A Project on m.p of Rbi

7/30/2019 A Project on m.p of Rbi

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A PROJECT ON:

MONETARY POLICY OF RESERVE BANK OF INDIA

BACHELOR OF COMMERCE BANKING & INSURANCE

SEMESTER V

ACADEMIC YEAR: 2013-2014

SUBMITTED BY:

NANDRE HARJAS KAUR

ROLL NO: 26

N.E.S RATNAM COLLEGE OPF ARTS, SCIENCE & COMMERCE,

BHANDUP (W), MUMBAI- 400078


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N.E.S RATNAM COLLEGE OF ARTS, SCIENCE & COMMERCE,

BHANDUP (W), MUMBAI- 400078

CERTIFICATE

CORSE CO-ORDINATOR: Principal:

Mrs. Riya Rupani Mrs. Rina Saha

PROJECT GUIDE / INTERNAL EXAMINER

Mrs. Riya Rupani

EXTERNAL EXAMINER


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DECLARATION

I Miss.Nandre Harjas kaur student of B.Com (B&I) Semester V (2012-

2013) hereby declare that I have completed the project on MONETARY

POLICY ON THE RESERVE BANK OF INDIA.

The information submitted is true & original to the best of my

knowledge.

Signature of student

Harjas kaur

Roll no: 26


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Acknowledgement

I owe a great many thanks to a great many people who helped &

supported me doing the writing of this book.

My deepest thanks to lecturer, Mrs. Riya Rupani guide of the project for

guiding & correcting various documents of mine with attention & care.

She has taken pains to go through my projects & make necessary

corrections as & when needed.

I extend my thanks to the principal of, NES Ratnam College of Arts,

Science & Commerce, Bhandup (W), for extending her support.

My deep sense of gratitude to Principal Mrs. Rina saha of NES Ratnam

College of Arts, Science & Commerce for support & guidance. Thanks &

appreciation to the helpful people at NES Ratnam College of Arts,

Science & Commerce, for their support.

I would also thank my institution & faculty members without whom this

project would have been a distant reality.


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Summary:


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INDEX

SR.NO TOPIC PAGE NO.

1 Introduction of Monetary Policy

2 Concept of Monetary Policy

3 Objective of Monetary Policy

4 Monetary Policy V/s Fiscal Policy

5 History of Reserve Bank of India6 Functions of Reserve Bank of India

7 Instrument of Monetary policy

8 Monetary Management of Reserve

Bank of India

9 Implementation of Reserve Bank

of India

10 Measures taken by Reserve Bank

of India for management of short

term liquidity

11 Recent changes in Reserve Bank of

Indias Monetary policy

12 Achievements & Limitation of

Monetary Policy of Reserve Bank

of India

13 Effectiveness at time of Recession14 Bibliography


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INTRODUCTION OF MONETARY POLICY

Monetary policy is a regulatory policy by which the central bank or monetary

authority of a country controls the supply of money, availability of bank credit and

cost of money, that is, the rate of Interest. Monetary policy has become a very

important economic policy instrument of modern welfare state to achieve the

desired changes in the size and composition of national income and employment

in the economy.Monetary Policy involves changes in the base rate of interest to influence the rate

of growth of aggregate demand, the money supply and ultimately price inflation.

Monetarist economists believe that monetary policy is a more powerful weapon

than fiscal policy in controlling inflation. Monetary policy also involves changes in

the value of the exchange rate since fluctuations in the currency also impact on

macroeconomic activity (incomes, output and prices).

Monetary policy / monetary management is regarded as an important tool of

economic management in India. RBI controls the supply of money and bank

credit. The Central bank has the duty to see that legitimate credit requirements

are met and at the same credit is not used for unproductive and speculative

purposes. RBI rightly calls its credit policy as one of controlled expansion.

Monetary policy refers to the use of instruments under the control of

the central bank to regulate the availability, cost and use of money

and credit.


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CONCEPT OF MONETARY POLICY

There are five types of monetary policy:

1. Money supply : The money supply or money stock is the total amount

ofmonetary assets available in an economy at a specific time. There are

several ways to define "money," but standard measures usually

include currency in circulation and demand deposits. Money supply data

are recorded and published, usually by the government or the central bank

of the country.

2.

3. Expansionary monetary policy: A type of fiscal policy focused on

increasing the size of a country's money supply in relation to demand,

taking advantage of the increased capital to announce tax cuts and

higher government expenditures to spur economic growth.

Reducing interest rates and allowing increased discount window lending

are also indirect method of expansionary monetary policy.

4.

