DocumentBE

EFFECTS OF MONETARY POLICY ON BUSINESS ENVIRONMENT IN INDIA

EFFECTS OF MONETARY POLICY ON BUSINESS ENVIRONMENT IN INDIA

Monetary Policy

By monetary policy, we mean policy concerned with changes in the supply of money. Issues connected with monetary policy are: objectives or goals of the policy, instruments of monetary control, its efficacy, implementation, intermediate target of the policy etc.

InIndia, the central monetary authority is theReserve Bank of India(RBI).

Scope of the project

The study covers a period of 6 financial years starting from 2008. Thus, the study is exclusively on the impact of monetary policy on the Indian Economy in the post-2008 era.

This study is exclusively based on secondary data. Secondary data were collected from the RBI bulletin, RBI occasional papers, RBI Annual Reports, World Bank Reports, Internet etc.

Why we selected this topic?

3

Historical concept

Indias monetary policy since the first plan period was one of 'controlled expansion- that is, a policy of adequate financing of economic growth ensuring reasonable price stability.

Thus, RBI helped the economy to expand via expansion of money and credit and attempted to check rise in prices through monetary and other control measures.

In India, the emphasis of monetary policy shifted towards control of inflation in 1995-96.

Ensuring price stability requires the pursuit of a consistent policy over a period of time.

Importance

The monetary policy strategy of a Central bank depends on a number of factors that are unique to the country and the context.

An important factor in this context is the degree of openness in the economy. The second factor is the stage of development of markets, institutions and technological development.

It is important to recognize that all the objectives cannot be effectively pursued by any single arm of economic policy. Hence, there is always the problem of assigning to each instrument the most appropriate target or objective.

Objectives

To examine the effectiveness of monetary policy in ensuring price stability in India

To find out to what extent monetary policy facilitated economic growth in India and its general impact in the post- 2008 era.

To find out the relation of credit management and monetary policy, we examined the qualitative and quantitative controls.

To study the effectiveness of the monetary policy keeping in mind the current scenario.

How the monetary policy is set ?

Role of RBI

a) Issue of Bank notes.

b) Management of the monetary system.

c) Regulation and supervision of banks and Non Banking Finance Companies (NBFCs).

d) Acting as a lender of the last resort.

e) Regulation and supervision of the Payment and Settlement Systems.

f) Maintaining and managing the countrys foreign exchange reserves.

g)Acting as a banker to the banks and the Governments.

h) Acting as the manager of the debt of the Governments.

i) Regulation and development of foreign exchange market.

j) Developmental functions including in the areas of rural credit and financial inclusion.

Monetary Policy Instruments

Bank Rate

Cash Reserve Ratio

Statutory Liquidity Ratio

Open Market Operations

Repo Rate

Reverse Repo Rate

Interest rates

CRR2008-092009-102010-112011-122012-132013-1455.7564.7544SLR2008-092009-102010-112011-122012-132013-14242524232323MSF2008-092009-102010-112011-122012-132013-148.259.58.59Bank Rate2008-092009-102010-112011-122012-132013-146669.58.59Repo Rate2008-092009-102010-112011-122012-132013-14556.758.587.75Reverse Repo Rate2008-092009-102010-112011-122012-132013-143.53.55.757.576.75

Percent (%)

EFFECT OF MONETARY POLICY ON:

Inflation and Price Stability

Economic Growth

Credit management and Supply

I. Inflation and Price Stability

Inflation A sustained increase in the general level of prices for goods and services.

Indicator of growth of economy

Cost Push Inflation- Increase in costs of any of the four factors of production (labor, capital, land or entrepreneurship) at full production

Demand Pull Inflation- Increase in aggregate demand, categorized by the four sections of the macro economy: households, businesses, governments and foreign buyers

Rapid Growth of Money Supply is main cause

Deflation- Fall in general level of prices of goods and services

Disinflation- Refers to a slowdown in the rate of inflation

Price stability is major reason to have a predictable rate of inflation

Inflation Targeting-Requires clear quantitative target (CPI 4% +/- 2% in India)

Inflation distorts the cost of borrowing and lending

Deflation causes low real interest rates for depositors .More people investing in gold .Less credit is available to industry

Falling prices cause customer to delay purchases leading to lower economic activity

Failure of other monetary policy , such as those based on the money supply or exchange rate

CPI-Consumer Price Index

Major index used by the RBI in India for calculating inflation

Estimation of price changes in a basket of goods and services representative of consumption

CPI is also used for indexing dearness allowance to employees for increase in prices.

