UPSC Prelims 2023 Q24: Indian Economy – Monetary Policy & Money Supply
- (a) Conducting 'Open Market Operations'
- (b) Oversight of settlement and payment systems
- (c) Debt and cash management for the Central and State Governments
- (d) Regulating the functions of Non - banking Financial Institutions
Answer: (a) Conducting 'Open Market Operations'
Explanation
RBI 'Sterilization' — Definition
Sterilization in monetary policy = actions taken by a central bank to neutralise the monetary impact of foreign exchange interventions on domestic money supply.
How it works:
1. RBI buys foreign currency (to prevent rupee appreciation) → injects rupees into economy → increases money supply
2. To 'sterilize' this: RBI sells government securities in the open market (Open Market Operations) → absorbs excess rupees → money supply returns to target level
| RBI Activity | Part of Sterilization? |
|---|---|
| Open Market Operations (OMO) | YES — primary sterilization tool |
| Oversight of payment systems | No — regulatory function |
| Debt and cash management for govt | No — fiscal agency function |
| Regulating NBFIs | No — regulatory function |
Open Market Operations = Sterilization tool.
Answer: (a) Conducting 'Open Market Operations'.
Why each option is right or wrong
- (a) CORRECT. Open Market Operations (buying/selling government securities) is the primary sterilization tool — it counteracts the monetary expansion caused by foreign exchange interventions.
- (b) Incorrect. Oversight of settlement and payment systems is a regulatory/infrastructure function of RBI, not related to sterilization.
- (c) Incorrect. Debt and cash management for Central and State Governments is RBI's fiscal agency role — unrelated to sterilization of forex interventions.
- (d) Incorrect. Regulating Non-Banking Financial Institutions is a supervisory function, not a monetary sterilization activity.
Key point
Sterilization = using OMO (selling govt securities) to absorb excess liquidity created by forex intervention. RBI buys dollars → rupees flow in → OMO sells bonds → rupees flow out = net neutralisation. OMO = sterilization tool.
Remember
RBI's 'sterilization' refers to conducting Open Market Operations (OMO) — selling government securities to absorb excess rupee liquidity created when RBI buys foreign exchange to manage the exchange rate.
Common mistakes
- Confusing sterilization with all RBI functions — sterilization is specifically about neutralizing forex intervention effects on money supply.
- Not knowing that debt management is separate from monetary operations — RBI manages government debt as an agent, which is different from monetary policy.
- Missing the connection between OMO and sterilization — whenever RBI intervenes in forex markets, OMO is used to sterilize the domestic monetary impact.
Exam tip
Sterilization = OMO to offset forex intervention. Simple chain: RBI buys USD → ₹ increases → OMO (sell bonds) → ₹ absorbed → money supply stabilized. This is also called 'sterilized intervention' in foreign exchange management.
Sources
- RBI — Monetary Policy Operations and Instruments
- NCERT Economics Class 12 — Money and Banking