Monetary Policy

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Monetary Policy

• Manish Sharma

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WHAT IS MONETARY POLICY

• The part of the economic policy which regulates
  the level of money in the economy in order to
  regulate inflation, improve balance of payments,
  increase gross national product etc. RBI, in
  case of India controls the monetary policy.
• The policy statement traditionally announced
  twice a year through which RBI insures Price
  stability for the economy.
• April-September - Slack Season Policy
• October-March - Busy Season Policy
• RBI reserves its right to alter monetary policy
  to time to time depending upon state of economy

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How is the Monetary Policy different from the
Fiscal Policy?

• The Monetary Policy is different from Fiscal
  Policy as the former brings about a change in the
  economy by changing money supply and interest
  rate
• Fiscal policy is a broader tool with the
  government to overcome recession and control
  inflation through change in government revenue
  and expenditure to influence the level of
  national output and prices.

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AIM OF MONETARY POLICY

• Maintain price stability
• Flow of credit to the productive sector of
  economy
• Stability of national currency
• Growth in employment income
• Achieving foreign exchange stability
• Managing suitable level of investment and savings
• Regulating rate of interest induce higher level
  of investment
• Achieving monetary equilibrium to ensure equality
  between demand supply of money.

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Instruments of Credit control

• Quantitative Credit control
• Controls the quantity of money in the economy
• Qualitative Controls
• Controls the direction of flow of money

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QUANTITATIVE - Tools

• Bank Rate-The rate at which RBI extends credit to
  comm. Banks .
• PLR-The rate which banks allows their personal
  customers.
• CRR-The percentage of banks deposits which they
  must keep as cash with RBI.
• SLR-A comm. Bank has to keep a portion of total
  deposits with itself in liquid assets.
• Open Market Operations
• LAF Repo reverse Repo
• MSS Market stabilization scheme

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BANK RATE

• Banks use this rate to price their Long term
  loans to individual and companies
• Increase in Bank rate Increase in lending
  rate of Commercial Banks Decline in
  aggregate money expenditure lowering
  inflation and vice versa.
• This tool now not much in use and remains same
  since years .

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Quantitative Credit Controls

• Bank Rate
• Bank rate is the minimum rate at which the
  central bank provides loans to the commercial
  banks. It is also called the discount rate.
• Usually, an increase in bank rate results in
  commercial banks increasing their lending rates.
  Changes in bank rate affect credit creation by
  banks through altering the cost of credit.

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TRENDS OF BANK RATE

• Bank Rate

In 1940s BR was at low 3 and remained unchanged
till 1953.In 1953 RBI adopted policy controlled
expansion BR raised to 3.5.It reached at max.
level in 1991 12. Presently it is 6

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Quantitative Credit controls

• Prime lending Rate (presently 12.75-13.25)
• PLR or prime lending rate as the rate of interest
  at which banks lend to their credit-worthy or
  favoured customers. It is treated as a benchmark
  rate for most retail and term loans.
• The RBI does not set these rates, but in a broad
  way stipulates the interest rates in the economy.
  The banks are at liberty to lend at a rate above
  or below the RBIs.
• The PLR is influenced by RBIs policy rates the
  repo rate and cash reserve ratio apart from the
  banks policy. In simple words, availability of
  funds in the banking system and demand for credit
  by consumers (both retail and industrial)
  determine what the PLR should be.

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CASH RESERVE RATIO

• RBI has the power to vary this ratio and there by
  use it as an instrument of Credit Control.
  Permissible limit is 3 to 15(1962)
• It is essential for a bank to maintain the ratio
  or otherwise it may not be able to meet the
  withdrawal demand of all its depositors, and
  failure to do so may eventually result in failure
  of the bank.
• Increase in CRR reduce the excess
  reserves available to a bank for lending
  contracting Credit
• Increase in CRR absorbs Foreign
  Capital Inflows checking rupees appreciation.

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TRENDS OF CRR

• In beginning it was 5 of demand deposit 2 of
  time deposits
• Reached max. in 1991,92 after 1993 it followed
  Narsimham report decreased.
• But from dec.06 it raised 7 times, 250bp to cool
  credit growth supply.

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STATUTORY LIQUIDITY RATIO

• Statutory Liquidity Ratio
• Narsimham committee recommended to reduced it at
  minimum level. According to that it is 25and
  remains unchanged.
• Khan committee suggested abolishment of SLR.
• The buying selling of these securities laid the
  foundation of the 1992 Harshad Mehta scam.

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TRENDS OF SLR

• It was 25 in 1949 after that it increased
  continuously 32(1972)--- 35 (1981)---36(1984)--
  - 38(1988).
• From 1997 it is constant at 25

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OMOs-Meanings Objectives

• Open Market Operations-these refer to the sale
  and purchase of Govt. securities by the RBI
• The main objective of these operations has been
  to stabilizes the prices of Govt. securities. The
  control of inflationary pressures has, however
  been the secondary objectives.
• It is used several times after 1991 for
  controlling inflows.

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Open market Operations

• The RBI conducts open market operations (OMO) by
  offering to buy or sell gilts.
• If it feels interest rates are too high, it may
  bring them down by offering to buy securities at
  a lower yield than what is available in the
  market.
• (a) MSS-market stabilization scheme
• (b) LAF-Liquidity adjustment facility (repo
  and reverse repo)

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OMO - TOOLS

• Repo Rate
• This is the rate at which the central bank
  adds funds to the monetary market. Present rate
  7.75
• Reverse Repo Rate
• The rate at which the central bank borrows
  funds from the market. It impacts Govt. bond
  yields and short term bank deposits. Present rate
  6

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EXPERTS VIEWS

• Monetary policy must accommodate primary
  supply shocks and then curbs secondary effects.
  The prime aim of Monetary policy should be
  targeting stability.
• Raghuram C Rajam,
  economist

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LIST OF BOOKS

• Economics, ICAI
• Fundamental of Economics- A.S.Raj
• Managerial Economics- Varshney Maheshwari
• Macro Economics- TMH
• Dictionary of Economics- Jain and saakshi.
• Indian Economy since Independence- edited by Uma
  Kapila
• Indian Economy- Dutt and Sundaram
• Economics- Samuelson and Nordhaus

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List of Websites

• www.rbi.gov.in
• www.livemint.com
• www.bloomberg.com
• www.timesofindia.com
• www.thehindu.com

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Thank You

• QA