5. Contractionary monetary policy:When the Federal Reserve uses its

tools to put the brakes on the economy in order to prevent inflation. The

will typically mean raising the federal funds rate, which

in turn, increases the rate that banks will charge each other

to borrow funds in order to meet the requirement of the Federal Reserve.

Thus, raising the federal funds rate will decrease the money supply because

it is essentially better for the banks to lend a little bit less and not have to

pay a higher federal funds rate.

6. Federal reserve system:The central bank of the United States. The Fed,as it is commonly called, regulates the U.S. monetary and financial system.

The Federal Reserve System is composed of a central governmental agency

in Washington, D.C. (the Board of Governors) and twelve regional Federal

Reserve Banks in major cities throughout the United States.
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7. Nominal interest rate:Nominal interest rate refers to the rate of interestprior to taking inflation into account. Depending on its application, an

inflation and risk premium must be added to the real interest rate in order

to obtain the nominal rate.


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OBJECTIVE OF MONETARY POLICY

The main objective of monetary policy in India is growth with stability.

Monetary Management regulates availability, cost and use of money

and credit. It also brings institutional changes in the financial sector of

the economy.Following are the main objectives of monetary policy in India:

1. Growth With Stability :-Traditionally, RBIs monetary policy was focused on controlling

inflation through contraction of money supply and credit. This resulted

in poor growth performance. Thus, RBI have now adopted the policy of

Growth with Stability. This means sufficient credit will be available for

growing needs of different sectors of economy and at the same time,inflation will be controlled with in a certain limit.

2. Regulation, Supervision And Development Of Financial Stability :-Financial stability means the ability of the economy to absorb shocks

and maintain confidence in financial system. Threats to financial

stability can come from internal and external shocks. Such shocks can

destabilize the countrys financial system. Thus, greater importance is

being given to RBIs role in maintaining confidence in financial systemthrough proper regulation and controls, without sacrificing the

objective of growth. Therefore, RBI is focusing on regulation,

supervision and development of financial system.

3. Promoting Priority Sector :-Priority sector includes agriculture, export and small scale

enterprises and weaker section of population. RBI with the help of bank

provides timely and adequately credit at affordable cost of weaker

sections and low income groups. RBI, along with NABARD, is focusing

on microfinance through the promotion of Self Help groups and other

institutions.


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4. Generation Of Employment :-Monetary policy helps in employment generation by influencing the

rate of investment and allocation of investment among various

economic activities of different labour Intensities.

5. External Stability :-With the growth of imports and exports Indias linkages with global

economy are getting stronger. Earlier, RBI controlled foreign exchange

market by determining exchange rate. Now, RBI has only indirect

control over external stability through the mechanism of managed

Flexibility, where it influences exchange rate by buying and selling

foreign currencies in open market.

6. Encouraging Savings And Investments :-RBI by offering attractive interest rates encourage savings in the

economy. A high rate of saving promotes investment. Thus the

monetary management by influencing rates of interest can influence

saving mobilization in the country.

7. Redistribution Of income And Wealth :-By control of inflation and deployment of credit to weaker sectors of

society the monetary policy may redistribute income and wealth

favoring to weaker sections.

8. Regulation Of NBFIs:-Non Banking Financial Institutions (NBFIs), like UTI, IDBI, and IFCI

plays an important role in deployment of credit and mobilization of

savings. RBI does not have any direct control on the functioning of such

institutions. However it can indirectly affects the policies and functions

of NBFIs through its monetary policy.


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FISCAL POLICY v/s MONETARY POLICY

Economic policy-makers are said to have two kinds of tools to influence

a country's economy: fiscal andmonetary.

Fiscal policy:

It relates to government spending and revenue collection. For example,

when demand is low in the economy, the government can step in and

increase its spending to stimulate demand. Or it can lower taxes to

increase disposable income for people as well as corporations.

Monetary policy:

It relates to the supply of money, which is controlled via factors such

as interest rates and reserve requirements (CRR) for banks. For

example, to control high inflation, policy-makers (usually an

independent central bank) can raise interest rates thereby reducing

money supply.


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DIFFERENCE BETWEEN FISCAL & MONETARY

POLICY

SERIALNO.

POINTS FISCAL POLICY MONETARY POLICY

1 Definition Fiscal policy is the use of

government

expenditure and

revenue collection to

influence the economy.

Monetary policy is the

process by which the

monetary authority of a

country controls the

supply of money, often

targeting a rate of

interest to attain a set of

objectives orientedtowards the growth and

stability of the economy.

2 Principle Manipulating the level

of aggregate demand in

the economy to achieve

economic objectives of

price stability,

full employment, and

economic growth.

