INDEX

Introduction

Objectives

Instruments of monetary policies

• Bank Rate of Interest

o Reasons for interest rate change

• Cash Reserve Ratio

• Statutory Liquidity Ratio

• Open market Operations

• Margin Requirements

• Deficit Financing

• Issue of New Currency

• Credit Control

Fiscal Policies

Instruments of fiscal policies

MONETARY AND FISCAL POLICIES

The Monetary and Credit Policy is the policy statement, traditionally

announced twice a year, through which the Reserve Bank of India seeks to ensure

price stability for the economy. These factors include - money supply, interest rates

and the inflation. In banking and economic terms money supply is referred to as

M3 – which indicates the level (stock) of legal currency in the economy. Besides,

the RBI also announces norms for the banking and financial sector and the

institutions which are governed by it.

MONETARY POLICY is the process by which the monetary authority of a

country control the supply of money, often targeting a rate of interest for the

purpose of promoting economic growth and stability. The official goals usually

include relatively stable prices and low unemployment.Monetary theory provides

insight into how to craft optimal monetary policy. It is referred to as either

being expansionary or contractionary, where an expansionary policy increases the

total supply of money in the economy more rapidly than usual, and contractionary

policy expands the money supply more slowly than usual or even shrinks it.

Expansionary policy is traditionally used to try to combat unemployment in

a recession by lowering interest rates in the hope that easy credit will entice

businesses into expanding. Contractionarypolicy is intended to slow inflation in

order to avoid the resulting distortions and deterioration of asset values.

Monetary policy differs from fiscal policy, which refers totaxationgovernment

spending, and associated borrowing.

Monetary policy is the management of money supply and interest ratesby central

banks to control prices and employment.

OBJECTIVES OF THE MONETARY POLICY

The objectives are to maintain price stability and ensure adequate flow of

credit to the productive sectors of the economy. Stability for the national currency

(after looking at prevailing economic conditions), growth in employment and

income are also looked into. The monetary policy affects the real sector through

long and variable periods while the financial markets are also impacted through

short-term implications.

There have been varying objectives of monetary policy in different countries in

different times and in different economic conditions.

Different objectives clash with each other and there is a problem of selecting a

right objective for the monetary policy of a country. The proper objective of the

monetary policy is to be selected by the monetary authority keeping in view the

specific conditions and requirements of the economy. Various objectives or goals

of monetary policy are:

• Neutrality of Money

• Price Stability

• Economic growth

• Exchange Stability

• Full Employment

INSTRUMENTS OF MONETARY POLICY

• Bank Rate of Interest

• Cash Reserve Ratio

• Statutory Liquidity Ratio

• Open market Operations

• Margin Requirements

• Deficit Financing

• Issue of New Currency

• Credit Control

BANK RATE OF INTEREST

It is the interest rate which is fixed by the RBI to control the lending

capacity of Commercial banks. During Inflation , RBI increases the bank rate of

interest due to which borrowing power of commercial banks reduces which thereby

reduces the supply of money or credit in the economy .When Money supply

Reduces it reduces the purchasing power and thereby curtailing Consumption and

lowering Prices.

An interest rate is the rate at which interest is paid by borrowers for the use

of money that they borrow from a lender. Specifically, the interest rate (I/m) is a

percent of principal (P) paid at some rate (m). For example, a small company

borrows capital from a bank to buy new assets for its business, and in return the

lender receives interest at a predetermined interest rate for deferring the use of

funds and instead lending it to the borrower. Interest rates are normally expressed

as a percentage of the principal for a period of one year.

Interest-rate targets are a vital tool of monetary policy and are taken into

account when dealing with variables like investment, inflation, and unemployment.

The central banks or reserve banks of countries generally tend to reduce interest

rates when they wish to increase investment and consumption in the country's

economy. However, a low interest rate as a macro-economic policy can

be risky and may lead to the creation of an economic bubble, in which large

amounts of investments are poured into the real-estate market and stock market.

REASONS FOR INTEREST RATE CHANGE

Political short-term gain: Lowering interest rates can give the economy a

short-run boost. Under normal conditions, most economists think a cut in

interest rates will only give a short term gain in economic activity that will soon

be offset by inflation. The quick boost can influence elections. Most economists

advocate independent central banks to limit the influence of politics on interest

rates.

Deferred consumption: When money is loaned the lender delays spending the

money on consumption goods. Since according to time preference theory

people prefer goods now to goods later, in a free market there will be a positive

interest rate.

Inflationary expectations: Most economies generally exhibit inflation,

meaning a given amount of money buys fewer goods in the future than it will

now. The borrower needs to compensate the lender for this.

Alternative investments: The lender has a choice between using his money in

different investments. If he chooses one, he forgoes the returns from all the

others. Different investments effectively compete for funds.

Risks of investment: There is always a risk that the borrower will go bankrupt,

abscond, die, or otherwise default on the loan. This means that a lender

generally charges a risk premium to ensure that, across his investments, he is

compensated for those that fail.

