also pointed out the impact of rising rates on the growth outlook to defend a pause on the rise in the Repo rate. The RBI Governor also pointed out the delayed impact of previous rate hikes on economic growth and price pressure. He stated that the cumulative impact of monetary policy actions over the last one year is still unfolding and needs to be monitored closely. (The Economic Times, 22 April 2023)

1. What is monetary policy? [1]
2. Who is entrusted with the responsibility of formulating monetary policy? [1]
3. Distinguish between repo rate and reverse repo rate. [2]
4. Distinguish between quantitative and selective instruments of credit control. [2]
5. State any two functions of RBI. [2]

Answer 1

i. Monetary policy is the policy pursued by the central bank to control and regulate the supply of money and the cost and availability of credit in order to achieve predetermined economic objectives, such as price stability and economic growth.

ii. The central bank is entrusted with formulating monetary and credit policy. In India, this responsibility is exercised by the Reserve Bank of India through the Monetary Policy Committee (MPC).

iii.

Basis of Difference	Repo Rate	Reverse Repo Rate
Meaning	Rate at which the RBI lends short-term funds to commercial banks	Rate at which the RBI borrows short-term funds from commercial banks
Basic transaction	RBI provides funds to banks against government securities	Banks provide their excess funds to the RBI against government securities
RBI’s operation	RBI buys securities and agrees to resell them to the banks	RBI sells securities and agrees to repurchase them from the banks
Effect on liquidity	Injects liquidity into the banking system	Absorbs excess liquidity from the banking system
Effect of a higher rate	Makes borrowing from the RBI costlier and supports credit contraction	Encourages banks to deposit more excess funds with the RBI

iv.

Basis of Difference	Quantitative Instruments	Selective Instruments
Objective	Control the overall quantity, availability and cost of credit	Regulate the allocation and direction of credit among different uses
Scope of impact	Affect all sectors depending on bank credit without discrimination	Focus on particular sectors, activities, borrowers or purposes of credit
Method of control	General financial measures, such as repo rate, open market operations and CRR	Specific and discretionary measures, such as margin requirements, credit rationing and moral suasion
Effect on credit	Expands or contracts total bank credit and influences interest rates	Redirects or channels existing credit towards socially and economically desirable uses
Main examples	Bank rate, repo rate, open market operations and cash reserve ratio	Consumer-credit regulation, margin requirements, credit rationing, direct action and publicity

v.

1. Bank of issue: RBI has the sole monopoly of issuing currency notes in India, except for one-rupee notes conventionally issued by the Government of India.
2. Controller of credit: RBI regulates bank credit through instruments such as the repo rate, reverse repo rate, open market operations and reserve-ratio requirements.