The RBI buys government securities worth Rs 50 crore from commercial…

The RBI buys government securities worth Rs 50 crore from commercial banks under a repo. The Cash Reserve Ratio is 20 per cent, banks keep no extra reserves, the public holds no currency and every loan comes back to the banks as a deposit. What happens to the money supply?

Answer & explanation

Correct answer: option 4

The correct answer is Option (4) → It rises by Rs 250 crore, but only till the agreed date of resale.

Two ideas decide this question. A purchase of securities by the RBI adds to bank reserves. A repo is a purchase that will be reversed on a fixed date.

The RBI pays for the securities, so bank reserves rise by Rs 50 crore. With a CRR of 20 per cent, the money multiplier is 1 ÷ 0.2 = 5.

Rise in deposits = 50 × 5 = Rs 250 crore

With no currency with the public, money supply rises by Rs 250 crore.

The rise does not last. In a repo the purchase agreement fixes the date and price of resale. On that date the RBI sells the securities back and the money is taken out again. So the rise is not permanent.

An outright purchase would have raised the money supply permanently. Rs 50 crore is only the rise in reserves, before the multiplier works.

NCERT (2026-27): “3.4 POLICY TOOLS TO CONTROL MONEY SUPPLY … When RBI buys a Government bond in the open market, it pays for it by giving a cheque. This cheque increases the total amount of reserves in the economy and thus increases the money supply. … As a result, the injection/absorption of the money is of permanent nature. However, there is another type of operation in which when the central bank buys the security, this agreement of purchase also has specification about date and price of resale of this security. This type of agreement is called a repurchase agreement or repo. The interest rate at which the money is lent in this way is called the repo rate.”

“3.3.2 Limits to Credit Creation and Money Multiplier … Since the bank is only expected to keep 20 per cent of its deposits as reserves, thus, reserves of Rs 100 (20per cent of 500 = 100) can support the deposits of Rs 500. … Thus, reserves of Rs 100 create deposits of Rs (5 × 100)=Rs 500.”