Monetary Policy

Group 5

Kapali 05Prachi 16Pankaj 21Nikhil 28Kedar 40On Ali 52Chandra 56

Fiscal PolicyRelated to budget,

government expenditure, taxation

Physical PolicyRelated to overcoming

specific problems of the economy

Monetary PolicyRelated to money

supply, exchange rate control and bank rate

control

Macroeconomic Policies

Fiscal Policy

Use of “Government Expenditure”, and “taxation” to manage the economy.

Variables affected by Fiscal Policy in the economy

Aggregate demand and the level of economic activity The pattern of resource allocationThe distribution of income.

Purpose of Fiscal Policy

Stabilise economic growth, avoiding the boom and bust economic cycle

Physical Policy

Meant to affect only strategic points of the economy

Variables affected by Physical Policy in the economy

Price and distribution of specific commodityInvestment and productionForeign Trade

Purpose of Physical Policy

Overcome specific problems such as pricing of particular commodity, shortages or surpluses developing in the economy etc.

Monetary Policy

Regulation of supply of Money and Cost and Availability of Credit in the economy

Variables affected by Monetary Policy in the economy

Interest RatesLiquidityCredit AvailabilityExchange Rates

Purpose of Monetary Policy

Maintain price stability, ensure adequate flow of credit to the productive sectors of the economy and overall economic growth

Monetary Policy – RBI’s role

Demand for Money

Demand for goods/services

Control on bank credit when prices rise/fall

Ensuring price stability and ensuring savings

Control on money supply, velocity of circulation of money during inflation

Instruments such as CRR, OMO & Bank Rate

•Inflation refers to a persistent rise in pricesInflation•Total volume of money circulating in the economyMoney Supply (M3)

•Minimum rate at which the central bank provides loans to commercial banksBank Rate•Amount of money that banks must set aside with RBI against their depositsCash Reserve Ratio (CRR)

•Percentage of bank funds to be maintained in government and approved securitiesStatutory Liquidity Ratio (SLR)

•Rate at which RBI lends to other banks against government securitiesRepo Rate•Rate at which RBI borrows from other banksReverse Repo Rate

•Capacity of bank meeting the time liabilities and other riskCapital Adequacy Ratio (CAR)

•Purchase and sale of securities in the open marketOpen Market Operations (OMO)

Monetary Policy – Terminology

•0.27 (New low in 30 years)Inflation•6.0%Bank Rate•5.0CRR•24.0%SLR•5.0%Repo Rate•3.5%Reverse Repo Rate

•12.75% – 13.25%PLR•50.95Re/$

Current Rates

Target Variables

-Inflation

-Interest rate

-Real GDP

-Employment

-Consumption

-Savings

-Investment

Policy Variables

- Money supply

- OMO: Liquidity conditions

- policy rates (CRR, repo etc.)

Monetary Policy – Influence

CRR Movement

Before 1991•Government raised funds below market rate

•No depth in Government Securities Market

•Regulation of deposit rates

•Under developed financial markets, Less financial instruments availability

Result•Complex, distorted interest rate structure

•Adversely affected viability and profitability of banks

•Transparency and norms could not be followed strictly

Boost Economy after 2001 Slowdown /

dotcom bubble

Stable CRR from 2004 to 2006

Rise in CRR to control liquidity, due to Heavy Capital Inflow &

to curb Re Appreciation

CRR hikes to curb inflation

CRR Cuts to boost economy after

Sub prime loss / Global meltdown

CRR Movement

http://www.rgemonitor.com/emergingmarkets-monitor/archive/200806/

Uncontrolled Inflation despite Further CRR hikes

CRR hikes proved to Be effective

To curb Inflation

Inflation Down on account of global credit crunch

Inflation Movement

Stable SLR from 1998 onwards

SLR Movement

Banks to made available more funds& More Efficiency

Repo rate reduction due to make credit available at cheaper rates

Repo and Reverse Repo rates Movement

Increased rates to control the liquidity

LAF - To Control Exchange Ratio – Outflow of $ from India Market

Sterilization to Control rupeeAppreciation

Exchange Rate Movement

The Surge in Foreign Exchange Reserves

www.rgemonitor.com/blog/economonitor/248231

Sterilization / Selling bonds & Buying dollars

Forex Reserves Position

Sterilization bonds under (MSS) - April 2004 Cap. Rs.700 Cr. In 2005 & 1500 Cr. In 2007

www.rgemonitor.com/blog/economonitor/248231

Sterilization under MSS

18

Global GDP -0.6%

Estimated PPP Global Growth

0.5%

Recession

US

EuropeJapan

Demand Slump

Production Plunge

Job losses

Tighter credit

World trade contraction

by 2.8%

Aggressive and unconventional measures taken by Governments and central banks

Current Global Scenario

Money and credit market

Local Institutions

Domestic Banks

Domestic MFs

NBFC

$ReRe.

Financial Channel

Impact on India

20

Monetary Policy

Fiscal Policy Growth amidGlobal economic slowdown

DeflationRe.

Challenges for RBI

Cannot simultaneously stimulate economic demand to reduce unemployment and restrain demand to combat inflation

Monetary policy is restricted by the impact of other government actions, especially Fiscal policy, i.e. decisions about government expenditures and taxation

Problems of an inflexible labour market, inadequate infrastructure and, most important, fiscal policy whose discipline is open to question limits the effectiveness of the Monetary policy

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Monetary Policy cannot work in isolation!!

Limitations – Monetary Policy

Thank You