Static Quiz 20 July 2022 (Indian Economy)

Solution: d) Justification: Statement 1: Repo Rate is the rate at which RBI lends money to commercial banks against the pledge of government securities whenever the banks are in need of funds to meet their day-to-day obligations.
Reverse repo rate is the rate of interest offered by RBI, when banks deposit their surplus funds with the RBI for short periods. When banks have surplus funds but have no lending (or) investment options, they deposit such funds with RBI. Banks earn interest on such funds. Both repo and reverse repo apply to banking institutions.
Statement 2: So, higher the repo rate higher the cost of short-term money and vice versa and thus lower the borrowing. Hence, liquidity is lower in the economy. Similarly, if the reverse repo rate increases banks park more funds with the RBI and lesser liquidity is available with the economy. So, an increase in both would have similar effects on primary liquidity (we will discuss about primary and secondary liquidity later).

Solution: d)
Justification: It is essentially the process through which the policy action of the central bank is transmitted to the ultimate objective of stable inflation and growth. The policy action consists typically of changing the interest rate at which it borrows or lends “reserves” (in our case, Rupees) on an overnight basis with commercial banks. The transmission mechanism hinges crucially on how monetary policy changes influence households’ and firms’ behavior. This change can take place through several channels. Studying these channels is a vast subject in finance and economics literature. Changes in the central bank’s policy rate impact the economy with lags through a variety of channels, the primary ones being (i) interest rate channel, (ii) credit channel, (iii) exchange rate channel, and (iv) asset price channel. How these channels function in a given economy depends on the stage of development of the economy and its underlying financial structure.
Statement 1: A large part of bank’s deposits are lent to the government through the SLR route at a certain interest rate, which is not responsive to the general interest policy in the economy.
Statement 2: The implicit assumption here is that bank balance sheets are strong and in a position to step-up quickly the supply of credit in response to lower funding cost and higher demand for credit – the bank lending or the credit the channel of transmission. Cross-country evidence indicates that monetary transmission is greatly hindered if the bank balance sheets are weak in that they do not have much loss-absorption capacity to deal squarely with their problem.
Statement 3: If major schemes keep sub venting interest rates, even if the banks change the interest rate, it will not elicit a response from the public because they are anyways borrowing funds at a lower interest rate (due to the interest subvention). Also, the monetary transmission also remains weak in India due to the following reasons:
The practice of yearly resetting of administered interest rates on small savings (including public provident fund) linked to
G-sec yields Sticky bank rates

Solution: d)
Justification: All are independently changed based on market conditions. However, the repo and reverse repo are usually changed with a certain gap in base points but it is not a rule to change both.

Solution: a)
Justification: The currency deposit ratio (cdr) is the ratio of money held by the public in currency to that they hold in
bank deposits.
Cdr = CU/DD.
If a person gets Re 1 she will put Rs 1/ (1 cdr) in her bank account and keep Rs cdr/ (1 cdr) in cash.
It reflects people’s preference for liquidity. It is a purely behavioural parameter which depends, among other things, on the seasonal pattern of expenditure
For example, cdr increases during the festive season as people convert deposits to cash balance for meeting extra expenditure during such periods.
Option (b) can’t be the answer as subdued consumption means people would like to keep money in banks and hold less cash.
Option (c) can’t be the answer as high policy rates promote savings, not consumption.

Solution: c)
Justification: When CRR is reduced, banks have more cash to lend to customers. This increases the liquidity in the market.
Primary liquidity is the amount that is injected in the market without any credit creation by banks. When banks lend the same money (obtained after relaxing CRR) repeatedly, extra credit is created. This extra credit is called secondary liquidity.
Option A and B are irrelevant to the analysis and option D is wrong in principle.