indian bussiness environment

Indian Business Environment

“How has the RBI made changes in the Monetary Policy after the liberalisation of the economy to achieve the predetermined

objectives during the First Five Year Plan”

Submitted By-Kartikeya Sharma- 14MI511Navanshu Agarwal- 14MI515Pritish Chauhan- 14MI516Shikhin Gupta- 14MI537Rakesh Kumar-14MI540

Monetary policy The monetary policy of any country refers to the regulatory policy, whereby the monetary

authority maintains its control over the supply of money for the realization of general economic objectives.

In a Narrow sense monetary policy means monetary matters and decisions of a country which aim at controlling the volume of money, influencing the level of interest rates, public spending, use of money and credit etc.

In a Broader sense, it includes all those monetary and non-monetary measures and decisions which influence the cost and supply of money.

In the context of developing economies like India, monetary policy has to be designed to meet the particular requirements of the economy. It stimulates or discourages spending on goods and services and, thus, influences economic activities and prices by regulating the supply of money, and the cost and availability of credit to producers and consumers in the economy. Households and business units make spending and investment decisions based upon current and expected future monetary policy actions. The various sectors of the economy respond in different ways, depending on the extent to which they are borrowers or lenders and the importance and relative availability of credit to the sector. By affecting the demand side of the economy, monetary policy tries to damp or perhaps even eliminate business fluctuations - economy-wide recessions and booms arising from fluctuations in aggregate demand.

Neutrality of Money: It means that the supply of money in the economy should remain constant as any monetary change is the root cause of all economic fluctuations. According to neutralists, the monetary change causes distortion and disturbances in the proper operation of the economic system of the country and if somehow neutral monetary policy is followed, there will be no cyclical fluctuations, no trade cycle, no inflation and no deflation in the economy.

Price Stabilization: Price Stability implies promoting economic development with considerable emphasis on price stability. The centre of focus is to facilitate the environment which is favourable to the architecture that enables the developmental projects to run swiftly while also maintaining reasonable price stability.

Achieving price stability has remained the dominant objective of monetary policy of Reserve Bank of India. It may however be noted that price stability does not mean absolutely no change in price at all. In a developing economy like ours some changes in relative prices do occur that generally put upward pressure on prices. Therefore, some changes in price level or, in other words, a certain rate of inflation is inevitable in a developing economy. Thus, price stability means reasonable rate of inflation. A high degree of inflation has adverse effects on the economy.

Objectives of Monetary Policy

Full Employment Level: Monetary policy helps in employment generation and aims to achieve full utilization of resources by influencing the rate of investment and allocation of investment among various economic activities of different labour Intensities. Full employment exists when all those who are ready to work at the existing wage rate get work

Foreign Exchange Stabilization: Monetary aim to achieve the stability of foreign exchange rate. If the rate of exchange is stable it shows that economic condition of the country is stable. Fluctuations in the exchange rate demote foreign investors against making investments as they are afraid that they might loose money.

Economic Growth: Monetary policy plays very effective role in promoting economic growth by providing adequate credit to productive sectors. It promotes sustained and continuous economic growth by maintaining an equilibrium between the total demand for money and total production capacity and further creating favourable conditions for saving and investment.


The problem is that these 5 objectives are contradictory. Neutrality of money wont help to achieve full employment level. Maintaining price stability, discourages producers from making more investment as the profit margin remains the same and as a result economic growth is hindered. Similarly if economic growth is favoured, then price stabilization wont be maintained.

The economic condition of a country determines the set of objectives chosen. Indian objectives are ‘Reduction in Inflation’ and ‘Economic Growth’. Monetary policy is reviewed and changed frequently to help out in this. These two objectives are contradictory as for more economic growth we want more money to be circulating in the economy but that means more money in hands of the consumer, leading to inflation.


The Quantitative Instruments are also known as the General Tools of monetary policy. These tools are related to the Quantity or Volume of the money. The Quantitative Tools of credit control are also called as General Tools for credit control. They are designed to regulate or control the total volume of bank credit in the economy. These tools are indirect in nature and are employed for influencing the quantity of credit in the country. The general tool of credit control comprises of following instruments:

Bank Rate (6.75%)- Bank Rate is the rate at which the RBI lends money to the commercial banks for their liquidity requirements or the rate of discounting the commercial bills of exchange. In other words bank rate is the rate at which the RBI rediscounts eligible papers (like approved securities, bills of exchange, commercial papers etc) held by commercial banks. Bank rate is important because its is the pace setter to other market rates of interest. Bank rates have been changed several times by RBI to control inflation and recession.

