Measures of Monetary policy of India

In order to carry out its monetary policy the RBI has adopted the following measures:

a) Measures for Expansion of currency Management of currency is one of the core central banking

function of the RBI. In term of section 22 of Reserve Bank of India Act, the RBI is the sole authority for issue of currency in India. The Reserve Bank has the objective of ensuring an adequate supply of clean and genuine notes as required by the public.

b) Measures of Credit Control: One of the important function of the RBI is the controlled expansion

of bank credit and money supply with special attention to the seasonal requirement for credit without affecting the output. Monetary authority has control over the decisions regarding the allocation of credit to priority sector and small borrowers.

It is an important tool used by the RBI to control the demand and supply of money(liquidity) in the economy. RBI focuses on its objective of “Economic development with stability”. It means bank will not only control inflationary trends in economy but also boost economic growth which would ultimately lead to increase in real income with stability.

Instruments for Credit Control under monetary policy

Control of credit is one of the main objective of monetary policy in India. Control of credit means increase or decrease of the flow of credit in the economy in accordance with its need.

Reserve Bank of India adopts all those measures for the control of credit which central bank in other countries.

These instruments may be classified as: 1. Quantitative Credit Control 2. Qualitative Credit Control

(A) Quantitative Credit Control Quantitative Credit Control means to control the total

quantum of credit in the economy. Under this, RBI has adopted the following instruments: (1)Bank Rate: Section 49 of RBI Act 1934,defines Bank Rate as “the

standard rate at which RBI is prepared to buy or re-discount bills of exchange or other commercial paper eligiable for purchase under this act. In India: RBI , NABARD, SID BI etc. allow the banks to re discount such bill with them and provide the fund.

Changes in bank rate are introduced with a view to controlling the price level and business activity, by changing the demand for loan. Its working is based upon the principle that changes in the bank rate results in changed interest rate in the market. Till 15th july,2013 bank rate was 10.25%,but it has been reduced to 9.5% w.e.f 20th sept,2013.

(2)Open Market Operation: An Open Market Operation is an instrument of monetary policy which involve buying and selling of government securities from or to the public and bank. This mechanism influences the reserve position of the banks, yeild on government securities and cost of bank credit. The RBI sells government securities to contract the flow of credit and buys government securities to increase credit flow.With a view to curbing the prevailing and evolving market conditions, last month RBI had announced conducting of open market operations by purchasing Government of India securities worth Rs.8,000 crore to eject liquidity in the economy.

(3) 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 liability. 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 Statutory Liquidity ratio. Previously SLR was 24% but recently it has been reduced to 23%.

(4)Cash reserve ratio: Cash reserve ratio is a certain percentage of bank deposit which banks are required to keep with RBI in the form of reserve or balances. Higher the CRR with the RBI lower will be the liquidity in the system and vice-versa. RBI is empowered to vary CRR between 15% and 3%. As of january 2013,the CRR is 4%.

(5)Multiple Rates of interest: In October 1960, RBI started ‘multiple rate of interest’ programme. Under this programme, RBI fixes credit quota for various commercial banks. If commercial banks borrow funds from RBI within their quota, they are charged interest at repo rate, but if commercial bank borrow more then their fixed quota, they are charged higher interest rates i.e. more than bank rate. RBI by changing quotas of commercial banks and by changing interest rate for lending beyond the quotas limit, can expand or contract credit. If RBI reduces quotas or increases interest rates it will contract credit and vice versa.

(6)Repo Rate and Reverse Repo Rate: ‘Repo’ and ‘Reverse repo’ are the main monetary policy rate. Repo rate means the interest rate at which commercial banks can borrow funds from RBI. Reverse repo rate means the interest rate given by RBI on deposits made by commercial banks with it. Increase in repo rate will contract credit as now commercial banks can get funds from RBI at higher interest. Similarly ,increase in reverse repr rate will also contract credit as commercial banks are more inclined to deposit their funds with RBI earn high interest.

Recently, new RBI Governor, Raghuram Rajan has increased repo rate and reverse repo rate to 7.5% and 6.5% respectively with the motive to fight back the currency depreciation and secondly to encourage saving as due to high inflation ,desired level of financial sector saving has not been achieved.

(B)Qualitative Credit ControlThis refers to the control of specific credit meant for certain specific objectives. It refers to regulating and controlling the credit to a specific sector/commodity/area. Following instruments of selective control are generally adapted:-(1) Marginal Requirement: Margin is the difference between loan

value and market value of security. It is fixed by the RBI. For different types of loan, margin requirement is different. If margin percentage is more, then less loan will be given for a certain value of security and vice-versa. For example:-A person mortgages his property worth Rs.1,00,000 against a loan. If suppose marginal requirement is 20%, then bank will only give a loan of Rs.80,000.

(2) Moral Suasion This method is also known as “Moral Persuasion” as the method that the Reserve Bank of India, being the apex bank uses here, is that of persuading the commercial banks to follow its directions/orders on the flow of credit. RBI puts a pressure on the commercial banks to put a ceiling on credit flow during inflation and be liberal in lending during deflation.

(3) Rationing of credit Under this method there is a maximum limit to loans and advances that can be made, which the commercial banks cannot exceed. RBI fixes ceiling for specific categories. Such rationing is used for situations when credit flow is to be checked, particularly for speculative activities.

(4) Publicity RBI uses media for publicity of its views on the current market condition and its directions that will be required to be implemented by the commercial banks to control the unrest. Though this method is not very successful in developing nation due to high illiteracy rate that make it difficult for people to understand such policies and its implications.

(5) Direct Action Under the banking regulation Act, the central bank has the authority to take strict action against any of the commercial banks that refuses to obey the direction given by RBI. There can be a restriction on advancing of loans imposed by RBI on such banks.