RAS question
The Liquidity Adjustment Facility (LAF) operates through:
Correct answer: (C) Repo and reverse repo auctions.
The Liquidity Adjustment Facility operates through repo and reverse repo auctions, with repo injecting liquidity and reverse repo/SDF absorbing liquidity for RBI's day-to-day liquidity management.
Explanation
Under the LAF, RBI manages day-to-day liquidity through repo operations, which inject liquidity, and reverse repo/SDF operations, which absorb liquidity. RBI's LAF scheme states that the revised scheme is operationalised through daily repo and reverse repo auctions: a 7-day fixed-rate repo conducted daily and an overnight fixed-rate reverse repo conducted daily on weekdays. That is why the mechanism is not a broad label such as open market operations or CRR changes. The exam point is the instrument pair: repo for adding liquidity when the system needs funds, and reverse repo/SDF for taking out surplus liquidity. The facility was introduced on the Narasimham Committee's recommendation.
Why the other options are wrong
- (A) Open market operations are separate from LAF; the RBI scheme identifies daily repo and reverse repo auctions as the LAF route, not OMO alone.
- (B) CRR adjustments are a separate quantitative tool, while LAF works through repo and reverse repo auctions.
- (D) Foreign exchange interventions are different from LAF, which the RBI scheme frames around repo and reverse repo auctions for liquidity management.
Concept
This tests monetary policy instruments, especially how RBI manages short-term system liquidity. It recurs in RAS because repo, reverse repo, CRR, OMO and forex intervention are commonly mixed up in economy questions.