Quantitative instruments of monetary policy

Cash Reserve Requirements (4.00%)- The Cash Reserve Ratio (CRR) is an effective instrument of credit control. Under the RBl Act of, 1934 every commercial bank has to keep certain minimum cash reserves with RBI. The RBI is empowered to vary the CRR between 3% and 15%. A high CRR reduces the cash for lending and a low CRR increases the cash for lending.

Statutory Liquidity Requirements (20.75%)- SLR is the amount that commercial banks are required to maintain in the form of gold or government approved securities before providing credit to the customers. SLR is stated in terms of a percentage of total deposits available with a commercial bank and is determined and maintained by the RBI in order to control the expansion of bank credit

Open Market Operations- It refers to buying and selling of government securities in open market in order to expand or contract the amount of money in the banking. . The RBI sells government securities to control 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.

Quantitative instruments of monetary policy

The Qualitative Instruments are also known as the Selective Tools of monetary policy. These tools are not directed towards the quality of credit or the use of the credit. They are used for discriminating between different uses of credit. It can be discrimination favouring export over import or essential over non-essential credit supply. This method can have influence over the lender and borrower of the credit. The Selective Tools of credit control comprises of following instruments:

Ceiling On Credit- The Ceiling on level of credit restricts the lending capacity of a bank to grant advances against certain controlled securities.

Margin Requirements-A loan is sanctioned against Collateral Security. Margin means that proportion of the value of security against which loan is not given. Margin against a particular security is reduced or increased in order to encourage or to discourage the flow of credit to a particular sector. It varies from 20% to 80%. For agricultural commodities it is as high as 75%. Higher the margin lesser will be the loan sanctioned.

Qualitative instruments of monetary policy

Discriminatory Interest Rate- Through DIR, RBI makes credit flow to certain priority or weaker sectors by charging concessional rates of interest. RBI issues supplementary instructions regarding granting of additional credit against sensitive commodities, issue of guarantees, making advances etc. .

Directives- The RBI issues directives to banks regarding advances. Directives are regarding the purpose for which loans may or may not be given.

Direct Action- It is too severe and is therefore rarely followed. It may involve refusal by RBI to rediscount bills or cancellation of license, if the bank has failed to comply with the directives of RBI.

Moral Suasion- Under Moral Suasion, RBI issues periodical letters to bank to exercise control over credit in general or advances against particular commodities. Periodic discussions are held with authorities of commercial banks in this respect.

Qualitative instruments of monetary policy

The evolution of monetary policy framework in India can be seen in phases: In the formative years during 1935–1950, the focus of monetary policy was to

regulate the supply of and demand for credit in the economy through the bank rate, reserve requirements and open market operations (OMO).

In the development phase during 1951–1970, monetary policy was geared towards supporting plan financing. This led to introduction of several quantitative control measures to contain consequent inflationary pressures. While ensuring credit to preferred sectors, the bank rate was often used as a monetary policy instrument.

During 1971–90, the focus of monetary policy was on credit planning. Both the statutory liquidity ratio (SLR) and the cash reserve ratio (CRR) were used to balance government financing and the attendant inflationary pressure.

Evolution of monetary policy in india

Subsequently, structural reforms and financial liberalisation in the 1990s shifted the financing paradigm for the government and commercial sectors with increasingly market-determined interest rates and exchange rate.

By the second half of the 1990s, in its liquidity management operations, the Reserve Bank was able to move away from direct instruments to indirect market based instruments. Starting in April 1999, the Reserve Bank introduced a full-fledged liquidity adjustment facility (LAF). It was operated through overnight fixed rate repo and reverse repo in November 2004. When the weighted average overnight call money rate was explicitly recognised as the operating target of monetary policy and the repo rate was made the only one independently varying policy rate

Evolution of monetary policy in india

The three major objectives of economic policy in India have been Growth, social justice and price stability. Government of India tries to manipulate it’s Monetary Policy, the Reserve Bank of India which is the Monetary authority in the country. The Monetary Policy of the Reserve Bank has been characterized are as of controlled monetary expansion. It aims at controlling inflation by restraining the secondary expansion of credit and regulating the supply of money in order to meet the requirements of different sectors of the economy to accelerate the pace of economic growth.

The Monetary Policy of RBI has undergone major changes during the economic reforms. Monetary Policy was separated from the Fiscal Policy after 1991. The major changes in the Indian Monetary Policy after Liberalisation were as follows:

Reduced CRR and SLR- The Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio(SLR) were gradually reduced during the economic reforms period in India. It was reduced from the earlier high level of 15% plus incremental CRR of 10.5% to 6% level .The SLR was also reduced from early 30.5% to a minimum of 24% level. This left more loan able funds with commercial banks.

