Question

The Reserve Bank of India purchases government securities worth \(₹5,000\) crore from the open market. Assuming Cash Reserve Ratio remains unchanged, the immediate effect of this operation will be:

• A. Reduction in money supply and liquidity
• B. Increase in liquidity and money supply
• C. Increase in CRR
• D. Reduction in bank deposits

Hint:

Remember: RBI buys securities \(\Rightarrow\) Money enters economy \(\Rightarrow\) Liquidity increases. RBI sells securities \(\Rightarrow\) Money leaves economy \(\Rightarrow\) Liquidity decreases.

Answer 1

The Correct Option is B

Concept: Open Market Operations (OMO) are an important quantitative monetary policy instrument used by the Reserve Bank of India to regulate money supply and liquidity in the economy. The RBI can:
• Purchase government securities.
• Sell government securities. When RBI purchases securities, it injects money into the banking system. When RBI sells securities, it withdraws money from the banking system.

Step 1: Understand the given situation. RBI purchases government securities worth: \[ ₹5,000 \text{ crore} \] The sellers of these securities receive money from RBI. Thus, \[ \text{Money flows from RBI to the public/banks} \]

Step 2: Analyze impact on banking system. As money enters banks:
• Bank reserves increase.
• Lending capacity increases.
• Credit creation increases.
• Market liquidity increases.

Step 3: Analyze effect on money supply. Higher reserves allow banks to create additional deposits through the process of credit creation. Therefore, \[ \text{Money Supply} \uparrow \] and \[ \text{Liquidity} \uparrow \]

Step 4: Evaluate options. Option A: Opposite effect. Option B: Correct. Option C: CRR is unchanged. Option D: Deposits tend to increase rather than decrease. Hence the correct answer is: \[ \boxed{\text{Increase in liquidity and money supply}} \]