CPI for Industrial Workers (IW)

CPI for Rural Laborers (RL)

CPI (Rural/Urban/Combined)

Weights are revised from time to time to reflect recent macroeconomic trends

2 villages from each district for CPI (Rural)

310 towns selected for calculating CPI (Urban)

Provisional CPI February 2015 for Chandigarh (Base Year 2012)
CategoryRuralUrbanCombinedFood and beverages121.9122.1122.1Pan, tobacco and intoxicants131.0148.6146.1Clothing and footwear120.3121120.9Housing-113.2-Fuel and light119.0119.6119.5Miscellaneous114.9110.4110.7All Groups119.3116.2116.4

Variation of CPI (% change in index) in 2012-2013, 2013-2014 and 2014-2015
Year2012-132013-142014-15APR10.39.48.6MAY10.49.38.3JUN109.97.4JUL9.99.68AUG109.57.8SEP9.79.86.5OCT9.810.15.5NOV9.911.24.4DEC10.69.95JAN10.88.85.19 (BY 2012)FEB10.98.15.37 (BY 2012)MAR10.48.3

WPI- Wholesale Price Index

Represents the price of goods at a wholesale stage i.e. bulk trading

Published by Office of Economic Adviser and used by Ministry of Finance

Number of items in index is changed to give true picture of economy (676 items used currently)

Gives true picture of Industrial situation

May be replaced by Producer Price Index which takes into account sellers price rather than buyers

Variation in WPI Index (Base Year 2004-05)
YearAll commoditiesPrimary articlesFood articlesNon-food articlesFuel and PowerManufactured products2013-14177.6241.6238.9213.2205.4151.52012-13167.6220.0211.8201.9186.5147.12011-12156.1200.3192.7182.7169.0139.52010-11143.3182.4179.6166.6148.3130.12009-10130.8154.9155.4136.2132.1123.12008-09126.0137.5134.8129.2135.0120.42007-08116.6123.9123.6114.4121.0113.42006-07111.4114.3115.5102.3120.9108.22005-06104.5104.3105.496.7113.6102.42004-05100.0100.0100.0100.0100.0100.0

Variation in WPI Index

CPI for Chandigarh

II. ECONOMIC GROWTH

Various types of Indian economic (monetary) indicators are used for various periods of time

The real gross domestic product (GDP), Money supply, Credit availability, Interest rates, Foreign trade, & balance of payment (BOP) are the other key macro economic indicators.

Achievement of economic growth by two ways:

1) Management of Aggregate Demand:

The monetary authority should keep the aggregate monetary demand in balance with the aggregate supply ofgoods and services. For this a flexible monetary policy is called for.

2) Encouragement to Saving and Investment:

The monetary authority can help economic development by creating a favourable environment for saving and investment which greatly influence economic growth. For this, the monetary policys aim of price stabilisation is very important. Reasonable pricestability encourages both saving and investment.

A comparison between interest rates and GDP growth

GDP (trillion USD)2008-092009-102010-112011-122012-132013-141.2241.3651.7081.88000000000000011.8591.877

Interest rates


Percent (%)

Foreign Direct Investment (FDI) and Monetary policy

FDI(US $ million)2008-092009-102010-112011-122012-132013-14335522246114939234731828616054

Interest rates


Percent (%)

Balance of Payment (BOP)

Balance of payment is the monetary expression of trade balance which is the balance between total exports and imports.

The Indias balance-of-payments (BoP) position improved dramatically in 2013-14, particularly in the last three quarters.

STOCK MARKETS

Monetary policy impacts stock prices but this is temporary and largely a sudden reaction to the degree of change in interest rate vis--vis the expectations of the market.

Interest rates


Percent (%)

Currency

III. CREDIT SUPPLY

The various methods employed by the RBI to control credit creationpowerof the commercial banks can be classified in two groups, viz., quantitative controls and qualitative controls. Quantitative controls are designed to regulate the volume of credit created by the banking system qualitative measures or selective methods are designed to regulate the flow of credit in specific uses.

Quantitative methods

Bank Rate

Rate payable by commercial banks on the loans from the Central Bank.

Open Market Operations

Cash Reserve Ratio

Ratio which banks maintain between their holdings of cash and their deposit liabilities

Statutory Liquidity Ratio

Repo and Reverse Repo Rate

Sale and purchase of securities by the Central bank to the commercial banks.

Net demand as liquid assets in the form of cash, gold and unencumbered approved securities.

rate at which the RBI lends short term money to banks.

rate at which the central bank absorbs liquidity from the banks

Qualitative Methods

Margin Requirements

designed to influence the flow of credit against specific commodities

Credit Rationing

method by which the Central Bank seeks to limit the maximum amount of loans and advances

Regulation of Consumer Credit

designed to check the flow of credit for consumer durable goods

Moral Suasion

will succeed only if the Central Bank is strong enough to influence the commercial banks

Money Supply

Money supply is the amount of money in circulation in the economy at any point of time. It not only includes the currency & coins in circulation, but it also includes demand & time deposits of banks, post office deposits and such related instruments.

