With reference to selling of Government securities by RBI, consider the following statements:
1. It injects liquidity in the banking system.
2. It reduces interest rates.
3. It controls potential inflation pressure due to excess surplus.
How many of the statements given above are correct?
(a) Only one
(b) Only two
(c) All three
(d) None
Explanation
Open Market Operations (OMO) refer to the central bank's buying and selling of government securities to regulate liquidity. When the central bank buys securities, it injects liquidity into the system by providing funds to commercial banks. Conversely, selling securities absorbs excess liquidity, helping to control inflation and stabilize short-term interest rates. In India, the Reserve Bank of India (RBI) conducts OMOs to manage money supply effectively. Since the 1991 economic reforms, OMOs have become a key monetary tool, gaining more importance than the Cash Reserve Ratio (CRR) in liquidity management.
Statement 1 is not correct: When RBI sells government securities, banks and financial institutions buy them by paying money to RBI, which leads to absorption of liquidity from the banking system. Hence, liquidity is reduced, not injected.
Statement 2 is not correct: By reducing liquidity in the system, selling G-Secs can actually increase interest rates, not reduce them. Less money in the system means the cost of borrowing (interest) can go up.
Statement 3 is correct: Selling securities mops up surplus liquidity, which helps it reduce inflationary pressures in the economy.
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