Liquidity preference: People prefer to have their resources available in a form

that can immediately be exchanged, rather than a form that takes time or money

to realize.

Taxes: Because some of the gains from interest may be subject to taxes, the

lender may insist on a higher rate to make up for this loss.

CASH RESERVE RATIO (CRR)

CRR, or cash reserve ratio, refers to a portion of deposits (ascash) which

banks have to keep/maintain with the RBI. During Inflation RBI increases the CRR

due to which commercial banks have to keep a greater portion of their deposits

with the RBI . This serves two purposes. It ensures that a portion of bank deposits

is totally risk-free and secondly it enables that RBI control liquidity in the system,

and thereby, inflation.

Cash Reserve Ratio (CRR) is the amount of funds that all Scheduled

Commercial Banks (SCB) excluding Regional Rural Banks (RRB) are required to

maintain without any floor or ceiling rate with RBI with reference to their total net

Demand and Time Liabilities (DTL) to ensure the liquidity and solvency of Banks

(Section 42 (1) of RBI Act 1934). The current CRR is 4.75% and at present no

incremental CRR is required to be maintained by the banks.

Computation of DTL

Demand Liabilities are liabilities which are payable on demand and Time

Liabilities are those which are payable otherwise than on demand. The

components for computation of DTL include Demand Liabilities, Time Liabilities

and Other Demand & Time Liabilities (ODTL) as under:-

a) Demand Liabilities:-

• Current Deposits, Savings bank deposits,Margins held against letters of

credit/guarantees.

• Balances in overdue fixed deposits, Outstanding TTs, MTs, DDs, Unclaimed

deposits

• Credit balances in the Cash Credit account and deposits held as security for

advances

b) Time Liabilities:-

• Fixed deposits, cash certificates, cumulative and recurring deposits, time

liabilities portion of savings bank deposits, staff security deposits, margin held

against letters of credit, if not payable on demand, & deposits held as securities

for advances which are not payable on demand and Gold deposits.

c) Other Demand and Time Liabilities (ODTL):-

• Interest accrued on deposits, bills payable, unpaid dividends, suspense account

balances representing amounts due to other banks or public, net credit balances

in branch adjustment account, any amounts due to the banking system which

are not in the nature of deposits or borrowing.

• Participation Certificates issued to other banks, the balances outstanding in the

blocked account pertaining to segregated outstanding credit entries for more

than 5 years in inter-branch adjustment account, the margin money on bills

purchased / discounted and gold borrowed by banks from abroad, Cash

collaterals received under collateralized derivative transactions and

Loans/borrowings from abroad.

d)Liabilities not included under DTL/ODTL

• Paid up capital, reserves, credit balance in the Profit & Loss Account, loan

taken from the RBI, refinance taken from Exim Bank, NHB, NABARD, SIDBI.

• Net income tax provision.

• Amount received from DICGC towards claims pending adjustments thereof.

• Amount received from ECGC.

• Amount received from insurance company on ad-hoc settlement of claims

pending judgment of the Court.

• Amount received from the Court Receiver.

• The liabilities arising on account of utilization of limits under Bankers

Acceptance Facility (BAF).

• District Rural Development Agency (DRDA) subsidy of Rs.10, 000/- kept in

Subsidy Reserve Fund account in the name of Self Help Groups.

• Subsidy released by NABARD under Investment Subsidy Scheme for

Construction/Renovation/Expansion of Rural Godowns.

• Net unrealized gain/loss arising from derivatives transaction under trading

portfolio.

• Income flows received in advance such as annual fees and other charges which

are not refundable.

• Bill rediscounted by a bank with eligible financial institutions as approved by

RBI.

• Provision not being a specific liability arising from contracting additional

liability and created from profit and loss account.

EXEMPTED CATEGORIES

• Liabilities to the banking system in India.

• Credit balances in ACU (US$) Accounts.

• Demand and Time Liabilities in respect of their Offshore Banking Units

(OBU).

• Inter-bank term deposits/term borrowing liabilities of original maturities of 15

days and above and up to one year.

• Inter-bank assets of term deposits and term lending of original maturity of 15

days and above and up to one year.

Procedure/maintenance

As a measure of simplification, a lag of one fortnight in the maintenance of

stipulated CRR by SCBs has been introduced. All SCBs are required to maintain

minimum CRR balances up to 70 per cent of the average daily required reserves

for a reporting fortnight on all days of the fortnight (w.e.f. December 2002). RBI

does not pay any interest on CRR maintained by SCBs.

Other provisions/penalty

• All SCBs are required to submit to RBI a provisional Return in Form 'A' within 7

days from the expiry of the relevant fortnight.

• Default in maintenance of CRR requirement on a daily basis (presently 70% of

the total requirement) by SCBs attracts penal interest for that day at 3% above

Bank Rate on the short fall.

• In case the shortfall continues on the next succeeding day/s, penal interest at the

rate of 5% p.a. above the Bank Rate is applicable.

