Monetary Policy of India

SUDHANSHU ANAND(07)B.COM(H) SECTION -1

ContentsIntroductionObjectivesInstrumentsQuantitative methodsQualitative methodsInflationMeaningProblems caused by InflationEffect of Monetary policy on inflation

INTRODUCTION

Monetary Policy Meaning.Reserve Bank of India states that,Monetary policy refers to the use of instruments under the control of the central bank to regulate the availability, cost and use of money and credit.

ObjectivesMaintaining price stabilityEnsuring adequate flow of credit to the productive Sectors of the economy to support economic growthRapid economic growthBalance of payment equilibriumFull employmentEquitable income distribution

MethodsThe RBI aims to achieve its objectives of economic growth and control of inflation through various methods.

These methods can be grouped as: General/ quantitative methods Selective/ qualitative methods

General/ Quantitative methods

These methods maintain and control the total quantity or volume of credit or money supply in the economy.Open Market OperationsOpen market operations indicate the buying/ selling of govt. securities in the open market to balance the money supply in the economyDeployment of CreditThe RBI has taken various measures to deploy credit in different sector of the economy. The certain %age of the bank credit has been fixed for various sectors like agriculture, export etc.

Direct InstrumentsCash reserve ratio (CRR)The money supply in the economy is influenced by CRR. It is the ratio of a banks time and demand liabilities to be kept in reserve with the RBI. The RBI is authorized to vary the CRR between 3% and 15%.

Statutory liquidity ratio (SLR): Under SLR, banks have to invest a certain percentage of its time and demand liabilities in govt. approved securities. The reduction in SLR enhances the liquidity of commercial banks.

Indirect InstrumentsLiquidity Adjustment Facility (LAF): Consists of daily infusion or absorption of liquidity on a repurchase basis, through repo (liquidity injection) and reverse repo (liquidity absorption) auction operations, using government securities as collateral.Repo Rate: Repo rate is the rate at which the RBI lends short-term money to the banks against securities. When the repo rate increases borrowing from RBI becomes more expensive.Reverse Repo Rate: The rate at which RBI borrows from commercial banks.

Bank rate: Bank Rate is the rate at which central bank of the country (in India it is RBI) allows finance to commercial banks. Bank Rate is a tool, which central bank uses for short-term purposes. Any upward revision in Bank Rate by central bank is an indication that banks should also increase deposit rates as well as Base Rate / Benchmark Prime Lending Rate.

Market Stabilization Scheme (MSS):Liquidity of a more enduring nature arising from large capital flows is absorbed through sale of short-dated government securities and treasury bills. The mobilized cash is held in a separate government account with the Reserve Bank.

SELECTIVE/ QUALITATIVE MEASURESThe RBI directs commercial banks to meet their social obligations through selective/ qualitative measures. These measures control the distribution and direction of credit to various sectors of the economy.

CEILING ON CREDITMARGIN REQUIREMENTSDISCRIMINATORY RATES OF INTEREST

INFLATIONInflation is broadly understood as the general rise in the prices of goods and services year on year, inflation is a more complex phenomena associated with the money supply and currency values.

Problems caused by InflationHigh and persistent inflation imposes significant socio-economic costs.High inflation distorts economic incentives by diverting resources away from productive investment to speculative activities. Inflation reduces households saving as they try to maintain the real value of their consumption.If domestic inflation remains persistently higher than those of the trading partners, it affects external competitiveness through appreciation of the real exchange rate.The Reserve Banks current assessment suggests that the threshold level of inflation for India is in the range of 46 per cent.

How does monetary policy affect inflation and other problems?

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