Manipulating the supply

of money to influence

outcomes like economic

growth, inflation,

exchange rates with

other currencies and

unemployment3 Policy Tools: Taxes; amount of

government spending

Interest rates; reserve

requirements; currency

peg; discount window;

quantitative easing;

open market operations;

signaling

4 Policy-maker: Government (e.g. U.S.

Congress, Treasury

Secretary)

Central Bank (e.g. U.S.

Federal Reserve)


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HISTORY OF RESERVE BANK OF INDIA

The Reserve Bank of India is the central bank of the country.

Central banks are a relatively recent innovation and most

central banks, as we know them today, were established around

the early twentieth century.

The Reserve Bank of India was set up on the basis of the

recommendations of the Hilton Young Commission. The Reserve

Bank of India Act, 1934 (II of 1934) provides the statutory basis

of the functioning of the Bank, which commenced operations

on April 1, 1935.

The Bank was constituted to

Regulate the issue of banknotes

Maintain reserves with a view to securing monetary stability and

To operate the credit and currency system of the country to its

advantage.

The Bank began its operations by taking over from the

Government the functions so far being performed by theController of Currency and from the Imperial Bank of India, the

management of Government accounts and public debt. The

existing currency offices at Calcutta, Bombay, Madras, Rangoon,

Karachi, Lahore and Cawnpore (Kanpur) became branches of the

Issue Department. Offices of the Banking Department were

established in Calcutta, Bombay, Madras, Delhi and Rangoon.


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Hilton Young

Commission

Board of

Directors

Share

CertificatesTelegram

RBI

Commenceme

nt

RBI

NationalisationRBI History
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Burma (Myanmar) seceded from the Indian Union in 1937 but the

Reserve Bank continued to act as the Central Bank for Burma till

Japanese Occupation of Burma and later up to April, 1947. After the

partition of India, the Reserve Bank served as the central bank of

Pakistan up to June 1948 when the State Bank of Pakistan commenced

operations. The Bank, which was originally set up as a shareholder's

bank, was nationalized in 1949.

An interesting feature of the Reserve Bank of India was that at its very

inception, the Bank was seen as playing a special role in the context of

development, especially Agriculture. When India commenced its plan

endeavors, the development role of the Bank came into focus, especially

in the sixties when the Reserve Bank, in many ways, pioneered the

concept and practice of using finance to catalyze development. The Bank

was also instrumental in institutional development and helped set up

institutions like the Deposit Insurance and Credit Guarantee Corporationof India, the Unit Trust of India, the Industrial Development Bank of India,

the National Bank of Agriculture and Rural Development, the Discount

and Finance House of India etc. to build the financial infrastructure of the

country.

With liberalization, the Bank's focus has shifted back to core central

banking functions like Monetary Policy, Bank Supervision and Regulation,

and Overseeing the Payments System and onto developing the financial

markets.


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FUNCTIONS OF RESERVE BANK OF INDIA

MEANING:

The Reserve Bank of India is the central bank of India it was established as a

shareholders bank on 1st April 1935. Its share capital was Rs. 5 crore, divided in to

5 lakhs fully paid up shares of Rs. 100 each. On 1st January 1949 it was

nationalized. Its headquarters is at Mumbai. RBI, like any other bank performs

almost all traditional Central banking functions. Due to countrys development it

has also undertaken developmental and promotional functions.

FUNCTIONS OF RBI :-

RBI performs many functions, some of them are:-

1. Issue Of Currency Notes :-

Under section 22 of RBI Act, the bank has the sole right to issue currency notes

of all denominations except one rupee coins and notes. The one-rupee notes and

coins and small coins are issued by Central Government and their distribution is

undertaken by RBI as the agent of the government. The RBI has a separate issue

department which is entrusted with the issue of currency notes.

2. Banker To The Government :-

The RBI acts as a banker agent and adviser to the government. It has obligation

to transact the banking business of Central Government as well as State

Governments. E.g.:- RBI receives and makes all payments on behalf of

government, remits its funds, buys and sells foreign currencies for it and gives it

advice on all banking matters. RBI helps the Government both Central and

states to float new loans and manage public debt. The bank makes ways and

meets advances of the government. On behalf of central government it sells

treasury bills and thereby provides short-term finance.

3. Bankers bank And Lender Off Last Resort :-

RBI acts as a banker to other banks. It provides financial assistance to

scheduled banks and state co-operative banks in form of rediscounting of eligible

bills and loans and advances against approved securities.


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RBI acts as a lender of last resort. It provides funds to bank when they fail to get it

from other sources. It also acts as a clearing house. Through RBI, banks make

interbanks payments.

