Macroeconomics & PolicyAssignmentKhyati DhabaliaPGDM RMRoll no. 19

I. Effectiveness of Monetary PolicyMonetary policy is regulatory policy by which the central bank or the monetary authority of a country controls the:a) Supply of moneyb) availability of bank creditc) rate of interestthe main objective of monetary policy is growth with stability.Current Rates (as on Dec 2, 2014):Repo rate under Liquidity Adjustment Facility: unchanged at 8.0%CRR: 4.0% of NDTLLiquidity under overnight repos at 0.25 % of NDTL at the LAF repo rate and under 7 day and 14 day term repos of up to 0.75 % of NDTLReverse repo rate under LAF unchanged at 7%MSF at 9%Bank Rate at 9%0Source: Fifth Bi-Monthly Monetary Policy Statement, 2014-15 By Dr. Raghuram G Rajan, Governor (http://rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=32649)Effectiveness of Monetary Policy:Achievements:a) Financial stability: RBI has been successful in maintaining financial stability during the global financial crisis because of its controls, regulations and supervision mechanism. it has also been able to maintain macroeconomic stability to a large extent during the global crisis period. b) Short Term liquidity management:The RBI has succeeded in managing short term liquidity in order to maintain stability in interest rate and exchange rate. it has developed various method to do this through LAF, OMO and MSS. in spite of large inflow, of foreign capital the RBI has managed its sterilization operations very well.c) Adaptability:The RBI has adopted its monetary policy approach with changing times. it has developed new methods of credit control and shifted from monetary targeting to multiple indicator approach. this has made the monetary system in India flexible helping it to move with times.d)Financial Inclusion:RBI, along with he NABARD,, has made a great impact in the growth of microfinance. it has supported the Self Help Group model and promoted other microfinance institutions. however, there is a lot more that needs to be done in this area.e) Promotion of Growth:RBI has used its instruments effectively to maintain the growth of the economy even during the current phase of global slowdown, India at present has the second highest rate of GDP growth after China. Monetary policy has played a major role in this.Limitations of the Monetary Policy:a) Existence of unorganized money market: Despite all that has been achieved by the banking sector through branch expansion, a large unorganised sector continues to exist, especially in the rural areas. RBI's monetary policy does not affect the functioning of this sector. it is comprised of indigenous bankers, money lenders, agents etc. who continue to provide credit to a large number of people at high rate of interest.b) Weak channels of monetary transmissions:Recently, RBI has admitted that the traditional channels of monetary transmission, interest rate, credit availability, asset prices and exchange rates are weak. This is because of underdeveloped securities market, unorganised money market and speculative assets market.c) Existence of black money:Due to high rate of taxation in the past, India has had high incidence of tax evasion. this has generate huge amount of black money. black economy gives rise to inflation and speculative activates. the impact of such money cannot be controlled by RBI's monetary policy.d) Preference for Cash Transactions:A large part of the country is still non-monetized and transactions are preferred to be done with cash rather than through the banking sector. e) Phasing out of selective methods:It is being argued that the RBI should revise the use of selective measures of credit control to directly attack the sector specific inflation, since the general methods are ineffective in case of such inflation. Methods like credit rationing and discriminatory interest rates can be used in his case.II. Features of FRBM Act:The Fiscal Responsibility and Budget Management Act, 2003 (FRBMA) was enacted by the Parliament of India to institutionalize financial discipline, reduce Indias fiscal deficit, improve macroeconomic management and the overall management of the public funds by moving towards a balanced budget. The main purpose was to eliminate revenue deficit of the country (building revenue surplus thereafter) and bring down the fiscal deficit to a manageable 3% of the GDP by March 2008. However, due to the 2007 international financial crisis, the deadlines for the implementation of the targets in the act was initially postponed and subsequently suspended in 2009. In 2011, Economic Advisory Council publicly advised the Government of India to reconsider reinstating the provisions of the FRBMA.Main Features

a)The Act mandates the central government to take appropriate measures to reduce fiscal deficit and revenue deficits so as to eliminate the revenue deficit by March 31, 2009 and thereafter build up adequate revenue surplus.

b)It requires the reduction in fiscal deficit by 0.3 per cent of GDP each year and the revenue deficit by 0.5 per cent. If this is not achieved through tax revenues, the necessary adjustment has to come from a reduction in expenditure.

c)The actual deficits may exceed the targets specified only on grounds of national security or natural calamity or such other exceptional grounds as the central government may specify.

d)The central government shall not borrow from the Reserve Bank of India except by way of advances to meet temporary excess of cash disbursements over cash receipts.

e)The Reserve Bank of India must not subscribe to the primary issues of central government securities from the year 2006-07.

f)Measures to be taken to ensure greater transparency in fiscal operations.

g)The central government to lay before both Houses of Parliament three statements Medium-term Fiscal Policy Statement, The Fiscal Policy Strategy Statement, The Macroeconomic Framework Statement along with the Annual Financial Statement.

h)Quarterly review of the trends in receipts and expenditure in relation to the budget be placed before both Houses of Parliament.

The Act applies only to the central government. Though few states like Karnataka, Kerala, Punjab, Tamil Nadu and Uttar Pradesh have enacted fiscal responsibility legislations, the objective of fiscal consolidation, growth and macroeconomic stability will not be achieved if all the states do not participate. However, though there has been an effort by the government to widen the tax net and ensure better compliance, there have been fears that welfare expenditure may get reduced to meet the targets mandated by the Act.

Objectives or Importance of the FRBM Act:

The first objective of the Act is to make the Government responsible to "ensure inter generational equity in fiscal management" implying that borrowings are nothing but deferred taxation and the governments living beyond their means leave a burden of debt on future generations. The second objective is to make the Government responsible for ensuring long term Macro Economic stability because reckless borrowings by government crowds out private investment or fuels inflation or leads to balance of payment crises eventually leading to macro-economic instability. The third objective is to make the Government responsible for removing fiscal impediments to the effective conduct of monetary policy because unsustainable increase in deficit makes the task of the RBI to control money supply difficult as the RBI also happens to be the debt manager of the government.