STATUTORY LIQUIDITY RATIO

Banks are required to invest a portion of their deposits in government

securities as a part of their statutory liquidity ratio (SLR) requirements . If SLR

increases the lending capacity of commercial banks decreases thereby regulating

the supply of money in the economy.

SLR means-

• Statutory Liquidity Ratio.

• It is a tool used by RBI to control inflation and to boost growth. Anyways since

last one year, RBI's primary aim is to control inflation.

• If RBI sets SLR to 25%, that a Bank must keep 25% of its Total deposits, into

non-cash forms prescribed by RBI: that is….

• In Gold

• In Corporate Bonds / Shares approved by RBI

• G-Sec (Government Securities/ Treasury Bonds)

• But most banks prefer to put all the money in Government securities (G-

Sec), because they're more safe and convenient than the other two.

• Interest Rates go down when SLR is decreased.

• If SLR is increased, then banks have less money to lend i.e., they'll charge

more interest rates on loans to keep the profit margin same.

OPEN MARKET OPERATIONS

It refers to the buying and selling of Govt.securities in the open market.

During inflationRBI sells securities in the open market whichleads to transfer of

money to RBI.Thus money supply is controlled in the economy.

An open market operation (also known as OMO) is an activity by a central

bank to buy or sell government bonds on the open market. A central bank uses

them as the primary means of implementing monetary policy. The usual aim of

open market operations is to manipulate the short term interest rate and the supply

of base money in an economy, and thus indirectly control the total money supply.

This involves meeting the demand of base money at the target interest rate by

buying and selling government securities, or other financial instruments. Monetary

targets, such as inflation, interest rates, or exchange rates, are used to guide this

implementation.

Process: Since most money now exists in the form of electronic records

rather than in the form of paper, open market operations are conducted simply by

electronically increasing or decreasing (crediting or debiting) the amount of base

money that a bank has in its reserve account at the central bank. Thus, the process

does not literally require new currency. However, this will increase the central

bank's requirement to print currency when the member bank demands banknotes,

in exchange for a decrease in its electronic balance. When there is an increased

demand for base money, the central bank must act if it wishes to maintain the

short-term interest rate. It does this by increasing the supply of base money. The

central bank goes to the open market to buy a financial asset, such as government

bonds, foreign currency, gold, or seemingly nonvolatile (until the 2008 financial

fallout) MBS's(Mortgage Backed Securities). To pay for these assets, bank

reserves in the form of new base money (for example newly printed cash) are

transferred to the seller's bank and the seller's account is credited. Thus, the total

amount of base money in the economy is increased. Conversely, if the central bank

sells these assets in the open market, the amount of base money held by the buyer's

bank is decreased, effectively destroying base money.Under inflation targeting,

open market operations target a specific short term interest rate in the debt markets.

This target is changed periodically to achieve and maintain an inflation rate within

a target range. However, other variants of monetary policy also often target interest

rates: the US Federal Reserve, the Bank of England and the European Central

Bank use variations on interest rate targets to guide open market operations.

Besides interest rate targeting there are other possible targets of open markets

operations. A second possible target is the contraction of the money supply, as

was the case in the U.S. in the late 1970s through the early 1980s under Fed

Chairman Paul Volcker.

Under a currency board open market operations would be used to achieve and

maintain a fixed exchange rate with relation to some foreign currency.

Under a gold standard, notes would be convertible to gold, so there would be no

open market operations. However, open market operations could be used to

keep the value of a fiat currency constant relative to gold.

A central bank can also use a mixture of policy settings that change depending

on circumstances. A central bank may peg its exchange rate (like a currency

board) with different levels or forms of commitment. The looser the exchange

rate peg, the more latitude the central bank has to target other variables (such as

interest rates). It may instead target a basket of foreign currencies rather than a

single currency. In some instances it is empowered to use additional means

other than open market operations, such as changes in reserve requirements or

capital controls, to achieve monetary outcomes.

How open market operations are conducted?

United States

In the United States, as of 2006, the Federal Reserve sets an interest rate

target for the Federal funds (overnight bank reserves) market. When the

actual Federal funds rate is higher than the target, the New York Reserve Bank will

usually increase the money supply via a repo (effectively borrowing from the

dealers' perspective; lending for the Reserve Bank). When the actual Federal funds

rate is less than the target, the Bank will usually decrease the money supply via

reverse repo (effectively lending from the dealers' perspective; borrowing for the

Reserve Bank).

In the U.S., the Federal Reserve most commonly uses overnight repurchase

agreements (repos) to temporarily create money, or reverse repos to temporarily

destroy money, which offset temporary changes in the level of bank reserves.The

Federal Reserve also makes outright purchases and sales of securities through

the System Open Market Account(SOMA) with its manager over the Trading Desk

at the New York Reserve Bank. The trade of securities in the SOMA changes the

balance of bank reserves, which also affects short term interest rates. The SOMA

manager is responsible for trades that result in a short term interest rate near the

target rate set by the Federal Open Market Committee (FOMC), or create money

by the outright purchase of securities.More rarely will it permanently destroy

money by the outright sale of securities. These trades are made with a group of

about 22 (currently 18 as an immediate aftermath of 08/09 credit crisis) banks or

bond dealers that are called primary dealers.