4. Controller Of Credit :-

RBI has power to control the volume of credit created by banks. The RBI

through its various quantitative and qualitative techniques regulates total supply

of money and bank credit in the interest of economy. RBI pumps in money during

busy season and withdraws money during slack season.

5. Exchange control And Custodian Of Foreign Reserve :-

RBI has the responsibility of maintaining fixed exchange rates with all member

countries of IMF. For this, RBI has centralized all foreign exchange reserves

(FOREX). RBI functions as custodian of nations foreign exchange reserves. It has

to maintain external value of Rupee. RBI achieves this aim through appropriate

monetary fiscal and trade policies and exchange control.

6. Collection And Publication Of Data :-

The RBI collects and complies statistical information on banking and financial

operations of the economy. The Reserve Bank of India Bulletin is a monthly

publication. It not only provides information, but also results of important studies

and investigations conducted by reserve bank are given. The Report on currency

and finance is an annual publication. It provides review of various developments

of economic and financial importance.

7. Regulatory And Supervisory Functions :-

The RBI has wide powers of supervision and control over commercial and co-

operative banks, relating to licensing, establishment, branch expansion, liquidity

of Assets, management and methods of working, amalgamation, re-construction

and liquidation. The supervisory functions of RBI have helped a great in improving

the standard of banking in India to develop on sound lines and to improve the

methods of their operation.

8. Clearing House Functions :-

The RBI acts as a clearing house for all member banks. This avoids unnecessary

transfer of funds between the various banks.


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9. Development And Promotional Functions :-

The RBI has helped in setting up Industrial Finance Corporations of India (IFCI),

State Financial Corporations (SFCs), Deposit Insurance Corporation, Agricultural

Refinance and Development Corporation (ARDC), units Trust of India (UTI) etc.

these institutions were set up to mobilize savings, promote saving habits and to

provide industrial and agricultural finance.

RBI has a special Agricultural Credit Department (ACD) which studies the

problems of agricultural credit. For this Regional Rural banks, Co-operative,

NABARD etc. were established. The RBI has also taken measures to promote

organized bill market to create elasticity in Indian Money Market in order to

satisfy seasonal credit needs.

Thus RBI has contributed to economic growth by promoting rural credit,

industrial financing, export trade etc.


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INSTRUMENTS OF MONETARY POLICY

Fiduciary or paper money is issued by the Central Bank on the basis

computation of estimated demand for cash. Monetary policy guides the Central

Banks supply of money in order to achieve the objectives of price stability (or lowinflation rate), full employment, and growth in aggregate income. This is

necessary because money is a medium of exchange and changes in its demand

relative to supply, necessitate spending adjustments.

To conduct monetary policy, some monetary variables which the Central Bank

controls are adjusted-a monetary aggregate, an interest rate or the exchange

rate-in order to affect the goals which it does not control. The instruments of

monetary policy used by the Central Bank depend on the level of development of

the economy, especially its financial sector.

The commonly used instruments are discussed below:

Reserve Requirement: The Central Bank may require Deposit Money

Banks to hold a fraction (or a combination) of their deposit liabilities

(reserves) as vault cash and or deposits with it. Fractional reserve limits

the amount of loans banks can make to the domestic economy and thus

limit the supply of money. The assumption is that Deposit Money Banks

generally maintain a stable relationship between their reserve holdingsand the amount of credit they extend to the public.

Open Market Operations: The Central Bank buys or sells ((on behalf of

the Fiscal Authorities (the Treasury)) securities to the banking and non-

banking public (that is in the open market). One such security is Treasury

Bills. When the Central Bank sells securities, it reduces the supply of

reserves and when it buys (back) securities-by redeeming them-it

increases the supply of reserves to the Deposit Money Banks, thus

affecting the supply of money.

Lending by the Central Bank: The Central Bank sometimes provide credit

to Deposit Money Banks, thus affecting the level of reserves and hence

the monetary base.


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Interest Rate: The Central Bank lends to financially sound Deposit

Money Banks at a most favorable rate of interest, called the minimum

rediscount rate (MRR). The MRR sets the floor for the interest rate

regime in the money market (the nominal anchor rate) and thereby

affects the supply of credit, the supply of savings (which affects the

supply of reserves and monetary aggregate) and the supply of

investment (which affects full employment and GDP).

Direct Credit Control: The Central Bank can direct Deposit Money Banks

on the maximum percentage or amount of loans (credit ceilings) to

different economic sectors or activities, interest rate caps, liquid asset

ratio and issue credit guarantee to preferred loans. In this way the

available savings is allocated and investment directed in particular

directions.

