Question 24

Sterilization, in the context of central banking, refers to the actions undertaken by a central bank to offset the monetary impact of its interventions in the foreign exchange market. For example, if the Reserve Bank of India (RBI) buys foreign currency to prevent the appreciation of the rupee, it injects an equivalent amount of Indian rupees into the domestic economy, thereby increasing the money supply. To 'sterilize' or neutralize this increase in money supply, the RBI would typically sell government securities in the open market (Open Market Operations or OMOs). This action absorbs the excess liquidity from the banking system, preventing it from fueling inflation.

The other options describe different functions of the RBI:

• Oversight of settlement and payment systems: This is part of the RBI's role in maintaining financial stability and efficiency.
• Debt and cash management for the Central and State Governments: This is a banking function of the RBI for the government.
• Regulating the functions of Non-banking Financial Institutions: This is part of the RBI's regulatory and supervisory role in the financial sector.

Therefore, conducting 'Open Market Operations' is the activity considered part of sterilization.