Money is created or destroyed by changing the reserve account of the bank with

the Federal Reserve. The Federal Reserve has conducted open market operations in

this manner since the 1920s, through the Open Market Desk at theFederal Reserve

Bank of New York, under the direction of the Federal Open Market Committee.

The open market operation is also a means through which inflation can be

controlled because when treasury bills are sold to commercial banks these banks

can no longer give out loans to the public for the period and therefore money is

being reduced from circulation.

Eurozone

The European Central Bank has similar mechanisms for their operations; it

describes its methods as a four-tiered approach with different goals: beside its main

goal of steering and smoothing Eurozone interest rates while managing

theliquidity situation in the market the ECB also has the aim of signalling the

stance of monetary policy with its operations.

Broadly speaking, the ECB controls liquidity in the banking system via

Refinancing Operations, which are basicallyrepurchase agreements i.e. banks put

up acceptable collateral with the ECB and receive a cash loan in return. These are

the following main categories of refinancing operations that can be employed

depending on the desired outcome:

The regular weekly main refinancing operations (MRO) with maturity of one

week and,

The monthly longer-term refinancing operations (LTRO) provide liquidity to

the financial sector, while ad-hoc

"Fine-tuning operations" (in the form of reverse or outright transactions,

foreign exchange swaps and the collection of fixed-term deposits) aim to

smooth interest rates caused by liquidity fluctuations in the market and

"Structural operations" are used to adjust the central banks' longer-term

structural positions vis-a-vis the financial sector.

Refinancing operations are conducted via an auction mechanism. The ECB

specifies the amount of liquidity it wishes to auction (called the allotted amount)

and asks banks for expressions of interest. In a fixed rate tender the ECB also

specifies the interest rate at which it is willing to lend money; alternatively, in a

variable rate tender the interest rate is not specified and banks bid against each

other (subject to a minimum bid rate specified by the ECB) to access the available

liquidity.

MRO auctions are held on Mondays, with settlement (i.e. disbursal of the

funds) occurring the following Wednesday. For example at its auction on 2008

October 6, the ECB made available 250 million in EUR on October 8 at a

minimum rate of 4.25%. It received 271 million in bids, and the allotted amount

(250) was awarded at an average weighted rate of 4.99%.

Since mid-October 2008, however, the ECB has been following a different

procedure on a temporary basis, the fixed rate MRO with full allottment. In this

case the ECB specifies the rate but not the amount of credit made available, and

banks can request as much as they wish (subject as always to being able to provide

sufficient collateral). This procedure was made necessary by the financial crisis of

2008 and is expected to end at some time in the future.

Though the ECB's main refinancing operations (MRO) are from repo auctions

with a biweekly maturity and monthly maturation, Long Term Refinancing

Operations (LTROs) are also issued, which traditionally mature after three months;

since 2008, tenders are now offered for six months, 12 months and 36 months. 

Switzerland

The Swiss National Bank currently targets the 3 month Swiss

franc LIBOR rate. The primary way the SNB influences the 3 month Swiss franc

LIBOR rate is through open market operations, with the most important monetary

policy instrument being repo transactions.

India

India’s Open Market Operation is much influenced by the fact that it is a

developing country and that the capital flows are much different than those in the

other developed countries. Thus Reserve Bank Of India, being the Central Bank of

the country, has to make policies and use instruments accordingly. Prior to the

1991 financial reforms, RBI’s major source of funding and control over credit and

interest rates was the CRR (Cash reserve ratio) and the SLR (Statutory Liquidity

Ratio). But after the reforms, the use of CRR as an effective tool was de-

emphasized and the use of open market operations increased. OMO’s are more

effective in adjusting market liquidity.

The two traditional type of OMO’s used by RBI:

• Outright purchase (PEMO): Is outright buying or selling of government

securities. (Permanent).

• Repurchase agreement (REPO): Is short term, and are subject to repurchase.

However, even after sidelining CRR as an instrument, there was still less

liquidity and skewedness in the market. And thus, on the recommendations of the

Narsimha Committee Report (1998), The RBI brought together a Liquidity

Adjustment Facility (LAF). It commenced in June, 2000, and it was set up to

oversee liquidity on a daily basis and to monitor market interest rates. For the LAF,

two rates are set by the RBI: repo rate and reverse repo rate. The repo rate is

applicable while selling securities to RBI (daily injection of liquidity), while the

reverse repo rate is applicable when banks buy back those securities (daily

absorption of liquidity). Also, these interest rates fixed by the RBI also help in

determining other market interest rates.