Moral Suasion: The Central Bank issues licenses or operating permit to

Deposit Money Banks and also regulates the operation of the bankingsystem. It can, from this advantage, persuade banks to follow certain

paths such as credit restraint or expansion, increased savings

mobilization and promotion of exports through financial support, which

otherwise they may not do, on the basis of their risk/return assessment.

Prudential Guidelines: The Central Bank may in writing require the

Deposit Money Banks to exercise particular care in their operations in

order that specified outcomes are realized. Key elements of prudential

guidelines remove some discretion from bank management and replace

it with rules in decision making.

Exchange Rate: The balance of payments can be in deficit or in surplus

and each of these affect the monetary base, and hence the money

supply in one direction or the other. By selling or buying foreign

exchange, the Central Bank ensures that the exchange rate is at levels

that do not affect domestic money supply in undesired direction,

through the balance of payments and the real exchange rate. The realexchange rate when misaligned affects the current account balance

because of its impact on external competitiveness. Moral suasion and

prudential guidelines are direct supervision or qualitative instruments.

The others are quantitative instruments because they have numerical

benchmarks.


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MONETARY MANAGEMENT OF RESERVE BANK OF INDIA

The Monetary Policy of RBI is not merely one of credit restriction, but it has also

the duty to see that legitimate credit requirements are met and at the same time

credit is not used for unproductive and speculative purposes RBI has various

weapons of monetary control and by using them, it hopes to achieve its monetary

policy.

I. Quantitative Credit Control Methods :-

In India, the legal framework of RBIs control over the credit structure has been

providedUnder Reserve Bank of India Act, 1934 and the Banking Regulation Act,

1949. Quantitative credit controls are used to maintain proper quantity of credit o

money supply in market.Some of the important general credit control methods are:-

1. Bank Rate Policy :-

Bank rate is the rate at which the Central bank lends money to the

commercial banks for their liquidity requirements. Bank rate is also called

discount rate. In other words bank rate is the rate at which the central bank

rediscounts eligible papers (like approved securities, bills of exchange,

commercial papers etc) held by commercial banks.Bank rate is important

because it is the pace setter to other market rates of interest. Bank rates

have been changed several times by RBI to control inflation and recession.By 2003, the bank rate has been reduced to 6% p.a.

2. Open market operations :-

It refers to buying and selling of government securities in open market in

order to expand or contract the amount of money in the banking system.

This technique is superior to bank rate policy. Purchases inject money into

the banking system while sale of securities do the opposite. During last two

decades the RBI has been undertaking switch operations. These involve the

purchase of one loan against the sale of another or, vice-versa. This policyaims at preventing unrestricted increase in liquidity.


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3. Cash Reserve Ratio (CRR) :-

The Cash Reserve Ratio (CRR) is an effective instrument of credit control.

Under the RBl Act of, l934 every commercial bank has to keep certain

minimum cash reserves with RBI. The RBI is empowered to vary the CRR

between 3% and 15%. A high CRR reduces the cash for lending and a low

CRR increases the cash for lending. The CRR has been brought down from

15% in 1991 to 7.5% in May 2001. It further reduced to 5.5% in December

2001. It stood at 5% on January 2009. In January 2010, RBI increased the

CRR from 5% to 5.75%. It further increased in April 2010 to 6% as

inflationary pressures had started building up in the economy. As of March

2011, CRR is 6%.

4. Statutory Liquidity Ratio (SLR) :-

Under SLR, the government has imposed an obligation on the banks to;

maintain a certain ratio to its total deposits with RBI in the form of liquid

assets like cash, gold and other securities. The RBI has power to fix SLR in

the range of 25% and 40% between 1990 and 1992 SLR was as high as

38.5%. Narasimham Committee did not favor maintenance of high SLR.

The SLR was lowered down to 25% from 10th

October 1997.It was further

reduced to 24% on November 2008. At present it is 25%.

5. Repo And Reverse Repo Rates:

In determining interest rate trends, the repo and reverse repo rates are

becoming important. Repo means Sale and Repurchase Agreement. Repo

is a swap deal involving the immediate Sale of Securities and simultaneous

purchase of those securities at a future date, at a predetermined price.

Repo rate helps commercial banks to acquire funds from RBI by selling

securities and also agreeing to repurchase at a later date.

Reverse repo rate is the rate that banks get from RBI for parking their

short term excess funds with RBI. Repo and reverse repo operations are

used by RBI in its Liquidity Adjustment Facility. RBI contracts credit by

increasing the repo and reverse repo rates and by decreasing them it

expands credit. Repo rate was 6.75% in March 2011 and Reverse repo rate

was 5.75% for the same period. On May 2011 RBI announced Monetary

Policy for 2011-12. To reduce inflation it hiked repo rate to,7.25% and

Reverse repo to 6.25%.


