MONEY SUPPLY & FRBM ACT Flashcards
What are the two main types of borrowing the government engages in?
Short-term loans (e.g., Treasury Bills) to cover temporary cash flow needs.
Long-term loans (e.g., Government Bonds) to fund major projects.
Describe the RBI’s role in facilitating government borrowing.
Issues debt instruments like T-Bills and bonds on behalf of the government.
Regulates the government securities market for smooth functioning.
Influences the cost of borrowing through monetary policy tools.
What is the difference between primary and secondary markets for government securities?
Primary Market: Where new government securities are issued.
Secondary Market: Where existing securities are traded among investors.
How can the RBI purchase government securities in the primary market?
Underwriting auctions (guaranteeing to buy unsold securities)
In rare cases, through direct purchase from the government
What is the main way the RBI buys and sells government securities in the secondary market?
Open Market Operations (OMOs) - buying to inject liquidity, selling to absorb liquidity.
Why is the RBI’s participation in both primary and secondary markets important?
Primary market: Ensures successful government borrowing even in tough times.
Secondary market: Helps manage money supply and interest rates.
Offers potential for direct economic intervention in exceptional circumstances.
What are Treasury Bills (T-Bills)?
Short-term government debt instruments with maturities of less than one year, used to bridge temporary funding gaps.
What are Government Bonds?
Long-term government debt instruments with maturities ranging from one year to 40 years, used to finance major projects. They offer investors regular interest payments (coupons).
Explain the purpose of Open Market Operations (OMOs).
OMOs are the primary tool used by the RBI to manage money supply and liquidity in the economy. The RBI buys government securities to increase money supply and sells government securities to decrease money supply.
How does the secondary market for government securities benefit investors?
Liquidity: It allows investors to sell their holdings before maturity.
Price Discovery: Reflects market sentiment and investor confidence in the government.
Wider Participation: Attracts a broader range of investors due to ease of trading.
What is the Fiscal Responsibility and Budget Management (FRBM) Act?
An Indian law enacted in 2003 that aims to reduce the government’s fiscal deficit, limit excessive borrowing, and promote long-term fiscal discipline.
What is the fiscal deficit?
The situation where a government’s spending exceeds its revenue in a given fiscal year.
How does the RBI’s repo rate influence government borrowing?
Higher repo rate makes it more expensive for banks to borrow from the RBI, which can indirectly increase the cost of government borrowing as well.
Lower repo rate makes borrowing cheaper, potentially lowering interest rates on government bonds.
Besides OMOs, what other monetary policy tools does the RBI use to influence the money supply?
Cash Reserve Ratio (CRR): The percentage of deposits banks must keep with the RBI.
Statutory Liquidity Ratio (SLR): The percentage of deposits banks must invest in government securities.
What are some of the objectives of the FRBM Act?
Reduce the fiscal deficit to a sustainable level.
Ensure responsible fiscal management (not burdening future generations with excessive debt).
Promote macroeconomic stability.
Why might the RBI directly purchase government securities from the primary market in exceptional circumstances?
To support the government during a financial crisis when investor demand for securities is low.
To finance specific government initiatives in line with broader economic goals.
What is the difference between inflation and interest rates?
Inflation: A general increase in the price level of goods and services over time, leading to a decline in purchasing power.
Interest Rates: The cost of borrowing money, expressed as a percentage of the loan amount.
How does an increase in money supply typically affect inflation?
An excessive increase in money supply relative to economic growth can lead to inflation. This is because more money chasing the same amount of goods leads to higher prices.
Why is the secondary market for government securities important for determining the price of government debt?
The secondary market reflects real-time investor sentiment. Prices in the secondary market fluctuate based on demand and supply. This helps determine the interest rate (yield) for government bonds, indicating the market’s perception of risk and return.
What are some potential drawbacks of excessive government borrowing?
Crowding out: Government borrowing can compete with private sector borrowing, driving up interest rates for businesses and consumers.
Intergenerational debt: Excessive debt can burden future generations with repayment obligations.
Inflationary pressure: If borrowing leads to excessive increases in money supply, it can contribute to inflation.
In a simplified scenario, how might the RBI use its monetary policy tools to combat inflation?
Increase the repo rate to make borrowing more expensive.
Increase CRR and SLR requirements, reducing banks’ ability to lend.
Sell government securities in the open market (OMOs) to absorb liquidity.
What is the primary objective of the Fiscal Responsibility and Budget Management Act (FRBM) of 2003?
To enforce fiscal discipline on the Indian government, primarily by limiting the fiscal deficit to a specified percentage of GDP.
Under the FRBM Act, what is a key restriction placed on government borrowing?
The government generally cannot borrow directly from the Reserve Bank of India (RBI). This means the RBI cannot purchase government securities directly from the primary market.
Name the TWO exceptional scenarios where the RBI is allowed to buy government securities directly in the primary market.
Short-term Ways and Means Advances (WMA) – to cover temporary budget shortfalls.
During national emergencies like war, disaster, agricultural crisis, or a significant fall in GDP.