India experiences large capital inflows every day, and even though the OMO

and the LAF policies were able to withhold the inflows, another instrument was

needed to keep the liquidity intact. Thus, on the recommendations of the Working

Group of RBI on instruments of Sterilization (December, 2003), a new scheme

known as the Market stabilization scheme (MSS) was set up. The LAF and the

OMO’s were dealing with day to day liquidity management, whereas the MSS was

set up to sterilize the liquidity absorption and make it more enduring.

According to this scheme, the RBI issues additional T-bills and securities to

absorb the liquidity. And the money goes into the Market Stabilization scheme

Account (MSSA). The RBI cannot use this account for paying any interest or

discounts and cannot credit any premiums to this account. The Government, in

collaboration with the RBI, fixes a ceiling amount on the issue of these

instruments.

But for an open market operation instrument to be effective, there has to be an

active securities market for RBI to make any kind of effect on the liquidity and

rates of interest.

MARGIN REQUIREMENTS

• During Inflation RBI fixes a high rate of margin on the securities kept by the

public for loans .If the margin increases the commercial banks will give less

amount of credit on the securities kept by the public thereby controlling inflation.

MARGIN(FINANCE)

In finance, a margin is collateral that the holder of a financial instrument has to

deposit to cover some or all of the credit risk of their counterparty (most often

their broker or an exchange). This risk can arise if the holder has done any of the

following:

borrowed cash from the counterparty to buy financial instruments,

sold financial instruments short, or

entered into a derivative contract.

The collateral can be in the form of cash or securities, and it is deposited in

a margin account. On United

States futures exchanges, "margin" was formerly called performance bond.

Most of the exchanges today use SPAN (Standard Portfolio Analysis of Risk)

methodology for calculation of margin in 'Options' and 'Futures'. SPAN was

developed by the Chicago Mercantile Exchange in 1988.

Deficit Financing

• It means printing of new currency notes by Reserve Bank of India .If more new

notes are printed it will increase the supply of money thereby increasing

demand and prices.

• Thus during Inflation, RBI will stop printing new currency notes thereby

controlling inflation.

o Deficit financing is defined as financing the budgetary deficit through

public loans and creation of new money. Deficit financing in India means

the expenditure which in excess of current revenue and public borrowing.

the government may cover the deficit in the following ways.

• By running down its accumulated cash reserve from RBI.

• Issue of new currency by government it self.

• Borrowing from reserve bank of India and RBI gives the loans by printing more

currency notes.

Objectives of deficit financing :

• To finance war:- Deficit financing has generally being used as a method of

financing war expenditure. During the war time through normal methods of

raising resources. It becomes difficult to mobilize adequate resources. Therefore

government has to adopt deficit financing.

• Remedy for depression :- In developed countries deficit financing is used as on

instrument of economic policy for removing the conditions of depression. Prof.

Keynes has also advocated for deficit financing as a remedy for depression and

unemployment.

• Economic development:- The main objective of deficit financing in an under

developed country like India is to promote economic development. The use of

deficit financing in fact becomes essential for financing the development plan

especially in underdeveloped countries.

• Mobilization of Resources :- deficit financing is also used for the mobilization

of surplus, ideal and unutilized resources in the country.

• For granting subsidies :- In a country like India government grants subsidies to

the producers to encourage them to produce a particular type of commodity,

granting subsidies is a very costly affair which we cannot meet with the regular

income this deficit financing becomes must for it.

• Increase in aggregate demand :- Deficit financing loads to increase in aggregate

demand through increased public expenditure. This increase the income and

purchasing power of the people as a consequence there is an increase

availability of goods and services and the production and employment level also

increase.

• For payment of interest:- Loan which are taken by the govt. are supposed to be

repaid with their interest for that government needs money deficit financing is

an important tool to get the income for the repayment of loan along with the

interest.

• To overcome low tax receipts.

• To overcome the losses of public sector enterprises

• For implementing anti povertyprogramme.

Adverse Effects Of Deficit Financing

• Deficit financing is not free from its diffects. It has its adverse effect on

economy. Important evil effects of deficit financing are given below.

• Leads to inflation :- Deficit financing may lead to inflation. due to deficit

financing money supply increases & the purchasing power of the people also

increase which increases the aggregate demand and the prices also increase.

• Adverse effect on saving:- Deficit financing leads to inflation and inflation

affects the habit of voluntary saving adversely. Infect it is not possible for the

people to maintain the previous rate of saving in the state of rising prices.

• Adverse effect on Investment ;- deficit financing effects investment adversely

when there is inflation in the economy trade unions make demand for higher

wages for that they go for strikes and lock outs which decreases the efficiency

of Labour and creates uncertainty in the business which a decreases the level of

investment of the country.

• Inequality :- in case of deficit financing income distribution becomes unequal.

During deficit financing deflationary pressure can be seen on the economy

which make the rich richer and the poor, poorer. The fix wage earners are badly

effected and their standard of living detoriates thus no gap b/w rich & poor

increases.

