📘 Q.3 IAS Prelims 2023 — Economics (Monetary Policy)
🧷 Authentic Classroom Explanation by IAS Monk
📌 The Question:
Which one of the following activities of the Reserve Bank of India is considered to be part of ‘sterilization’?
(a) Conducting ‘Open Market Operations’
(b) Oversight of settlement and payment systems
(c) Debt and cash management for the Central and State Governments
(d) Regulating the functions of Non-banking Financial Institutions
✅ Correct Answer: (a) Conducting ‘Open Market Operations’
🧠 Curiosity Raiser
When foreign money floods into an economy, why doesn’t the RBI simply celebrate higher reserves?
Why does it quietly pull money out instead?
That invisible act of balance is called sterilization.
📘 Enrichment Notes (Sterilization — decoded cleanly)
🔹 What is Sterilization?
Sterilization refers to central bank operations aimed at neutralizing the impact of capital inflows (or outflows) on domestic money supply.
- When foreign capital enters India → RBI buys dollars → injects rupees into the system
- This can fuel inflation or asset bubbles
- To counter this, RBI withdraws excess liquidity
This neutralizing act is sterilization.
🔹 How does RBI Sterilize Liquidity?
The classic and most direct instrument is:
✅ Open Market Operations (OMOs)
- RBI sells government securities in the open market
- Banks buy these securities → liquidity gets absorbed
- Domestic money supply contracts, offsetting earlier expansion
📌 Hence, OMOs are a core sterilization tool
🔹 Why other options are incorrect?
❌ Oversight of settlement and payment systems
- Related to financial infrastructure, not money supply management
❌ Debt and cash management for governments
- Fiscal coordination role, not a monetary sterilization function
❌ Regulating NBFCs
- Prudential regulation, unrelated to liquidity neutralization
🧩 Concept Lock (for Prelims recall)
Sterilization = Capital flows neutralized via OMOs
Think:
Dollar inflow → Rupee injection → OMO sale → Liquidity absorbed
🧘♂️ IAS Monk Whisper
Reserves give strength, but unchecked liquidity breeds instability.
Sterilization is the monk’s silence after the applause.