Reforms since liberalisation

Increased Micro Finance- The RBI started focusing more on the SHG (Self Help Groups) to strengthen the Rural Finance. Micro Finance Institutions (MFIs) were kept under priority sector lending

Fixing Prudential Norms- In order to induce professionalism in its operations, the RBI fixed prudential norms for commercial banks. It includes recognition of income sources, classification of assets, provisions for bad-debts, maintaining international standards in accounting practices etc. It helped banks in reducing and re-structuring non-performing assets (NPAS).

Introduction of CRAR- Capital to risk weighted assets ratio (CRAR) was started in 1992. Almost all the banks in India were to reach the capital adequacy ratio (CAR) above the statutory level of 9%.

Diversification of Banking- The Indian Banking sector was well-diversified. Many of the banks started new services and new products. Some bank even established subsidiaries in Merchant Banking, Mutual Funds, Insurance, Venture Capital etc.


Operational Autonomy- During this reforms period commercial banks enjoyed the operational freedom. If a bank satisfied the CAR then it got freedom in opening new branches.

Improved Profitability and Efficiency- During the reform period, the productivity and efficiency of many commercial banks was improved. It happened due to reduced, non-performing loans, use of technology, use of computers and some other relevant measures adopted by the govt.

Changes in Accordance to the External Reforms- The external sector went through major changes. It comprised of various controls on imports, reduce tariffs, etc. The Monetary Policy showed the impact of liberal inflow of the foreign capital and its implication on domestic money supply.


Management of key policy variables by RBI Over the Years

During the reforms though Monetary Policy has achieved higher success. It is not free from limitation or demerits. It needs to be evaluated on a proper scale:

Monetary Policy fails to tackle Budgetary Deficit- The higher level of budget deficit has made Monetary Policy ineffective. The automatic monetization of deficit has let to high monetary expansion.

The coverage area of Monetary Policy is limited- Monetary Policy covers only commercial banking sector. Other non-banking institutions remains untouched. It limits the effectiveness of the Monetary Policy in India.

Money market is not organized- There is a huge size of money market in our country. It does not come under the control of the RBI. Thus any tools of the Monetary Policy does not affect the unorganized money market making Monetary Policy less affective.

Predominance of cash transaction- In India still there is huge dominance of the cash in total money supply. It is one of the main obstacles in the effective implementation of the Monetary Policy. Because monetary policy operates on the bank credit rather on cash.

Increase volatility –As the Monetary has adopted changes in accordance to the changes in the external sector in India, It could lead to high amount of the volatility

Economists have warned that high inflation could slow down India's economic momentum, making it difficult to achieve the ambitious target of more than nine percent growth.

Drawbacks in Monetary Policy

Highlights:

-Repo Rate has been reduced by 25 basis points from 6.50% to 6.25%-Consequently, the reverse repo rate stands adjusted to 5.75 per cent, and the marginal standing facility (MSF) rate and the Bank Rate to 6.75 per cent.-Cash Reserve Rate (CRR) @ 4.00% has been unchanged since 9th February 2013-Statutory Liquidity Ratio (SLR) was reduced to 20.75% from 1st October 2016

Analysis of Current Monetary Policy

India recently set an inflation target of 4% with a tolerance band of +/-2%. This target is potentially fraught with the impact of the 7th Pay Commission, seasonality in food prices, fluctuation in international crude prices and the roll-out of the Goods and Services Tax from April 2017. Commenting on the impact of GST on inflation the regulator said that it would depend on the rate decided by the GST council.

While the impact of the GST on CPI inflation would largely depend on the standard rate decided by the GST Council, almost 50 per cent of the CPI is expected to be exempt. The regulator also noted that the GST implementation might have one-off effects, which tend to dissipate after a year of its implementation.

Even the Reserve Bank’s survey of professional forecasters indicated a better anchoring of their inflation expectations, and expect inflation to ease to 4.7 per cent by 2017 and to 4.4 per cent by 2018, both lying within the Reserve Bank’s inflation target band.

Reserve Bank of India Governor Urjit Patel cut interest rates by a quarter point as forecast by economists citing softening inflation outlook and retained growth forecast but said outlook is improving with good monsoon.


The sharp drop in inflation reflects a downward shift in the momentum of food inflation – which holds the key to future inflation outcomes – rather than merely the statistical effects of a favourable base effect.

The RBI lowered its repo rate by 25 basis to 6.25% and maintained that it would continue with its accommodative monetary stance.

The Reserve Bank of India hopes that the growth momentum in the economy would continue. The momentum of growth is expected to quicken with a normal monsoon raising agricultural growth and rural demand, as well as by the stimulus to the urban consumption spending from the pay commission’s award. The Reserve Bank of India in its Monetary Policy Report has stated that the seasonal surge in sensitive food times like pulses, fruits and vegetables may have peaked in July, considerably improving its near-term inflation outlook.


Thank You

PS: Sonam Gupta Bewafa Hai

indian bussiness environment

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