• Problem of balance of payment :- Deficit financing leads to inflation. A high

price level as compared to other countries will make the exports more

expensive and thus they start declining. On the other hand rise in domestic

income and price may encourage people to import more commodities from

abroad. This will create a deficit in balance of payment and the balance of

payment will become unfavorable.

• Increase in the cost of production :- When deficit financing leads to the rise in

the price level the cost of development projects also rises this means a larger

dose of deficit financing is required on the port of government for completion

of these projects.

• Change in the pattern of investment:- Deficit financing leads to inflation.

During inflation prices rise and reach to a very high level in that case people

instead of indulging into productive activities they start doing speculative

activities.

Is Deficit Financing Inflationary?

Deficit financing may not necessarily be inflationary there are certain

conditions under which deficit financing may not lead to inflation. With increase in

money supply due to deficit financing prices do rise but rise in price will only be

temporary for about a period. As flow of goods and services increase prices will

began to fall. deficit financing is an important device for financing development

plans for underdeveloped countries and accelerate their rate of economic

development. But If deficit financing is not kept with in limits It may give rise to

prices, distorted investment and unequal and unjust distribution of income.

therefore it is essential that deficit financing is kept within limits and its impact on

prices and costs are softened through various controls.

ISSUE OF NEW CURRENCY

During Inflation the RBI will issue new currency notes replacing many old

notes.This will reduce the supply of money in the economy.

The Indian rupee ( ) is the official currency of the Republic of India. The

issuance of the currency is controlled by the Reserve Bank of India. The Indian

rupee symbol   (officially adopted in 2010) is derived from

the Devanagari consonant "र" (Ra) with an added horizontal bar.

Money as a means of payment, consists of coins, paper money and

withdrawable bank deposits. Today, credit cards and electronic cash form an

important component of the payment system. For a common person though, money

simply means currency and coins. This is so because in India, the payment system,

especially for retail transactions still revolves around currency and coins. There is

very little, however, that the common person knows about currency and coins he

handles on a daily basis.

The Indian currency is called the Indian Rupee (INR) and the coins are

called paise. One Rupee consists of 100 paise. At present, notes in India are issued

in the denomination of Rs.5, Rs.10, Rs.20, Rs.50, Rs.100, Rs.500 and Rs.1000.

These notes are called bank notes as they are issued by the Reserve Bank of

India . The Reserve Bank can also issue notes in the denominations of five

thousand rupees and ten thousand rupees, or any other denomination that the

Central Government may specify. There cannot, though, be notes in denominations

higher than ten thousand rupees in terms of the current provisions of the Reserve

Bank of India Act, 1934.

Coins in India are presently being issued in denominations of 10 paise, 20

paise, 25 paise, 50 paise, one rupee, two rupees and five rupees. Coins upto 50

paise are called 'small coins' and coins of Rupee one and above are called 'Rupee

Coins'. Coins can be issued up to the denomination of Rs.1000 as per the Coinage

Act, 1906.

Issue of India currency coins 

The initial decimal issues of the country comprised of 1, 2, 5, 10, 25 and 50

nayepaise, in addition to 1 rupee. The 1 naya paisa was made of bronze, the 25 and

50 nayepaise and 1 rupee were made of nickel and the 2, 5, and 10 nayepaise were

made of the alloy of nickel and copper. In 1964, the expression naya(e) was taken

out from every coin. Between 1964 and 1967, 1, 2, 3, 5 & 10 paise made of

aluminum were launched. In 1968, 20 paise were brought in which was made of

the alloy of nickel and brass, and in 1982, this was substituted by aluminum coins.

Between 1972 and 1975, 25 and 50 paise coins and 1 rupee made of the alloy of

nickel and copper were also substituted by nickel coins. Two rupees coins were

launched in 1982 and this was made of the alloy of copper and nickel. In 1988, 10,

25 and 50 paise coins were brought in and they were made of stainless steel.

Subsequently, in 1992, 1 and 5 rupee coins were launched. Of late, the Reserve

Bank of India manufactures 5 rupee coins from brass through its mints.

Between the period of 2005 and 2008, new 1, 2 and 5 rupee and 50 paise

coins were brought in. The weight was less than before and minted in ferrite

stainless steel. This initiative was actuated by melting the previous coins whose par

value was below their scrap value.

Typically, the coins with the denominations of 1, 2, 5 and 10 rupees are

issued and available in the market. Despite the fact they are legitimate, paise coins

have got more and more uncommon in standard transactions. The Government of

India has made a resolution to gradually end all paise coins.

BLUEPRINT

The Union Government of India sanctions the blueprint of banknotes on the

advices of the Central Board of the Reserve Bank of India. India currency

banknotes are produced at the following venues:

Bank Note Press, Dewas

Currency Note Press, Nashik

Watermark Paper Manufacturing Mill, Hoshangabad

Bharatiya Note Mudra Nigam (P) Limited presses at Mysore and Salboni

The contemporary set of Indian currency notes, which were introduced in 1996, is

known as the Mahatma Gandhi series. Currently, banknotes are circulated with

denominations of 5 rupees, 10 rupees, 20 rupees, 50 rupees, 100 rupees, 500

rupees, and 1,000 rupees. The printing of 5 rupee notes ceased previously.

