Banking, Money & Fiscal Policy

What you'll learn

Learn how RBI's monetary policy (repo rate, CRR, SLR, MPC) and the government's fiscal policy (deficits, FRBM) steer India's economy, as tested in UPSC Prelims.

This chapter has

Banking, Money & Fiscal Policy — solved practice questions

8 UPSC Indian Economy questions with step-by-step solutions. Attempt each, then reveal the answer.

1. Q1medium

   Consider the following statements about the Reserve Bank of India (RBI): 1. It was established in 1935 on the recommendations of the Hilton Young Commission. 2. It was nationalised in the year 1949. Which of the statements given above is/are correct?

   • A1 only
   • B2 only
   • CBoth 1 and 2
   • DNeither 1 nor 2
   Show answer & solution

   Correct answer: (C) Both 1 and 2

   The RBI was established on 1 April 1935 under the RBI Act, 1934; the Hilton Young Commission had recommended setting up a central bank. It was nationalised on 1 January 1949. Both statements are correct.

2. Q2hard

   Which of the following are components of 'narrow money' (M1) as measured by the RBI? 1. Currency with the public 2. Demand deposits with banks 3. Time deposits with banks Select the correct answer using the code given below:

   • A1 and 2 only
   • B1 and 3 only
   • C2 and 3 only
   • D1, 2 and 3
   Show answer & solution

   Correct answer: (A) 1 and 2 only

   M1 (narrow money) = currency with the public + demand deposits with banks + other deposits with the RBI. Time deposits are excluded from M1 and are counted in M3 (broad money).

3. Q3medium

   The Cash Reserve Ratio (CRR) is best described as:

   • AThe portion of NDTL that banks must keep as cash reserves with the RBI
   • BThe portion of NDTL that banks must keep in liquid assets with themselves
   • CThe rate at which the RBI lends short-term funds to banks
   • DThe minimum capital that banks must hold against their risk-weighted assets
   Show answer & solution

   Correct answer: (A) The portion of NDTL that banks must keep as cash reserves with the RBI

   CRR is the percentage of a bank's Net Demand and Time Liabilities (NDTL) that it must maintain as cash balances with the RBI. These reserves earn no interest.

4. Q4medium

   In which of the following forms can a commercial bank maintain its Statutory Liquidity Ratio (SLR)? 1. Cash 2. Gold 3. RBI-approved government securities Select the correct answer using the code given below:

   • A1 only
   • B1 and 3 only
   • C3 only
   • D1, 2 and 3
   Show answer & solution

   Correct answer: (D) 1, 2 and 3

   SLR is the portion of NDTL that a bank must maintain with itself in the form of liquid assets — cash, gold, and RBI-approved securities (mainly government securities).

5. Q5medium

   The 'repo rate' announced by the RBI refers to the rate at which:

   • ABanks lend to their most creditworthy customers
   • BThe RBI lends short-term funds to commercial banks against government securities
   • CBanks borrow from one another in the call money market
   • DThe RBI borrows funds from commercial banks
   Show answer & solution

   Correct answer: (B) The RBI lends short-term funds to commercial banks against government securities

   Under a repo (repurchase) transaction, the RBI lends short-term funds to commercial banks against the collateral of government securities. When the RBI borrows from banks, the applicable rate is the reverse repo rate.

6. Q6hard

   In order to control a situation of high inflation, which of the following actions is the RBI most likely to take?

   • AReduce the repo rate
   • BReduce the Cash Reserve Ratio
   • CIncrease the repo rate
   • DBuy government securities in the open market
   Show answer & solution

   Correct answer: (C) Increase the repo rate

   To curb inflation, the RBI adopts a contractionary stance — raising the repo rate (and CRR/SLR) and selling securities through open market operations to absorb liquidity. Cutting rates, reducing CRR, or buying securities would instead inject liquidity.

7. Q7hard

   The fiscal deficit of the government is best defined as:

   • ATotal expenditure minus total receipts excluding borrowings
   • BRevenue expenditure minus revenue receipts
   • CFiscal deficit minus interest payments
   • DTotal expenditure minus total revenue receipts
   Show answer & solution

   Correct answer: (A) Total expenditure minus total receipts excluding borrowings

   Fiscal deficit = total expenditure − total receipts excluding borrowings. It represents the total borrowing requirement of the government in a given year.

8. Q8hard

   The primary deficit in the Union Budget is equal to:

   • AFiscal deficit plus interest payments
   • BFiscal deficit minus interest payments
   • CRevenue deficit minus grants for capital assets
   • DFiscal deficit minus revenue deficit
   Show answer & solution

   Correct answer: (B) Fiscal deficit minus interest payments

   Primary deficit = fiscal deficit − interest payments. It measures the current year's borrowing requirement after excluding the interest burden arising from past borrowings.

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