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MONETARY POLICY OF RBI

BY : VINISHA CHANDIL

MONETARY POLICY

Regulation of supply of Money and Cost and Availability of Credit in the economy.

Variables affected by Monetary Policy in the

economy

Interest RatesLiquidityCredit AvailabilityExchange Rates

Purpose of Monetary Policy Maintain price stability, ensure adequate flow of credit to the productive sectors of the economy and overall economic growth.

FISCAL POLICY

Use of “Government Expenditure”, and “taxation” to manage the economy.

Variables affected by Fiscal Policy in the economy

Aggregate demand and the level of economic activity The pattern of resource allocationThe distribution of income.

Purpose of Fiscal Policy Stabilise economic growth, avoiding the boom and bust economic cycle

How is the Monetary Policy different from the

Fiscal Policy?

MONETARY POLICY FISCAL POLICY

• Regulates the supply of money.

• Regulates the cost and availability of credit in the

economy.•Deals with both the

lending and borrowing rates of interest for commercial banks.

•Aims to maintain price stability, full employment

and economic growth.

•Defined as a deliberate change in government

revenue and expenditure to influence the level of

national output and prices.

•Broader tool with the government .

•Used to overcome recession and control

inflation.

6Monetary Policy

ABOUT MONETARY POLICY

It is a process by which the monetary authority of a country controls

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

purpose of promoting economic growth and stability.

In INDIA, RBI was established on April 1,1935 with the provisionof Reserve bank of India Act .

RBI controls the monetary policy. It is announced twice a year,

through which RBI, regulate the price stability for the economy.

1.Slack season policy April-September

2.Busy season policy October-March

GOAL OF MONETARY POLICY To maintain relatively stable Prices and Low

unemployment

OBJECTIVES

Rapid Economic Growth

Price Stability

Exchange Rate Stability

Balance of Payments (BOP) Equilibrium

Full Employment

FORMS OF MONETARY POLICY

Expansionary policy Increases the total supply of money

in the economy rapidly

Contractionary policy Decreases the total money

supply, or increases it slowly

Expansionary policyis used to combat unemployment

in a recession by lowering Interest Rates .

Contractionary policy involves raising interest rates

to combat inflation.

ELEMENTS OF MONETARY

POLICY

QUANTITATIVE

MEASURES

QUALITATIVE

MEASURES

• Bank rate

• Open market

operations

• Cash reserve ratio

(CRR)

• Statutory liquidity

ratio (SLR)

• Rationing of credit

• Moral Suasion

• Direct Action

• Regulation in

consumer credit

• Marginal standing

facility(MSF)

BANK RATE POLICY

• Bank rate is the

minimum rate at which

the Central bank provides

loans to the commercial

banks. It is also called the

Discount rate.

• The bank rate has been

12.00% in 1991

8.75% in 2013

8.75% in 2015

Dear money policy

Bank rate

interest rate

borrowing will be less profitable

results contraction

of credit

Near money policy

Bank rate

interest rate

borrowing will be more profitable

results expansion of

credit

BANK RATE• Bank Rate is a tool, which central

bank uses for short-term purposes.

• Funds are provided either through lending directly or rediscounting or buying money market instruments like commercial bills and treasury bills.

• 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.

• This any revision in the Bank rate indicates could mean more or less interest on your deposits and also an increase or decrease in your EMI.

OPEN MARKET OPERATIONS An open market operation is an instruments of monetary

policy which involves buying or selling of

government securities from or to the public and banks.

This mechanism influences the reserve position of the

banks, yield on government securities and cost of bank

credit.

• 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.

OMO’s TOOL

REPO RATE REVERSE REPO RATE

Repo rate is the rate at which RBI lends to commercial banks generally against

government securities

Reverse Repo rate is the rate at which RBI

borrows money from the commercial banks

Tightening of the policy

The repo rate is 7.75 % The reverse repo rate is 6.75%.

Reverse Repo Rate

LOAN TAKER

=RBI

Repo Rate

LOAN TAKER

= BANK

REPO RATE IS ALWAYS HIGHER

THAN

REVERSE REPO RATE

CASH RESERVE RATIO

It is the percentage of total deposit in which CommercialBanks are required to maintain in the form of cash reserves.

When the RBI feels that the money supply is increasing andcausing an upward pressure on inflation, the RBI has the optionof increasing the CRR thereby reducing the deposits availablewith banks to make loans and hence reducing the moneysupply and inflation.

• Increase in CRR means that banks have less funds available and money is sucked out of circulation.

• Thus we can say that this serves duel purposes i.e. it not only ensures that a portion of bank deposits is totally risk-free, but also enables RBI to control liquidity in the system, and thereby, inflation by tying the hands of the banks in lending money.

STATUTORY LIQUID RATIO

Every financial institution has to maintain/invest a certain quantity of liquid assets with themselves at any point of time of their total time and demand liabilities before providing credits to its customer.

These assets can be cash, precious metals, approved securities like bonds etc. The current SLR is 21.50%.

CREDIT RATIONING

It refers to the situation where lenders limit the supply of additionalcredit to borrowers who demand funds, even if the latter are willingto pay higher interest rates.

Minimum of “Capital : Total Assets” (ratio between capital and totalasset) can also be prescribed by Reserve Bank of India.

Generally two measures are adopted:

Imposition of upper limits on the credit available to welldeveloped industries and large scale firms.

Charging a higher or progressive interest rate on bank loansbeyond a certain limit.

Moral Suasion

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.

21Monetary Policy

DIRECT CONTROL

This method is adopted when a commercial bank does notco-operate the central bank in achieving its desirableobjectives.

It is used as a last resort in case other methods prove

ineffective.

In this method the monetary authorities with clear directive to

carry out their lending activity in a specified manner.

Most of the consumer durables like T.V., Refrigerator, Motorcar, etc. are available on

installment basis.

If there is excess demand for certain consumer durables leading to their high prices, central bank can reduce consumer credit by (a) increasing down payment, and (b) reducing the number of installments of repayment of such credit.

Regulation in Consumer Credit

CHANGE IN LENDING MARGINS

MARGINAL REQUIREMENTS

It is the gap between the value of the mortgaged property and the

amount advanced. RBI increases lending margins to decrease

bank credit.

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.

• Inflation refers to a persistent rise in pricesInflation

• Total volume of money circulating in the economyMoney Supply

• Minimum rate at which the central bank provides loans to commercial banksBank Rate

• Amount of money that banks must set aside with RBI against their depositsCash Reserve Ratio (CRR)

• Percentage of bank funds to be maintained in government and approved securities

Statutory Liquidity Ratio (SLR)

• Rate at which RBI lends to other banks against government securitiesRepo Rate

• Rate at which RBI borrows from other banksReverse Repo Rate

• Capacity of bank meeting the time liabilities and other riskCapital Adequacy Ratio

(CAR)

• Purchase and sale of securities in the open marketOpen Market Operations

(OMO)

MONETARY POLICY – TERMINOLOGY

• 8.75% (w.e.f. 15 Jan 2015)Bank Rate

• 4.00% (w.e.f. 9 Feb 2013)CRR

• 21.50% (w.e.f. 7 Feb 2015)SLR

• 7.75% (w.e.f. 15 Jan 2015)Repo Rate

• 6.75% (w.e.f. 28 Jan 2015)Reverse Repo

Rate

• 8.75% (w.e.f. 15 Jan 2015)Marginal (MSF)

CURRENT RATES

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