UPSC Essentials has launched a new initiative aimed at enhancing Mains answer writing skills for candidates preparing for the Civil Services Examination. This program encompasses crucial topics from both the static and dynamic segments of the UPSC syllabus, covering various General Studies papers. The questions provided are meticulously chosen based on their significance to the UPSC exam and contemporary events, enabling candidates to concentrate on the most pertinent themes for the Mains. This practice is intended to be a valuable addition to aspirants’ preparation for the UPSC Civil Services Mains. Engage with today’s GS-3 questions and evaluate your progress.
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Excess liquidity within the banking sector can hinder the effectiveness of monetary policy, even if the policy rate remains unchanged. This issue is particularly relevant in light of the Reserve Bank of India’s recent hurdles in managing liquidity.
Different satellite orbits present varying benefits and drawbacks concerning coverage, resolution, latency, and energy consumption. This can be illustrated by examining Low Earth Orbit (LEO), Medium Earth Orbit (MEO), and Geosynchronous Orbit (GSO).
QUESTION 1: The presence of excess liquidity in the banking sector can diminish the effectiveness of monetary policy transmission, even with a stable policy rate. Discuss this issue in the context of the Reserve Bank of India’s current struggles with liquidity management.
Importance: This topic is directly related to GS Paper 3: Indian Economy, specifically focusing on monetary policy and the banking system. It also addresses the link between liquidity management and factors like inflation, interest rates, credit growth, and the transmission of monetary policy. The question is pertinent for analyzing the RBI’s implementation of tools such as the Cash Reserve Ratio (CRR), Variable Rate Reverse Repo (VRRR), and Open Market Operations (OMOs).
Note: This response is not a model answer for UPSC but serves as a guide for your thought process that can be integrated into your responses.
— Excess liquidity refers to a situation where banks possess more funds than required for regular operations and transactions. Even if the Reserve Bank of India maintains the repo rate, an abundance of liquidity can lead to short-term money-market rates falling below this policy rate, thereby reducing the effectiveness of the intended monetary policy.
— Currently, the RBI is grappling with a challenge as the liquidity in the banking system soared to ₹10.3 lakh crore on September 3, 2026, marking a four-year high. The average daily surplus rose to ₹3.67 lakh crore in August, up from ₹1.07 lakh crore in July.
Consider incorporating the following points into your response:
Impact of Excess Liquidity in the Banking Sector
— The substantial foreign currency inflows, prompted by the RBI’s special US dollar-rupee swap facility, along with liquidity generated from the RBI’s foreign exchange operations, have greatly contributed to the current liquidity surplus. As of August 31, this facility had attracted $136.377 billion in deposits, predominantly in Foreign Currency Non-Resident (Bank) accounts. While such inflows enhance the rupee’s external position and maintain its value, the conversion processes can significantly increase rupee liquidity within the domestic banking sector.
— Excessive liquidity exerts downward pressure on overnight money-market rates. If these rates drop substantially below the repo rate, the primary objective of monetary policy effectiveness is compromised: banks can access abundant funds at lower market rates irrespective of the unchanged RBI policy rate. Consequently, the signaling function of the repo rate may weaken, distorting the transmission of the RBI’s policy stance to other interest rates.
— Therefore, the RBI faces the challenge of managing excess liquidity while avoiding unnecessary tightening. It can utilize instruments such as Variable Rate Reverse Repo (VRRR) and Open Market Operations (OMOs) to absorb surplus funds, while the Cash Reserve Ratio (CRR) is instrumental in determining the amount of money banks can deploy. The careful selection and adjustment of these instruments are crucial, as an overly aggressive liquidity withdrawal could lead to significant interest rate increases, which would disrupt the government securities market.
— The situation is complicated by the risk that core liquidity could rise even further without effective liquidity management strategies. Concurrently, seasonal demand for currency during festive periods and the maturation of the RBI’s forward positions may absorb some of the surplus. Therefore, the RBI must navigate a delicate balance between ensuring effective monetary policy transmission, managing inflationary pressures, maintaining orderly financial market operations, and preventing excessive volatility in interest rates.
— This current scenario underscores that the effectiveness of monetary policy hinges not solely on the level of the policy repo rate but also on the liquidity environment in which it operates. The RBI aims to ensure adequate liquidity to facilitate orderly lending and economic activities while avoiding a surplus so large that market rates diverge from the intended monetary policy direction.
(Sources: Challenges posed by excess liquidity in the banking system, RBI’s forex swap attracts $136.37 billion, Surge in FCNR(B) deposits)
What constitutes excess liquidity in the banking sector?
How do CRR, VRRR, and OMOs assist in absorbing liquidity?
Related Previous Year Questions:
Examine the perspective that financial inclusion is a vital component of social and economic inclusion in a nation like India. Additionally, discuss the significance of the RBI’s Financial Inclusion Index. (2026)
What factors contribute to persistent high food inflation in India? Comment on the effectiveness of the RBI’s monetary policy in addressing this type of inflation. (2024)
QUESTION 2: Various satellite orbits present different trade-offs regarding coverage, resolution, latency, and energy demands. Discuss this in relation to Low Earth Orbit (LEO), Medium Earth Orbit (MEO), and Geosynchronous Orbit (GSO).
Importance: This topic is directly associated with GS Paper 3: Space Technology and Applications. The question assesses understanding of the implications and applications of different satellite orbits.
