Arrange the following monetary policy tools by the order in which RBI typically uses them to control inflation:
- Open Market Operations (OMO)
- Repo Rate Hike
- Cash Reserve Ratio (CRR) Adjustment
- Statutory Liquidity Ratio (SLR) Adjustment
Show Answer & Explanation
Correct Answer: (A)
Explanation:
The correct order reflects a typical escalation from the most frequently used and flexible tools to the most powerful and less frequently used ones.
- (1) Open Market Operations (OMO): Used for day-to-day liquidity management.
- (2) Repo Rate Hike: The primary signaling tool, adjusted bi-monthly by the MPC.
- (3) CRR Adjustment: A powerful, blunt tool used less frequently for major liquidity adjustments.
- (4) SLR Adjustment: A structural tool that is adjusted very infrequently.
This sequence (1), (2), (3), (4) correctly lists the tools from most-frequent to least-frequent.
📚 Additional Info: Order of Monetary Policy Tool Usage
The RBI uses a range of tools to manage inflation, generally preferring market-based instruments for fine-tuning and resorting to more direct, blunt instruments for larger adjustments. The typical order of preference or escalation is as follows:
(1) Open Market Operations (OMO)
- What it is: The buying and selling of government securities by the RBI. To control inflation, the RBI sells securities to suck excess money out of the banking system.
- Usage: This is a highly flexible tool used for day-to-day liquidity management. It’s the first and most frequent line of action.
(2) Repo Rate Hike
- What it is: The interest rate at which the RBI lends money to commercial banks. Raising this rate makes borrowing more expensive for banks and, in turn, for consumers.
- Usage: This is the primary signaling tool. The Monetary Policy Committee (MPC) announces changes to the repo rate bi-monthly to set the overall direction of interest rates.
(3) Cash Reserve Ratio (CRR) Adjustment
- What it is: The percentage of a bank’s total deposits that must be kept as a cash reserve with the RBI. Raising the CRR directly reduces the funds available for banks to lend.
- Usage: This is a powerful, blunt instrument. It’s used less frequently because it directly impacts bank profitability and isn’t suitable for fine-tuning.
(4) Statutory Liquidity Ratio (SLR) Adjustment
- What it is: The percentage of a bank’s deposits that must be maintained in liquid assets (cash, gold, government securities).
- Usage: This is considered a structural tool and is the least likely to be adjusted for short-term inflation management. Changes to SLR are very infrequent.