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II. SELECTIVE / QUALITATIVE CREDIT CONTROL METHODS :-

Under Selective Credit Control, credit is provided to selected borrowers for

selected purpose, depending upon the use to which the control tries to regulate

the quality of credit - the direction towards the credit flows.

The Selective Controls are:-

1. Ceiling On Credit:

The Ceiling on level of credit restricts the lending capacity of a bank to grant

advances against certain controlled securities.

2. Margin Requirements:

A loan is sanctioned against Collateral Security. Margin means that proportion of

the value of security against which loan is not given. Margin against a particularsecurity is reduced or increased in order to encourager to discourage the flow of

credit to a particular sector. It varies from 20% to 80%. For agricultural

commodities it is as high as 75%. Higher the margin lesser will be the loan

sanctioned.

3. Discriminatory Interest Rate (DIR):

Through DIR, RBI makes credit flow to certain priority or weaker sectors by

charging concessional rates of interest. RBI issues supplementary instructions

regarding granting of additional credit against sensitive commodities, issue ofguarantees, making advances etc.

4. Directives:-

The RBI issues directives to banks regarding advances. Directives are regarding

the purpose for which loans may or may not be given.

5. Direct Action:-

It is too severe and is therefore rarely followed. It may involve refusal by RBI to

rediscount bills or cancellation of license, if the bank has failed to comply with thedirectives of RBI.

6. Moral Suasion:-

Under Moral Suasion, RBI issues periodical letters to bank to exercise control over

credit in general or advances against particular commodities. Periodic discussions

are held with authorities of commercial banks in this respect.


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MEASURES TAKEN BY RESRVE BANK OF INDIA FOR

MANAGEMENT OF SHORT TERM LIQUIDITY

RBIS SHORT TERM LIQUIDITY MANAGEMENT:-

Liquidity Management of Central bank means supplying to the market the

amount of liquidity that is consistent with a desired level of short-term interestrate. It is defined as the framework, set of instruments and the rules that the

central bank follows in order to manage the amount of money supply to control

short term interest rates with the objective of price stability.

In RBIs overall management short term liquidity management occupies a very

important place due to following factors:-

1) In financial sector, in 1990s, many reforms were introduced. The importantreforms are deregulation of interest rates and exchange rates. Earlier these

rates were determined by RBI, after reforms, they are determined by

demand and supply. RBI in absence of direct intervention indirectly

influences these rates by using multiple indicators approach.

2) Due to liberalization capital flows between countries have increased. From

US $118 Million during 1991-92, capital flows to. India rose to US $15 billion

in 2004-05.

3) Foreign capital flows have increased employment. It adds to the supply of

foreign exchange and has resulted into appreciation of domestic currency.

With this, the exports have become more expensive.

4) When capital inflows are converted into rupees, they get injected into the

economy thereby, increasing the money supply.

So to maintain price stability RBI has to manage the exchange rate and Interest

rate.


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B) RBIS MEASURES FOR SHORT TERM LIQUIDITY MANAGEMENT:-

1. Repo I Reverse Repo:-To improve short term liquidity management, RBl. introduced repos in December

1992. Repo is Sale and Repurchase Agreement. It is a swap deal involving the

immediate Sale of Securities and simultaneously purchase of those securities at a

future date, at a predetermined price. Such deals take place between RBI and

banks. Due to lack of demand repos auctions were discontinued in March 1995,

they were resumed again in 1997. Reverse repo rate is the rate that banks get

from RBI for parking their short term excess funds with RBI.

2. Interim Liquidity Adjustment Facility (ILAR):-To develop short term money market Narasimham Committee 1998

recommended LAF. Accordingly in 1999 RBI introduced ILAF. It (ILAF) provided a

mechanism for liquidity management through a combination of repos, exportcredit refinance and collateralized lending facilities supported by Open Market

Operations.

3. Liquidity Adjustment Facility (LAP):-

RBI introduced-full-fledged LAF. It has been revised further. Under LAF, Reverse

repo auctions and Repo auctions are conducted on daily basis. In India, the

emergence of LAF was a single biggest factor which helped RBI to manage short

term liquidity and maintain interest rate stability. In 2009-10, liquidity absorption

through reverse repo reached its peak on 4th September 2009 at Rs. 1,68,215crore.

4. Sterilization:-

Sterilizations mean re-cycling of foreign capital inflows to prevent appreciation of

domestic currency and to check the inflationary impact of such capital.

Sterilization is carried out through open market operations. But Sterilizations can

also leads to some problems. Thus RBI also, uses a variety of other measures to

manage interest rates.


