MONETARY POLICY

Presented by: Agrawal

Bhavin (02) Madhavi Nitin

(28)

Mr. CD DesmukhThe First Indian Governor of Reserve Bank Of India

Mr. Raghuram RajanThe Present Indian Governor of Reserve Bank Of India

What is Monetary Policy?

Monetary policy is 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.

In India, the central monetary authority is the Reserve 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.

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 and stocks: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: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 tries to increase the efficiency in the financial system and tries to incorporate structural changes such as deregulating interest rates,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.

Monetary operations

Monetary operations involve monetary techniques which operate on monetary magnitudes such as money supply, interest rates and availability of credit aimed to maintain Price Stability, Stable exchange rate, Healthy Balance of Payment, Financial stability, Economic growth. RBI, the apex institute of India which monitors and regulates the monetary policy of the country stabilizes the price by controlling Inflation.

RBI takes into account the following monetary policies:

Major Operations

1. Open Market Operations (OMO):

An open market operation is an instrument of monetary policy which involves buying or selling of government securities from or to the public and banks. The RBI sells government securities to 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.

2. Credit Authorization Scheme (CAS):

Under this instrument of credit regulation RBI as per the guideline authorizes the banks to advance loans to desired sectors.

3. Cash Reserve Ratio (CRR):

Cash Reserve Ratio is a certain percentage of bank deposits which banks are required to keep with RBI in the form of reserves 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 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.

Current CRR: 4.00% (w.e.f 09/02/2013)

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. There was a reduction of SLR from 38.5% to 25% because of the suggestion by Narshimam Committee.

Current SLR: 22.00% (w.e.f. 09/08/2014)

5. Bank Rate Policy:

The bank rate, also known as the discount rate, is the rate of interest charged by the RBI for providing funds or loans to the banking system. This banking system involves commercial and co-operative banks, IDBI, IFC, EXIM Bank, and other approved financial institutes. Funds are provided either through lending directly or rediscounting or buying money market instruments. 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.

Current Bank Rate: 8.75% (w.e.f. 15/01/2015)

6. 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.

7. 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.

8. 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.

Current Repo Rate: 7.75% (w.e.f.15/01/2015)

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 and demand decreases resulting to decrease in inflation.

Reverse Repo Rate: 6.75% (w.e.f.15/01/2015)

Current Situation

Since July 2014, inflationary pressures (measured by changes in the consumer price index) have been easing.

Crude prices, barring geo-political shocks, are expected to remain low over the year. Weak demand conditions have also moderated inflation excluding food and fuel, especially in the reading for December. Finally, the government has reiterated its commitment to adhering to its fiscal deficit target.

Inflation outcomes have fallen significantly below the 8 per cent targeted by January 2015. On current policy settings, inflation is likely to be below 6 per cent by January 2016.

The RBI had committed to initiate the process of monetary easing as soon as data indicated that medium term inflationary targets would be met.

Keeping this commitment in mind, it has been decided to:

> reduce the policy repo rate under the liquidity adjustment facility (LAF) by 25 basis points from 8.0 per cent to 7.75 per cent with immediate effect;

> keep the cash reserve ratio (CRR) of scheduled banks unchanged at 4.0 per cent of net demand and time liabilities (NDTL);

> continue with daily variable rate repos and reverse repos to smooth liquidity.

Consequently, the reverse repo rate under the LAF stands adjusted to 6.75 per cent, and the marginal standing facility (MSF) rate and the Bank Rate to 8.75 per cent with immediate effect.

In a surprise move, the Reserve Bank of India (RBI) on Thursday cut the reverse repo rate by 25 basis points to 7.75%. The move comes at a time when inflation is steadily coming down and cries for a rate cut were growing loud.

http://www.tradingeconomics.com/india/interest-rate/forecast

Effect on Economy

Bankers and market players have already started factoring in a deep cut in the repo rate this year, with estimates ranging from 50 bps to as much as 125 bps.

RBI’s surprise move led to euphoria in the markets. Benchmark indices posted record gains, with the BSE Sensex soaring 729 points, or 2.66 per cent.

The rupee appreciated to 61.48/dollar in intra-day trade but due to dollar-buying by state-run banks, possibly on behalf of the central bank, the currency ended at 62.07, compared with its previous close of 62.19.

Analysts said Budget 2015-16, to be presented next month, could decide the course of monetary policy through its stance on fiscal consolidation.

BS Reporter  |  Mumbai  January 16, 2015