However, it has commenced once more from 2009. ATMs (automated teller

machines) normally provide currency notes with denominations of 100 rupees, 500

rupees, and 1,000 rupees. The zero rupee note is also there but it is not formally

circulated by the Government of India. It is a representation of dissent and a

Nongovernmental Organization (NGO) in India prints and circulates it.

Distribution

Coins are received from the Mints and issued into circulation through its

Regional Issue offices/sub-offices of the Reserve Bank and a wide network of

currency chests and coin depots maintained by banks and Government treasuries

spread across the country. The RBI Issue Offices/sub-offices are located at

Ahmedabad, Bangalore, Belapur (Navi Mumbai), Bhopal, Bhubaneshwar,

Chandigarh, Chennai, Guwahati, Hyderabad, Jammu, Jaipur, Kanpur, Kolkata,

Lucknow, Mumbai, Nagpur, New Delhi, Patna and Thiruvananthapuram. These

offices issue coins to the public directly through their counters and also send coin

remittances to the currency chests and small coin depots. There are 4422 currency

chest branches and 3784 small coin depots spread throughout the country. The

currency chests and small coin depots distribute coins to the public, customers and

other bank branches in their area of operation. The members of the public can

approach the RBI offices or the above agencies for requirement of coins.

Measures to improve the supply of coins

The various Mints in the country have been modernised and upgraded to

enhance their production capacities.

Government has in the recent past, imported coins to augment the indigenous

production.

Notes in denomination of Rs.5 have been reintroduced to supplement the supply

of coins.

New initiatives for distribution

Coin Dispensing Machines have been installed at select Regional Offices of the

Reserve Bank on pilot basis.

Dedicated Single-window counters have been opened in several of the Reserve

Bank's offices for issuing coins of different denominations packed in pouches.

Mobile counters are being organised by the Reserve Bank in commercial and

other important areas of the town where soiled notes can be exchanged for

coins.

CREDIT CONTROL

Credit Control is an important tool used by Reserve Bank of India, a major

weapon of the monetary policy used to control the demand and supply of money

(liquidity) in the economy. Central Bank administers control over the credit that

the commercial banks grant. Such a method is used by RBI to bring “Economic

Development with Stability”.

It means that banks will not only control inflationary trends in the economy

but also boost economic growth which would ultimately lead to increase in real

national income with stability.

In view of its functions such as issuing notes and custodian of cash reserves,

credit not being controlled by RBI would lead to Social and Economic instability

in the country.

Need for Credit Control

Controlling credit in the Economy is amongst the most important functions of the

Reserve Bank of India. The basic and important needs of Credit Control in the

economy are-

To encourage the overall growth of the “priority sector” i.e. those sectors of the

economy which is recognized by the government as “prioritized” depending

upon their economic condition or government interest. These sectors broadly

totals to around 15 in number.

To keep a check over the channelization of credit so that credit is not delivered

for undesirable purposes.

To achieve the objective of controlling “Inflation” as well as “Deflation”.

To boost the economy by facilitating the flow of adequate volume of bank

credit to different sectors.

To develop the economy.

Objectives of Credit Control

Credit control policy is just an arm of Economic Policy which comes under

the purview of Reserve Bank of India, hence, its main objective being

attainment of high growth rate while maintaining reasonable stability of the

internal purchasing power of money. The broad objectives of Credit Control

Policy in India have been-

Ensure an adequate level of liquidity enough to attain high economic

growth rate along with maximum utilization of resource but without generating

high inflationary pressure.

Attain stability in exchange rate and money market of the country.

Meeting the financial requirement during slump in the economy and in the

normal times as well.

Control business cycle and meet business needs.

Methods of Credit Control

There are two methods that the RBI uses to control the money supply in the

economy-

Qualitative Method

Quantitative Method

During the period of inflation Reserve Bank of India tightens its

policies to restrict the money supply, whereas during deflation it allows the

commercial bank to pump money in the economy.

Qualitative Method

Qualitative Method controls the manner of channelizing of cash and credit in

the economy. It is a ‘selective method’ of control as it restricts credit for certain

section where as expands for the other known as the ‘priority sector’ depending on

the situation.

By Quality we mean the uses to which bank credit is directed.

For example- the Bank may feel that spectators or the big capitalists are getting a

disproportionately large share in the total credit, causing various disturbances and

inequality in the economy, while the small-scale industries, consumer goods

industries and agriculture are starved of credit.

Correcting this type of discrepancy is a matter of Qualitative Credit Control.

Tools used under this method are-

Marginal Requirement

Marginal Requirement of loan = current value of security offered for loan-

value of loans granted. The marginal requirement is increased for those business

activities, the flow of whose credit is to be restricted in the economy.

e.g.- a person mortgages his property worth Rs. 1,00,000 against loan. The

bank will give loan of Rs. 80,000 only. The marginal requirement here is 20%.