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5. Market Stabilization Scheme (MSS):-

Till 2003-04 the impact of large capital inflows was managed through day-to-day

LAF and OMO. In the process, the government securities available with RBI

declined, as they were being used for absorbing excess liquidity. In order to

handle these issues, RBI signed a Memorandum of Understanding (MOU) with

Government for issuance of Treasury Bills and dated government securities under

Market Stabilization Scheme (MSS). These Bills and Securities are used to absorb

excess liquidity from market and: maintain stability in foreign exchange market.


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RECENT CHANGES IN RBIS MONETARY POLICY

Since 1991 RBIs monetary management has undergone some major

changes:

1. Multiple Indicator Approach :-

Up to late 1990s, RBI used the Monetary targeting approach to its

monetary policy. Monetary targeting refers to a monetary policy strategy aimed

at maintaining price stability by focusing on changes in growth of money supply.

After 1991 reforms this approach became difficult to follow. So RBI adopted

multiple indicator Approach in which it looks at a variety of economic indicators

and monitor their impact on inflation and economic growth.2. Selective Methods Being Phased Out :

With rapid progress in financial markets, the selective methods of credit

control are being slowly phased out. Quantitative methods are becoming more

important.

3. Reduction In Reserve Requirements :

In post-reform period the CRR and SLR have been progressively lowered. Thishas been done as a part of financial sector reforms. As a result, more bank funds

have been released for lending. This has led to the growth of economy.

4. Deregulation Of Administered Interest Rate System :

Earlier lending rate of banks was determined by RBI. Since 1990s this system

has changed and lending rates are determined by commercial banks on the basis

of market forces.

5. Delinking Of Monetary Policy From Budget Deficit :

In1994 government phased out the use of adhoc treasury Bills.These bills

was used by government to borrow from RBI to finance fiscal deficit. With

phasing out of Bills, RBI would no longer lend to government to meet fiscal

deficit.


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6. Liquidity Adjustment Facility (LAF):

LAF allows banks to borrow money through repurchase agreement LAF was

introduced by RBI during June, 2000, in phases. The funds under LAF are used bybanks to meet day-to-day mismatches in liquidity.

7. Provision Of Micro Finance:

By linking the banking system with Self Help Groups, RBI has introduced the

scheme of micro finance for rural poor. Along with NABARD, RBI is promoting

various other microfinance institutions.

8. External Sector:

With globalization large amount of foreign capital is attracted. To provide

stability in financial markets, RBI uses sterilization and LAF to absorb the excess

liquidity that comes in with huge inflow of foreign capital.

9. Expectation As A Channel Of Monetary Transmission:

Traditionally, there were four key channels of monetary policy transmission

Interest rate, credit availability, asset prices and exchange rate channels. Interest

rate is the most dominant transmission channel as any change in monetary policy

has immediate effect on it. In recent years fifth channel, Expectation has been

added. Future expectations about asset prices, general price and Income levels

influence the four traditional channels.


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ACHIEVEMENT & LIMITATION OF MONETARY POLICY OF

RBI

EVALUATION OF MONETARY POLICY :-

The RBI aims at one time was controlled expansion. On one hand it

was taking steps to expand bank credit. On other hand RBI uses

quantitative and qualitative methods to control credit. These two

contradictory objectives limited the success of monetary policy. The

performance of monetary policy can be seen from its achievements and

failures, let us discuss.

Achievements / Positive Aspects Of Monetary Policy :-

1. Short Term Liquidity Management :-

RBI has developed various methods to maintain stability in interest rate

and exchange rate like LAF, OMO and MSS. RBI has also managed its

sterilization operations very well.

2. Financial Stability :-

With the help of controls, regulation and supervision mechanism, RBI

has been successful in maintaining financial stability. During the period

of global crisis it has also been able to maintain macro economic

stability.

3. Financial Inclusion :-

Along with NABARD, RBI has made a great impact in the growth of

microfinance. RBI has supported Self Help Group Model and promoted

other microfinance institutions.4. Adaptability:-

In India monetary policy is flexible, as it changes with time. RBI has

developed new methods of credit control and shifted from monetary

targeting to multiple indicator approach.


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5. Increase In Growth:-

To maintain the growth of economy RBI has used its instruments'

effectively. At present India has the second highest rate of GDP growthafter China. Thus monetary policy has played an important role.

6. Increase In Bank Deposits:-

The increase in bank deposits over the years indicates trust and

confidence of people in banking sector. Effective supervision of RBI

over banks and financial institutions is largely responsible for trust and

confidence of public in banking sector.

7. Competition Among Banks :-

The monetary policy of RBI has resulted in healthy competition among

banks in the country. The competition is due to deregulation of interest

rates and other measures taken by RBI. Now-a-days due to

professionalism banks provide better service to customers.


