Static Quiz 24 January 2023 (Indian Economy)

Solution: d) Justification: To calculate economic growth, you need to estimate the total actual production of the last year and compare it to that of next year.
Option A: Market cost calculations include inflation, and thus a mere increase in prices will indicate an increase in GDP even if there has not been an actual production increase. So, A is wrong.
Option B: GNP at factor cost is more realistic because it also takes into account the NFIA as well as factor cost (which is the manufacturing cost). But, then it does not take into account the depreciation of goods in the economy which effectively reduces the total effective production of last year.
Option C and D: By these means, option D is the best choice, as option C is calculated at market cost.

Solution: d)
Justification: It is essentially the process through which the policy action of the central bank is transmitted to the ultimate objective of stable inflation and growth. The policy action consists typically of changing the interest rate at which it borrows or lends “reserves” (in our case, Rupees) on an overnight basis with commercial banks. The transmission mechanism hinges crucially on how monetary policy changes influence households’ and firms’ behavior. This change can take place through several channels. Studying these channels is a vast subject in finance and economics literature. Changes in the central bank’s policy rate impact the economy with lags through a variety of channels, the primary ones being (i) interest rate channel, (ii) credit channel, (iii) exchange rate channel, and (iv) asset price channel. How these channels function in a given economy depends on the stage of development of the economy and its underlying financial structure.
Statement 1: A large part of bank’s deposits are lent to the government through the SLR route at a certain interest rate, which is not responsive to the general interest policy in the economy.
Statement 2: The implicit assumption here is that bank balance sheets are strong and in a position to step-up quickly the supply of credit in response to lower funding cost and higher demand for credit – the bank lending or the credit the channel of transmission. Cross-country evidence indicates that monetary transmission is greatly hindered if the bank balance sheets are weak in that they do not have much loss-absorption capacity to deal squarely with their problem.
Statement 3: If major schemes keep sub venting interest rates, even if the banks change the interest rate, it will not elicit a response from the public because they are anyways borrowing funds at a lower interest rate (due to the interest subvention). Also, the monetary transmission also remains weak in India due to the following reasons:
The practice of yearly resetting of administered interest rates on small savings (including public provident fund) linked to G-sec yields Sticky bank rates

Solution: d)
Justification: All are independently changed based on market conditions. However, the repo and reverse repo are usually changed with a certain gap in base points but it is not a rule to change both.

Solution: b)
Justification: Truncation is the process of stopping the flow of the physical cheque issued by a drawer at some point by the presenting bank en-route to the paying bank branch. In its place, an electronic image of the cheque is transmitted to the paying branch through the clearing house, along with relevant information like data on the MICR band, date of presentation, presenting bank, etc. Cheque truncation thus obviates the need to move the physical instruments across bank branches, other than in exceptional circumstances for clearing purposes. This effectively eliminates the associated cost of movement of the physical cheques, reduces the time required for their collection and brings elegance to the entire activity of cheque processing. Thus, it also reduces the scope of loss of instruments in transit and removes reconciliation-related and logistics-related problems, thus benefitting the system as a whole. CTS has been implemented in New Delhi, Chennai and Mumbai with effect from February 1, 2008, September 24, 2011 and April 27, 2013 respectively. After migration of the entire cheque volume from MICR system to CTS, the traditional MICR-based cheque processing has been discontinued across the country.

Solution: c)
Justification: When CRR is reduced, banks have more cash to lend to customers. This increases the liquidity in the market.
Primary liquidity is the amount that is injected in the market without any credit creation by banks. When banks lend the same money (obtained after relaxing CRR) repeatedly, extra credit is created. This extra credit is called secondary liquidity.
Option A and B are irrelevant to the analysis and option D is wrong in principle.