Monetary policy of India


Monetary policy of India


Monetary policy is the process by which monetary authority of a country, generally a central bank controls the supply of money in the economy by exercising its control over interest rates in order to maintain price stability and achieve high economic growth.[1] In India, the central monetary authority is the Reserve Bank of India (RBI).

Contents

Objectives

Monetary Policy essentially is so designed as to maintain the price stability in the economy. Other objectives of the monetary policy of India, as stated by RBI, are:

Price Stability
Price Stability implies promoting economic development with considerable emphasis on price stability. The centre of focus is to facilitate the environment which is favourable to the architecture that enables the developmental projects to run swiftly while also maintaining reasonable price stability.
Controlled Expansion Of Bank Credit
One of the important functions of RBI is the controlled expansion of bank credit and money supply with special attention to seasonal requirement for credit without affecting the output.
Promotion of Fixed Investment
The aim here is to increase the productivity of investment by restraining non essential fixed investment.
Restriction of Inventories
Overfilling of stocks and products becoming outdated due to excess of stock often results is sickness of the unit. To avoid this problem the central monetary authority carries out this essential function of restricting the inventories. The main objective of this policy is to avoid over-stocking and idle money in the organization
Promotion of Exports and Food Procurement Operations
Monetary policy pays special attention in order to boost exports and facilitate the trade. It is an independent objective of monetary policy.
Desired Distribution of Credit
Monetary authority has control over the decisions regarding the allocation of credit to priority sector and small borrowers. This policy decides over the specified percentage of credit that is to be allocated to priority sector and small borrowers.
Equitable Distribution of Credit
The policy of Reserve Bank aims equitable distribution to all sectors of the economy and all social and economic class of people
To Promote Efficiency
It is another essential aspect where the central banks pay a lot of attention. It tries to increase the efficiency in the financial system and tries to incorporate structural changes such as deregulating interest rates, ease operational constraints in the credit delivery system, to introduce new money market instruments etc.
Reducing the Rigidity
RBI tries to bring about the flexibilities in the operations which provide a considerable autonomy. It encourages more competitive environment and diversification. It maintains its control over financial system whenever and wherever necessary to maintain the discipline and prudence in operations of the financial system.

Monetary operations

Monetary operations involve monetary techniques which operate on monetary magnitudes such as money supply, interest rates and availability of credit aimed to maintain Price Stability, Stable exchange rate, Healthy Balance of Payment, Financial stability, Economic growth. RBI, the apex institute of India which monitors and regulates the monetary policy of the country stabilizes the price by controlling Inflation. RBI takes into account the following monetary policies:

Major Operations

Open Market Operations
An open market operation is an instrument of monetary policy which involves buying or selling of government securities from or to the public and banks. This mechanism influences the reserve position of the banks, yield on government securities and cost of bank credit. The RBI sells government securities to contract the flow of credit and buys government securities to increase credit flow. Open market operation makes bank rate policy effective and maintains stability in government securities market.
CRR Graph from 1992 to 2011[2]
Cash Reserve Ratio
Cash Reserve Ratio is a certain percentage of bank deposits which banks are required to keep with RBI in the form of reserves or balances .Higher the CRR with the RBI lower will be the liquidity in the system and vice-versa.RBI is empowered to vary CRR between 15 percent and 3 percent. But as per the suggestion by the Narshimam committee Report the CRR was reduced from 15% in the 1990 to 5 percent in 2002. As of October 2011, the CRR is 6 percent.[3]
SLR Graph from 1991 to 2011[4]
Statutory Liquidity Ratio
Every financial institute have to maintain a certain amount of liquid assets from their time and demand liabilities with the RBI. These liquid assets can be cash, precious metals, approved securities like bonds etc. The ratio of the liquid assets to time and demand liabilities is termed as Statutory Liquidity Ratio.There was a reduction from 38.5% to 25% because of the suggestion by Narshimam Committee. The current SLR is 24%.[5]
Bank Rate Graph from 1991 to 2011
Bank Rate Policy[6]
Bank rate is the rate of interest charged by the RBI for providing funds or loans to the banking system. This banking system involves commercial and co-operative banks, Industrial Development Bank of India, IFC, EXIM Bank, and other approved financial institutes. Funds are provided either through lending directly or rediscounting or buying money market instruments like commercial bills and treasury bills. Increase in Bank Rate increases the cost of borrowing by commercial banks which results into the reduction in credit volume to the banks and hence declines the supply of money. Increase in the bank rate is the symbol of tightening of RBI monetary policy. Bank rate is also known as Discount rate. The current Bank rate is 6%.
Credit Ceiling
In this operation RBI issues prior information or direction that loans to the commercial banks will be given up to a certain limit. In this case commercial bank will be tight in advancing loans to the public. They will allocate loans to limited sectors. Few example of ceiling are agriculture sector advances, priority sector lending.
Credit Authorization Scheme
Credit Authorization Scheme was introduced in November, 1965 when P C Bhattacharya was the chairman of RBI. Under this instrument of credit regulation RBI as per the guideline authorizes the banks to advance loans to desired sectors.[7]
Moral Suasion
Moral Suasion is just as a request by the RBI to the commercial banks to take so and so action and measures in so and so trend of the economy. RBI may request commercial banks not to give loans for unproductive purpose which does not add to economic growth but increases inflation.
Repo Rate and Reverse Repo Rate
Repo rate is the rate at which RBI lends to commercial banks generally against government securities. Reduction in Repo rate helps the commercial banks to get money at a cheaper rate and increase in Repo rate discourages the commercial banks to get money as the rate increases and becomes expensive. Reverse Repo rate is the rate at which RBI borrows money from the commercial banks. The increase in the Repo rate will increase the cost of borrowing and lending of the banks which will discourage the public to borrow money and will encourage them to deposit. As the rates are high the availability of credit and demand decreases resulting to decrease in inflation. This increase in Repo Rate and Reverse Repo Rate is a symbol of tightening of the policy. As of October 2011, the repo rate is 8.25 and reverse repo rate is 7.25.

Key Indicators

As of October 2011, the key indicators are[8][9]

Indicator Current rate
Inflation 9.41% On 7Th October
Bank rate 6%
CRR 6%
SLR 24%
Repo rate 8.50%
Reverse repo rate 7.50%

[10]

References


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