Money and the Reserve Bank of India

Prerequisites

• Basic Concepts of the Economy: nominal vs real values, GDP and the sectors of the economy
• Money, Banking and Inflation: chapter overview: how the four topics fit together

The Hook: The ₹500 Note in Your Pocket

Why it matters: Prelims regularly tests the components of M1 and M3, the RBI’s year of establishment and nationalisation, and who issues which currency. Mains uses this base for questions on central bank autonomy and the RBI’s role.

Money (मुद्रा): Functions and Forms

Why money replaced barter

Under barter (वस्तु विनिमय), goods are exchanged directly for goods. It fails because of the lack of a double coincidence of wants, the lack of a common measure of value, indivisibility of goods, and the difficulty of storing value and making deferred payments. Money solves all four problems.

Functions of money

Forms of money

• Commodity money: has value as a good (grain, cattle, gold coins).
• Fiat money (आदेश मुद्रा): paper notes and coins with no intrinsic value; accepted because the State declares them legal tender. Indian currency today is fiat money.
• Legal tender (वैध मुद्रा): must be accepted in settlement of debt. RBI notes are unlimited legal tender. Coins are limited legal tender under the Coinage Act, 2011.
• Bank money (credit money): demand deposits that can be transferred by cheque, card, UPI and similar instruments. Accepting it is optional, so it is not legal tender, but it is the largest part of money supply.
• Digital rupee (e₹): the RBI’s Central Bank Digital Currency (CBDC). It is a legal tender issued by the RBI in digital form. Pilots began for the wholesale segment on 1 November 2022 and for the retail segment on 1 December 2022. Unlike UPI, which moves bank deposits, e₹ is a direct claim on the RBI.

Measures of Money Supply (मुद्रा पूर्ति)

Money supply is the stock of money held by the public (households, firms and others, excluding the Government and the banking system) at a point in time. It is a stock, not a flow.

• Liquidity: M1 is the most liquid and M4 the least liquid.
• “Other deposits with the RBI” are deposits of quasi-government bodies, foreign central banks and international bodies such as the IMF and World Bank. They exclude the deposits of the Government and of banks.
• The RBI’s Second Working Group on Money Supply (chaired by Y.V. Reddy, 1998) introduced new monetary aggregates (NM0–NM3) and liquidity aggregates (L1–L3). M3 remains the measure most quoted in exam questions.

Money multiplier (मुद्रा गुणक)

Banks keep only a fraction of deposits as reserves and lend the rest. Each loan becomes a deposit somewhere else, so a rupee of reserve money supports several rupees of broad money.

In the simplest textbook case, with a reserve ratio \(r\) and no cash leakage, the deposit multiplier is \( \frac{1}{r} \). For example, if \(r = 10\%\) the multiplier is 10. A higher CRR lowers the multiplier. A lower CRR raises it. This is why CRR is a monetary policy tool (see Monetary Policy).

The Reserve Bank of India (भारतीय रिज़र्व बैंक)

Timeline

timeline
    title Reserve Bank of India: key dates
    1926 : Hilton Young Commission (Royal Commission on Indian Currency and Finance) recommends a central bank
    1934 : Reserve Bank of India Act passed
    1935 : RBI starts operations on 1 April, HQ Calcutta, as a shareholders' bank
    1937 : Central office moves permanently to Bombay
    1949 : Nationalised on 1 January under the RBI (Transfer to Public Ownership) Act, 1948
    2016 : Flexible inflation targeting and the MPC written into the RBI Act
    2022 : Digital rupee pilots begin

Governors to remember

Organisation

• The Central Board of Directors governs the RBI: the Governor, up to four Deputy Governors, directors nominated by the Central Government (including two Government officials), and one director from each of the four Local Boards (Mumbai, Kolkata, Chennai, New Delhi).
• The Governor and Deputy Governors are appointed by the Central Government for a term of up to five years, and are eligible for reappointment.
• The RBI’s accounting year was changed from July–June to April–March, starting from 2020-21, to match the Government’s financial year.
• The RBI has a regional office at Raipur for Chhattisgarh.

Functions of the RBI

Currency management

• Minimum Reserve System (1957): the RBI must hold reserves worth at least ₹200 crore, of which at least ₹115 crore must be gold. Note issue is not tied to a fixed proportion of gold, so it is a fiat system.
• Note presses: Nashik and Dewas (owned by the Government through SPMCIL); Mysuru and Salboni (owned by the RBI through BRBNMPL).
• Mints (Government): Mumbai, Hyderabad, Kolkata, Noida.
• Demonetisation: On 8 November 2016, the ₹500 and ₹1,000 notes of the then series ceased to be legal tender. On 19 May 2023, the RBI announced the withdrawal of ₹2,000 notes from circulation, though they remain legal tender.

Memory Tricks

Don’t Confuse

Common Mistakes

Practice

All questions below are original practice questions written in CGPSC style. They are not previous-year questions.

Level 1: Foundation

1. The lack of a ______ of wants is the main defect of barter.
2. Broad money in India is denoted by ______.
3. The first Indian Governor of the RBI was ______.

Level 2: Prelims MCQs

Q1. Consider the following statements about the Reserve Bank of India:

1. It began operations on 1 April 1935 with its central office in Calcutta.
2. It was established as a wholly Government-owned bank.
3. Its central office moved permanently to Bombay in 1937.

Which of the statements given above is/are correct?

• (a) 1 only
• (b) 1 and 3 only
• (c) 2 and 3 only
• (d) 1, 2 and 3

Q2. Which of the following is not a component of M1 in India?

• (a) Currency with the public
• (b) Demand deposits with banks
• (c) Net time deposits with banks
• (d) Other deposits with the RBI

Q3. Match List I (Item) with List II (Issuing or signing authority):

• (a) A-1, B-2, C-3, D-4
• (b) A-2, B-1, C-4, D-3
• (c) A-2, B-1, C-3, D-4
• (d) A-3, B-1, C-2, D-4

Q4. If the cash reserve ratio is raised, other things remaining the same, the money multiplier will:

• (a) rise
• (b) fall
• (c) remain unchanged
• (d) first rise, then fall

Q5. Arrange the following monetary aggregates in decreasing order of liquidity:

1. M4
2. M1
3. M3
4. M2

• (a) 2, 4, 3, 1
• (b) 1, 3, 4, 2
• (c) 2, 3, 4, 1
• (d) 4, 2, 1, 3

Level 3: Mains Answer Writing

Q1. (60 words) Distinguish between narrow money and broad money.

Q2. (150–200 words) Describe the functions of the Reserve Bank of India. How has its role changed since 2016?

Quick Revision Table

Key Takeaways

What’s Next

• Monetary Policy and the MPC: how the RBI uses repo, CRR and other tools
• Banking Structure in India: the banks the RBI regulates
• Inflation: what happens when money grows faster than output
• Public Finance: Government borrowing, which the RBI manages