In case the flow of credit has to be increased, the marginal requirement will be

lowered. RBI has been using this method since 1956.

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. Minimum of ”Capital: Total Assets" (ratio

between capital and total asset) can also be prescribed by Reserve Bank of India.

Publicity

RBI uses media for the 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 nations

due to high illiteracy existing making it difficult for people to understand such

policies and its implications.

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 directions

given by Reserve Bank of India. There can be a restriction on advancing of loans

imposed by Reserve Bank of India on such banks.

e.g. - RBI had put up certain restrictions on the working of the Metropolitan Co-

operative Banks. Also the ‘Bank of Karad’ had to come to an end in 1992

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.

Quantitative Method

By Quantitative Credit Control we mean the control of the total quantity of

credit. For Example- let us consider that the Central Bank, on the basis of its

calculations, considers that Rs. 50,000 is the maximum safe limit for the expansion

of credit. But the actual credit at that given point of time is Rs. 55,000(say). Thus it

then becomes necessary for the Central Bank to bring it down to 50,000 by

tightening its policies. Similarly if the actual credit is less, say 45,000, then the

apex bank regulates its policies in favor of pumping credit into the economy.

Different tools used under this method are-

Bank Rate

Bank Rate also known as the Discount Rate, the official minimum rate at which the

Central Bank of the country is ready to rediscount approved bills of exchange or

lend on approved securities.

Section 49 of the Reserve Bank of India Act 1934, defines Bank Rate as

“the standard rate at which it (RBI) is prepared to buy or re-discount bills of

exchange or other commercial paper eligible for purchase under this Act”.

When the commercial bank for instance, has lent or invested all its

available funds and has little or no cash over and above the prescribed minimum, it

may ask the central bank for funds. It may either re-discount some of its bills with

the central bank or it may borrow from the central bank against the collateral of its

own promissory notes.

In either case, the central bank accommodates the commercial bank and

increases the latter’s cash reserves. This Rate is increased during the times of

inflation when the money supply in the economy has to be controlled.

At any time there are various rates of interest ruling at the market, like the

Deposit Rate, Lending Rate of commercial banks, market discount rate and so on.

But, since the central bank is the leader of the money market and the lender of the

last resort, al other rates are closely related to the bank rate. The changes in the

bank rate are, therefore, followed by changes in all other rates as the money

market.

The graph on the right hand side shows variations in the Bank Rate since 1935-

2011.

Working of the Bank Rate

This section will answer how Bank Rate policy operates to control the level of

prices and business activity in the country.

Changes in bank rate are introduced with a view to controlling the price

levels and business activity, by changing the demand for loans. Its working is

based upon the principle that changes in the bank rate results in changed interest

rate in the market.

Suppose a country is facing inflationary pressure. The Central Bank, in such

situations, will increase the bank rate thereby resulting to a hiked lending rate. This

increase will discourage borrowing. It will also lead to a fall in the business

activity due to following reasons.

• Employment of some factors of production will have to be reduced by the

businessmen.

• The manufacturers and stock exchange dealers will have to liquidate their

stocks, which they held through bank loans, to pay off their loans.

FISCAL POLICY

• It refers to the Revenue and Expenditure policy of the Govt. which is generally

used to cure recession and maintain economic stability in the country.

How is theMonetary Policy different from the Fiscal Policy?

• The Monetary Policy regulates the supply of money and the cost and availability

of credit in the economy. It deals with both the lending and borrowing rates of

interest for commercial banks.

• The Monetary Policy aims to maintain price stability, full employment and

economic growth.

• 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, whereas fiscal

policy is a broader tool with the government.

• The Fiscal Policy can be used to overcome recession and control inflation. It may

be defined as a deliberate change in government revenue and expenditure to

influence the level of national output and prices.

INSTRUMENTS OF FISCAL POLICY

• Reduction of Govt. Expenditure

• Increase in Taxation

• Imposition of new Taxes

• Wage Control

• Rationing

• Public Debt

• Increase in savings

• Maintaining Surplus Budget

Other Measures

• Increase in Imports of Raw materials

• Decrease in Exports

• Increase in Productivity

• Provision of Subsidies

• Use of Latest Technology

• Rational Industrial Policy

References

1. Konni, Donnel C.O. and Weighnrich. H., Management, Eight Edition,

McGraw Hill

International Book Company, 1997.

2. Philip Kotler, Marketing Management, Prentice-Hall of India, Edition 1998.

3. Aninnya Sen, Microeconomics – Theory and Apoplications , OUP.

4.Heyne, P. T., Boettke, P. J., Prychitko, D. L. (2002): The Economic Way of

Thinking (10th ed). Prentice Hall.

5.Larch, M. and J. Nogueira Martins (2009): Fiscal Policy Making in the

European Union - An Assessment of Current Practice and Challenges.

Routledge.