Valuation and analysis of the money supply helps the economist and policy makers to frame the policy or to alter the existing policy of increasing or reducing the supply of money.

The different types of money are typically classified as "M"s. The "M"s usually range from M0 (narrowest) to M3 (broadest) but which "M"s are actually focused on in policy formulation depends on the country's central bank.

In India, the Reserve Bank of India follows M0, M1, M2, M3 and M4 monetary aggregates.

M4: M3 + All deposits with post office savings banks

Monetary Aggregates

M0 (Reserve Money):

M1:Currency with the public + Deposit money of the public

M2: M1 + Savings deposits with Post office savings banks

M3: M1+ Time deposits with the banking system

Money supply

EFFECTIVENESS OF MONETARY POLICY

The factors impeding smooth monetary policy transmission to the credit market include-

Rigidities in re-pricing for fixed deposits

A large unorganized market in India.

The large size of government borrowings,

practice of yearly resetting of interest rates on small savings linked to G-sec yields,

Interest rate subventions that break the link between monetary policy and lending rates,

Preferential tax benefits on fixed maturity plans of debt mutual funds of tenor one year or more vis-a-vis fixed deposits of corresponding maturities, high level of NPAs, an oligopolistic credit market and a significant presence of informal finance.

These factors effectively dampen the policy rate transmission to the final outcome, by making alternate investment vehicles more attractive, especially during periods of monetary easing.

Analysis of economy as given in the 2013-14 monetary policy

During 2013-14, amid slow growth and high inflation, the Indian economy had to contend with serious challenges to external stability emanating from an unsustainably high current account deficit (CAD), capital outflows and consequent exchange rate pressures.

After two consecutive years of moderation, GDP growth improved marginally in 2013-14 due to a rebound in the growth of agriculture and allied activities and electricity, besides buoyant activity in financing, insurance, real estate and business services.

Growth continues to be slow with contraction in mining and manufacturing.

Inflation declined during latter months of 2013- 14, but remains above the level that could secure sustainable growth

Central government finances continued to improve in 2013- 14 with the gross fiscal deficit (GFD) at 4.5 per cent of GDP lower than 4.8 per cent budgeted for the year and also realised for 2012-13.

The external sector adjustment over the year was even more remarkable. Though the current account deficit was large in Q1 of 2013-14 at 4.9 per cent of GDP, a correction in CAD subsequently helped compress full year CAD to 1.7 per cent of GDP

FUTURE PROSPECTS FOR INDIA

The year 2014-15 has begun on a promising note. Index of Industrial Production (IIP) growth is beginning to look up, while inflation on an average, so far, has been lower than in the corresponding period of the previous year.

The Union Budget aims to keep the economy on the path of fiscal consolidation.

Export growth has improved, while capital inflows remain adequate.

Going forward, the fiscal deficit is likely to reduce further in 2014-15. The budgetary targets are realisable, though concerted efforts will be necessary to achieve these targets.

With greater political stability, commitment to fiscal consolidation, strengthening of the monetary policy framework and better policy implementation, GDP growth is expected to be around 5.5 per cent in 2014-15 from the sub-5 per cent growth in the preceding two years.

What to worry about ?

Food price pressures witnessed in 2013-14 despite a normal monsoon raised concerns over supply chain inefficiencies as well as the need for improving the agro-marketing infrastructure in the country. Sharp swings in vegetable prices often have a destabilising impact on inflation expectations and concomitantly raise the general level of prices.

Achievement of budgetary targets was made possible by a sharp cutback in expenditures and higher non-tax revenues, aided in a large part by higher dividend receipts from various public sector enterprises (PSEs) and public sector banks (PSBs). While many PSEs were already cash rich with inadequate investment plans, it is important to ensure that this practice does not affect the internal financing or reserves of the public enterprises that could hamper their investments in the future.

Thank You

Questions ?

YEAR EXPORT IMPORT TRADE BALANCE

AMOUNT GROWTH AMOUNT

AMOUNT

2008-09 189001 13.7 308521 -119521

2009-10 182442 -3.4 300644 -118203

2010-11 256159 40.4 383481 -127322

2011-12 309774 20.9 499533 -189759

2012-13 306581 -1.03 502237 -195656

2013-14 318607 3.92 466216 -147609

YEAREXPORT IMPORT TRADEBALANCE

AMOUNTGROWTHAMOUNT

AMOUNT

2008-0918900113.7308521 -119521

2009-10182442-3.4300644 -118203

2010-1125615940.4383481 -127322

2011-1230977420.9499533 -189759

2012-13306581-1.03502237 -195656

2013-143186073.92466216 -147609

Documents

DocumentBE