RBI- MONETARY EASING/TIGHTENING

IN NEXT REVIEW?

SRAVANI KARRI

BHAGIRATH M P

NIKHAR KEDIA

SAURAV MISHRA

Changes in monetary stance (last 10-year period)

Phase I of 5 years of 2003-08 of high growth but rising inflation concern towards the later part of the period when repo rate was raised from 6 per cent to 9 per cent and the cash reserve ratio (CRR) was raised from 4.5 per cent to 9 per cent.

Phase II of 2 years of 2008-10 following the global financial crisis when the repo rate was reduced from 9 per cent to 5.25 per cent and CRR was reduced from 9 per cent to 5.75 per cent.

Phase III of 2 years of 2010-12 of monetary tightening responding to rising inflation when policy rate was raised from 5.25 per cent to 8.5 per cent but CRR was reduced to 5.5 per cent.

Phase IV of over a year of monetary easing in 2012-13 and 2013-14 so far with the repo rate reduced to 7.25 per cent and CRR lowered to 4.0 per cent; though since mid-July 2013, the RBI has tightened the monetary and liquidity conditions without changing the policy repo rate and CRR to address exchange market volatility.

Tools of Monetary Policy Bank rate: Rate at which RBI allows finance to commercial banks

CRR: Maintaining a daily cash reserve equivalent with RBI. Used to impound excess liquidity or release funds into the economy

SLR: Minimum portion of Net Demand and time liabilities in form of cash, gold, etc. as liquid assets, in addition to cash reserve requirements

Repo/ Reverse-Repo rate:

Repo rate is the rate at which the RBI lends money to commercial banks in the event of any shortfall of funds. Repo rate is used by monetary authorities to control inflation.

Reverse repo rate is the rate at which theRBI borrows money from commercial banks within the country. It is a monetary policy instrument which can be used to control the money supply in the country.

Open market operations : Involves buying and selling of govt. securities by RBI to influence volumes of cash reserves .

Monetary Easing

Used by central bank to stimulate the economy when standard economic policy has become ineffective

How is it done?

Buying financial assets (eg. bonds) from commercial banks via open market operations

Purpose?

Flood them with reserves (cash in the vault) in hopes that they will lend it out and start a virtuous cycle of investment and consumption.

Aimed at: Price levels (Inflation),Liquidity conditions(Policy rates reduced), CAD (less monetary easing)

Cut in CRR, Repo rate, MSF

Policy rate measures’ Lag time:

Inflation: 3-4 quarters

Growth : 2-3 quarters

Monetary Tightening

Monetary Tightening: In order to control or reduce the inflation in a country, the central bank may use some monetary policies. This is called Monetary Tightening

Reserve Bank of India often does this by increasing interest rates which might result into decrease in Liquidity.

When the Liquidity decreases and the demand for money decreases which might result in lower inflation

However this is not the case in present scenario

GDP in India

Per Capita GDP in India is around $1,491 in 2012; 141th position amongst all countries

Time Period GDP growth Comments

2004-05 to 2010-11 8.5% -

2008-09 6.7% Global financial crises

2009-10 8.6%

2010-11 9.3%

2011-12 6.2% Euro crises, slump in world economy

2012-13 5.0% Domestic policy constraints, manufacturing & services

1Q 2013-14 4.4% CAD, Currency, sentiment

GDP growth numbers

Agriculture~15%

Manufacturing~25%

Services~60%

Components of GDP

Current Scenario

RBI is raising interest rates

July : 7.25

Sept: 7.5

Oct : 7.75

Nov : Expected to go up

Expectation

Interest Liquidity Demand Inflation

Reality

In spite of two consecutive raises in interest rates the inflation is at a 10 month high at 7%

Rationale

Inflation is currently driven by exogenous factors

WPI food inflation at 18.19%

Driven mostly due to fuel prices and increased demand

Falling rupee compounding the problem

20% avg hike in rural wages

Result of tightening policy

GDP forecast further revised to 4.8%

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