Monetary policy of India.docx

8/10/2019 Monetary policy of India.docx

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Monetary policy of India

Monetary policyis the process by which monetary authority of a country, generally a central bank controls the

supply of money in the economy by its control over interest rates in order to maintain price stability and achieve

high economic growth.[1]In India, the central monetary authority is theReserve Bank of India(RBI). 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Overfilling of stocks and products becoming outdated due to excess of stock often results is sickness of the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 restrictingthe 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 asmoney supply,

interest rates and availability ofcreditaimed to maintainPriceStability, Stableexchange rate,HealthyBalance of

Payment,Financial stability, Economic growth.RBI,the apex institute ofIndiawhich monitors and regulates the

monetary policyof the country stabilizes the price by controllingInflation.RBI takes into account the following

monetary policies:

Major Operations

Open Market Operations

An open market operation is aninstrumentofmonetary policywhich involves buying or selling of

governmentsecuritiesfrom or to the public andbanks.This mechanism influences the reserve position of
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the banks, yield ongovernmentsecurities and cost of bank credit. The RBI sellsgovernment securitiesto

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.

Cash Reserve Ratio

Cash Reserve Ratio is a certain percentage ofbank depositswhich banks are required to keep with RBI in

the form of reserves or balances .Higher the CRR with the RBI lower will be the liquidityin the system and

vice-versa.RBI is empowered to vary CRR between 15 percent and 3 percent. But as per the suggestion by

the Narsimham committee Report the CRR was reduced from 15% in the 1990 to 5 percent in 2002. the

CRR is 4.00 percent.[3]

SLR Graph from 1991 to 2011[4]

Statutory Liquidity Ratio

Every financial institution has to maintain a certain quantity of liquid assets with themselves at any point of

time of their total time and demand liabilities. These 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 the

Statutory liquidity ratio.There was a reduction of SLR from 38.5% to 25% because of the suggestion by

Narshimam Committee. The current SLR is 22.0%(w.e.f.05/08/14).[5]

Bank Rate Policy[6]

Thebank rate,also known as the discount rate, is the rate of interest charged by the RBI for providing

funds orloansto 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 andtreasury 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. As of 1 January 2013,

the bank rate was 8.75% and as on 21 June 2014 bank rate is 9%.

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 chairmanof 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 anddemand decreases resulting to decrease ininflation.This increase in Repo Rate and Reverse Repo Rate is a

symbol of tightening of the policy. As of October 2013, the repo rate was 7.75 % and reverse repo rate was

6.75%. On January 28, 2014, RBI raised repo rate by 25 basis points to 8.00 % and reverse repo rate by 25

basis points to 7.00%.[8]

Key Indicators

As of 5 August 2014, the key indicators are[9][10]
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the call rate and inter-bank term money rate were dropped, with effect from May 1, 1989. The Indian call money

market has been transformed into a pure inter-bank market during 200607.[3]The major call money markets are in

Mumbai,Kolkata,Delhi,Chennai,Ahmedabad.

Treasury bill market

Treasury bills are instrument of short-term borrowing by theGovernment of India,issued as promissory notes underdiscount. The interest received on them is the discount which is the difference between the price at which they are

issued and their redemption value. They have assured yield and negligible risk of default. Under one classification,

treasury bills are categorised as ad hoc, tap and auction bills and under another classification it is classified on the

maturity period like 91-days TBs, 182-days TBs, 364-days TBs and two types of 10-days TBs. In the recent times

(200203, 200304), theReserve Bank of Indiahas been issuing only 91-day and 364-day treasury bills. the auction

format of 91-day treasury bill has changed from uniform price to multiple price to encourage more responsible

bidding from the market players.[4]the bills are two kinds- Adhoc and regular. The adhoc bills are issued for

investment by the state governments, semi government departments and foreign central banks for temporary

investment. They are not sold to banks and general public. The treasury bills sold to the public and banks are called

regular treasury bills. They are freely marketable. commercial bank buy entire quantity of such bills issued on

tender. They are bought and sold on discount basis. Ad-hoc bills were abolished in April 1997.

Ready forward contract (Repos)

Repo is an abbreviation forRepurchase agreement,which involves a simultaneous "sale and purchase" agreement.[5]

When banks have any shortage of funds, they can borrow it fromReserve Bank of Indiaor from other banks. The

rate at which the RBI lends money to commercial banks is calledrepo rate,a short term forrepurchase agreement.A

reduction in the repo rate will help banks to get money at a cheaper rate. When the repo rate increases borrowing

from RBI becomes more expensive.[1].

Money market mutual funds

Money market mutual funds invest money in specifically, high-quality and very short maturity-based money market

instruments. The RBI has approved the establishment of very few such funds in India. In 1997, only one MMMF

was in operation, and that too with very small amount of capital.

[6]

Reserve Bank of India

The influence of theReserve Bank of India's power over the Indian money market is confined almost exclusively to

the organised banking structure.It is also considered to be the biggest regulator in the markets. There are certain

rates and data which are released at regular intervals which have a huge impact on all the financial markets in

INDIA. The unorganised sector, which consists mostly of indigenous bankers and non-banking financial companies,

although occupying an important position in the money market have not been properly integrated with the rest of the

money market.[7]

Reforms

The recommendations of the Sukhmoy Chakravarty Committee on the Review of the Working of the Monetarysystem, and the Narasimham Committee Report on the Working of the Financial System in India, 1991, The

Reserve Bank of India has initiated a series of money market reforms basically directed towards the efficient

discharge of its objectives. The bank reduced the ceiling rate on bank advances and on inter-bank call and short-

notice money. There has been a significant lowering of the minimum lending rate of commercial banks and public

sector development financial institutions from 18% in 199091 to 10.5% in 200506.[8]

Reforms made in the Indian Money Market are:- Deregulation of the Interest Rate : In recent period the government

has adopted an interest rate policy of liberal nature. It lifted the ceiling rates of the call money market, short-term
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deposits, bills rediscounting, etc. Commercial banks are advised to see the interest rate change that takes place

within the limit. There was a further deregulation of interest rates during the economic reforms. Currently interest

rates are determined by the working of market forces except for a few regulations. Money Market Mutual Fund

(MMMFs) : In order to provide additional short-term investment revenue, the RBI encouraged and established the

Money Market Mutual Funds (MMMFs) in April 1992. MMMFs are allowed to sell units to corporate and

individuals. The upper limit of 50 crore investments has also been lifted. Financial institutions such as the IDBI and

the UTI have set up such funds. Establishment of the DFI : The Discount and Finance House of India (DFHI) was

set up in April 1988 to impart liquidity in the money market. It was set up jointly by the RBI, Public sector Banks

and Financial Institutions. DFHI has played an important role in stabilizing the Indian money market. Liquidity

Adjustment Facility (LAF) : Through the LAF, the RBI remains in the money market on a continue basis through

the repo transaction. LAF adjusts liquidity in the market through absorption and or injection of financial resources.

Electronic Transactions : In order to impart transparency and efficiency in the money market transaction the

electronic dealing system has been started. It covers all deals in the money market. Similarly it is useful for the RBI

to watchdog the money market. Establishment of the CCIL : The Clearing Corporation of India limited (CCIL) was

set up in April 2001. The CCIL clears all transactions in government securities, and repose reported on the

Negotiated Dealing System. Development of New Market Instruments : The government has consistently tried to

introduce new short-term investment instruments. Examples: Treasury Bills of various duration, Commercial papers,

Certificates of Deposits, MMMFs, etc. have been introduced in the Indian Money Market.

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Monetary policy of India.docx