Retail inflation at 16-month high of 3.9% as food items get dearer

Statement 1 is correct. As per the data given in the Economic Survey 2019-2020, the weightage of food in the Consumer Price Index (CPI) Combined is 45.9% as compared to 24.4% in Wholesale Price Index (WPI). Statement 2 is correct. The CPI measures the average change in prices over time that consumers pay for a basket of goods and services, commonly known as inflation, whereas WPI does not measure the average change in prices. Statement 3 is incorrect. In April 2014, the RBI adopted the Consumer Price Index (CPI) as its key measure of inflation. Hence, option A is the correct answer.

The responsibility for maintaining price stability and controlling inflation in India lies primarily with the Reserve Bank of India (RBI). The RBI formulates and implements monetary policy to maintain price stability and ensure adequate flow of credit to productive sectors of the economy. As the central bank of the country, the RBI uses various tools such as repo rate, reverse repo rate, cash reserve ratio (CRR), and statutory liquidity ratio (SLR) to influence liquidity and interest rates in the economy, thereby affecting inflationary pressures.

* Statement I- correct: In the aftermath of the COVID-19 pandemic, many central banks around the world observed rising inflation. To combat this inflation, they resorted to raising interest rates. This is a well-established monetary policy tool to curb inflation by making borrowing more expensive and encouraging saving, thereby reducing the money supply in circulation.  * Statement II- correct: Central banks are entrusted with maintaining price stability and managing inflation. Raising interest rates is one of the primary instruments they use to achieve this objective. While other factors can influence inflation, central banks do have the ability to significantly impact it through monetary policy measures. Therefore, both statements accurately reflect the role of central banks and their use of interest rates to manage inflation and statement 2 is the correct explanation for statement 1.

Statement 1 is incorrect. Typically, the RBI uses open market operations to sell government securities to drain money from the system and control inflation. Buying government securities would inject money into the system, potentially fueling inflation further. Statement 2 is correct. Selling dollars in the market - If the rupee is rapidly depreciating, the RBI might intervene in the foreign exchange market by selling dollars from its reserves. This increased supply of dollars in the market can help stabilize the exchange rate and slow down the depreciation of the rupee. Statement 3 is correct. Lower interest rates in the US/EU make India a more attractive destination for foreign investment, leading to a large inflow of dollars. This causes the rupee to strengthen (appreciate). To prevent the rupee from appreciating too rapidly and hurting exporters, the RBI buys the excess dollars from the market.

Option A and B are incorrect: RBI plays a key/primary role in controlling inflation through its monetary policy. Option C is correct: Decreased money circulation can help control inflation, while increased circulation can contribute to it. Option D is incorrect: Increased money supply shall only increase inflation.

Statement 1 is correct: The Federal Reserve's monetary policy decisions, particularly regarding interest rates, can impact global capital flows. If the Fed raises interest rates, it can make US investments more attractive, potentially leading to some outflow of capital from India. This could affect demand for Indian government bonds and influence their yield. Statement 2 is correct: The RBI's monetary policy plays a crucial role in influencing Indian government bond yields. The RBI's actions like setting repo rates, open market operations, and cash reserve ratio (CRR) can affect the overall liquidity in the banking system. Higher liquidity can lead to lower yields, and vice versa. Statement 3 is correct: Inflation expectations and short-term interest rates are important factors for investors when considering the return on government bonds. Higher inflation expectations can lead investors to demand higher yields to compensate for the potential erosion of purchasing power. Similarly, short-term interest rates can act as a benchmark for bond yields. Therefore, all three factors significantly influence the yields of Indian government bonds.

Creating new money to finance a budget deficit will be the most inflationary effect. Because it increases the money supply without any increase in the production of goods and services.

Expansionary Monetary Policy aims to stimulate economic activity by increasing the money supply and lowering interest rates. Statement 1 is incorrect. Cut and optimize the Statutory Liquidity Ratio: This aligns with expansionary policy as it allows banks to lend more. Statement 2 is correct. Increase the Marginal Standing Facility Rate: This goes against expansionary policy because it makes it more expensive for banks to borrow from RBI, potentially reducing liquidity. Statement 3 is incorrect. Cut the Bank Rate and Repo Rate: This is a key tool for expansionary policy. Lowering these rates encourages banks to borrow from RBI and lend at lower rates to businesses and individuals, stimulating economic activity. Therefore, increasing the Marginal Standing Facility Rate (MSF Rate) would contradict the goals of an expansionary monetary policy.

Statement 1 is correct. Capital Adequacy Ratio (CAR): This is a crucial regulatory tool used by central banks to ensure banks have sufficient capital reserves to absorb potential financial losses. It acts as a buffer to protect depositors' funds in case of loan defaults or other financial risks. Statement 2 is Incorrect. CAR is not decided by individual banks. The CAR is mandated and regulated by the central bank of a country, in India's case, the Reserve Bank of India (RBI). The RBI sets a minimum CAR that all banks operating in the country must adhere to. This ensures a level playing field and safeguards the financial system's stability.

Tight monetary policy is an action taken by a central bank, such as the Federal Reserve, to curb overheated economic growth. Central banks employ tight monetary policy when an economy is experiencing rapid acceleration or when inflation, which pertains to overall prices, is escalating too swiftly. Statement 1 is correct. A tight monetary policy by the US Federal Reserve means higher interest rates in the US. This attracts global investors to shift their capital towards US assets for better returns. As a result, there can be capital flight from emerging markets like India to the US. Statement 2 is correct. When capital flows out, the domestic currency tends to depreciate, and global interest rates rise. Firms that have borrowed in foreign currencies through External Commercial Borrowings (ECBs) will now face higher repayment costs in rupee terms. Thus, their cost of servicing these loans increases, raising their overall financial burden. Statement 3 is incorrect. Devaluation of the domestic currency actually increases the currency risk associated with ECBs. Since these loans are denominated in foreign currency (like USD), a weaker rupee means firms have to pay more in rupees to repay the same amount of foreign debt. Therefore, devaluation heightens, not reduces, currency risk. NOTE: The given question was dropped by UPSC from the Official Answer Key.