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    Question

    Suppose, there is huge inflow of foreign currencies. To

    avoid drastic appreciation, RBI had to absorb them in exchange of domestic currencies. Now to control the increased money supply, RBI sells Government securities. This is called:
    A Open Market Operation (OMO) Correct Answer Incorrect Answer
    B Market Stabilization Scheme (MSS) Correct Answer Incorrect Answer
    C Sterilization Correct Answer Incorrect Answer
    D Currency Swap Correct Answer Incorrect Answer
    E None of the above Correct Answer Incorrect Answer

    Solution

    When there is excess inflow of foreign currencies, RBI absorbs most of it to prevent any adverse effect. Such drastic inflow caused steep rise of exchange rate causing fall of export and other negative consequences. Thus RBI decides to absorb foreign currencies (dollars) from the market. Since it will done in exchange for rupees, it will increase money supply in the market. This may leads to the issue of inflation. Thus now RBI sales Government Securities to absorb excess money supply from the market. Since this sterilizes the economy from many adverse shocks, the entire operation is called sterilization.

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