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FAILURES / LIMITATIONS OF MONETARY POLICY

1. Huge Budgetary Deficits :-

RBI makes every possible attempt to control inflation and to balance

money supply in the market. However Central Government's hugebudgetary deficits have made monetary policy ineffective. Huge

budgetary deficits have resulted in excessive monetary growth.

2. Coverage Of Only Commercial Banks :-

Instruments of monetary policy cover only commercial banks so

inflationary pressures caused by banking finance can be controlled by

RBI, but in India, inflation also results from deficit financing and scarcity

of goods on which RBI may not have any control.

3. Problem Of Management Of Banks And Financial Institutions :-

The monetary policy can succeed to control inflation and to bring

overall development only when the management of banks and

Financial institutions are efficient and dedicated. Many officials of

banks and financial institutions are corrupt and inefficient which leads

to financial scams in this way overall economy is affected.

4. Unorganized Money Market :-

Presence of unorganized sector of money market is one of the main

obstacles in effective working of the monetary policy. As RBI has no

power over the unorganized sector of money market, its monetary

policy becomes less effective.

5. Less Accountability:-

At present time, the goals of monetary policy in India, are not set out in

specific terms and there is insufficient freedom in the use of

instruments. In such a setting, accountability tends to be weak as there

is lack of clarity in the responsibility of governments and RBI.


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6. Black Money :-

There is a growing presence of black money in the economy. Black

money falls beyond the purview of banking control of RBI. It means

large proposition of total money Supply in a country remains outside

the purview of RBI's monetary management.

7. Increase Volatility :-

The integration of domestic and foreign exchange markets could lead to

increased volatility in the domestic market as the impact of exogenous

factors could be transmitted to domestic market. The widening of

foreign exchange market and development of rupee - foreign exchange

swap would reduce risks and volatility.

8. Lack Of Transparency :-

According to S. S. Tara pore, the monetary policy formulation, in its

present form in India, cannot be continued indefinitely. For a more

effective policy, it would be necessary to have greater transparency in

the policy formulation and transmission process and the RBI would

need to be clearly demarcated.


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EFFECTIVENESS AT THE TIME OF RECESSION

The objective of this thesis is to describe, analyze and discuss the

traditional monetary policy and its instruments during a recession.

There are some discussions amongst different schools of economists,the Keynesian and the Monetarist, on whether the monetary policy will

have an effect on the real economy. Where fiscal policy affects the

economy directly through the multiplier effect the monetary policy will

only indirectly affect the real economy through the transmission

channels.

Its efficiency has especially been questioned when the economy iscaught in a liquidity trap where the monetary interest rates are close to

the zero-limit bound. Four alternative strategies that could help the

economy to escape the liquidity trap are therefore presented in section

6.Most central banks agree on price-stability as the most important

medium to long term target that a central bank can pursue. Denmark

has for a long time had a fixed exchange rate first to the deutschmark

and later to the euro. Since the Danish krone is fixed to the euro the

degree of freedom in terms of monetary policy is rather limited as thespread between the two monetary interest rates can not be too

significant. This is to make sure that the exchange rate is held within a

certain bound.

Other regimes, i.e. inflation targeting, have been used by other central

banks in order to reach the goal of price-stability. Research has shown

that both fixed exchange rate policy and inflation targeting are almostequally efficient in terms of reaching price stability.After years of global

economic boom and high inflation the economic situation changed with

the start of the financial crisis.


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Negative growth rates in real GDP in 2008 and 2009 had severe

consequences for the economy in general. The start of the financial

crisis challenged the stability of the financial sector and the distrust

amongst the financial institutions in the Danish economy meant that

the money market froze. The spread seemed to be the result of amoney market where the counterparties were extremely risk-averse

and were very careful as to take on more risk.

This is supported by the empirical data analyzed by an econometric

model that measures credit- and liquidity risk influences on the money

market interest rate. The interest rate in the traditional monetary

policy can in such a situation, as we saw under the financial crisis, beineffective as it can not reduce the risk premium on the money market

by itself.

The analysis shows that Denmarks National bank and other central

banks have used alternative monetary strategies besides its traditional

monetary strategy in order to stabilize the financial sectors. The

economy has still not fully recovered and looking at the Danishmonetary policy isolated it has not been found sufficient but have been

necessary supplement to other economic alternatives, i.e. fiscal policy

and banking packages.


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CONCLUSION:

Thus, from above we can say that despite several problems RBI has

made a good effort for effective implementation of the monetary policy

in India.

Documents

A Project on m.p of Rbi