Monetary Policy

Manish Sharma
WHAT IS MONETARY POLICY

 The part of the economic policy which regulates

the level of money in the economy in order to
regulate inflation, improve balance of payments,
increase gross national product etc. RBI, in case
of India controls the monetary policy.
 The policy statement traditionally announced
twice a year through which RBI insures Price
stability for the economy.
– April-September - Slack Season Policy
– October-March - Busy Season Policy
 RBI reserves its right to alter monetary policy to
time to time depending upon state of economy
How is the Monetary Policy
different from the Fiscal
Policy?
 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

 Fiscal policy is a broader tool with the

government to overcome recession and
control inflation through change in
government revenue and expenditure to
influence the level of national output and
prices.
 AIM OF MONETARY POLICY
 Maintain price stability
 Flow of credit to the productive sector of economy
 Stability of national currency
 Growth in employment & income
 Achieving foreign exchange stability
 Managing suitable level of investment and savings
 Regulating rate of interest & induce higher level of
investment
 Achieving monetary equilibrium to ensure equality
between demand & supply of money.
 Instruments of Credit
control
 QuantitativeCredit control:
Controls the quantity of money in the
economy

 Qualitative
Controls:
Controls the direction of flow of
money
 QUANTITATIVE - Tools
 Bank Rate-The rate at which RBI extends
credit to comm. Banks .
 PLR-The rate which banks allows their
personal customers.
 CRR-The percentage of bank’s deposits which
they must keep as cash with RBI.
 SLR-A comm. Bank has to keep a portion of
total deposits with itself in liquid assets.
 Open Market Operations
 LAF – Repo & reverse Repo
 MSS – Market stabilization scheme
 BANK RATE
 Banks use this rate to price their Long
term loans to individual and companies
 Increase in Bank rate Increase in
lending rate of Commercial Banks
Decline in aggregate money expenditure
lowering inflation
and vice versa.
 This tool now not much in use and
remains same since years .
Quantitative Credit Controls
 Bank Rate:
 Bank rate is the minimum rate at which the
central bank provides loans to the commercial
banks. It is also called the discount rate.
 Usually, an increase in bank rate results in
commercial banks increasing their lending rates.
Changes in bank rate affect credit creation by
banks through altering the cost of credit.
 TRENDS OF BANK RATE
Bank Rate In 1940’s BR was at
low 3% and
14.00 remained
12.00 unchanged till
10.00 1953.In 1953 RBI
adopted policy
in %

8.00
6.00 controlled expansion
4.00 BR raised to 3.5%.It
2.00
reached at max.
0.00
level in 1991 12%.
Presently it is 6%
52

53

81

90

91

97

01

07
40
19

19

19
19

19

19

19

20

20

Years
Quantitative Credit controls
 Prime lending Rate: (presently – 12.75-13.25%)

 PLR or prime lending rate as the rate of interest at which banks

lend to their credit-worthy or favoured customers. It is treated
as a benchmark rate for most retail and term loans.

 The RBI does not set these rates, but in a broad way stipulates
the interest rates in the economy. The banks are at liberty to
lend at a rate above or below the RBI’s.

 The PLR is influenced by RBI’s policy rates — the repo rate and
cash reserve ratio — apart from the bank’s policy. In simple
words, availability of funds in the banking system and demand
for credit by consumers (both retail and industrial) determine
what the PLR should be.
 CASH RESERVE RATIO
 RBI has the power to vary this ratio and there by
use it as an instrument of Credit Control.
Permissible limit is 3 to 15%(1962)
 It is essential for a bank to maintain the ratio or
otherwise it may not be able to meet the
withdrawal demand of all its depositors, and failure
to do so may eventually result in failure of the
bank.
 Increase in CRR reduce the excess reserves
available to a bank for lending contracting
Credit
 Increase in CRR absorbs Foreign Capital
Inflows checking rupees appreciation.
TRENDS OF CRR
 In beginning it was
5% of demand
deposit & 2% of time
deposits
 Reached max. in
1991,92 after 1993 it
followed Narsimham
report & decreased.
 But from dec.06 it
raised 7 times, 250bp
to cool credit growth
& supply.
 STATUTORY LIQUIDITY RATIO

 Statutory Liquidity Ratio

 Narsimham committee recommended to
reduced it at minimum level. According to that
it is 25%and remains unchanged.
 Khan committee suggested abolishment of
SLR.

The buying & selling of these securities laid the

foundation of the 1992 Harshad Mehta scam.
TRENDS OF SLR

It was 25% in 1949

after that it increased
continuously
32%(1972)--- 35%
(1981)---36%(1984)---
38%(1988).
From 1997 it is
constant at 25%
OMOs-Meanings & Objectives

 Open Market Operations-these refer to

the sale and purchase of Govt.
securities by the RBI
 The main objective of these operations
has been to stabilizes the prices of
Govt. securities. The control of
inflationary pressures has, however
been the secondary objectives.
 It is used several times after 1991 for
controlling inflows.
 Open market Operations
 The RBI conducts open market
operations (OMO) by offering to buy or
sell gilts.
 If it feels interest rates are too high, it
may bring them down by offering to
buy securities at a lower yield than
what is available in the market.
(a) MSS-market stabilization scheme
(b) LAF-Liquidity adjustment facility
(repo and reverse repo)
 12
OMO - TOOLS
 Repo Rate
10
This is the rate at which the
central bank adds funds to the
monetary market. Present rate
7.75% 8

 Reverse Repo Rate

The rate at which the central 6
bank borrows funds from the
market. It impacts Govt. bond
yields and short term bank
deposits. Present rate 6% 4

0
 EXPERT’S VIEWS

“ Monetary policy must accommodate primary

supply shocks and then curbs secondary
effects. The prime aim of Monetary policy
should be targeting stability.”
Raghuram C Rajam, economist
 LIST OF BOOKS
1. Economics, ICAI
2. Fundamental of Economics- A.S.Raj
3. Managerial Economics- Varshney & Maheshwari
4. Macro Economics- TMH
5. Dictionary of Economics- Jain and saakshi.
6. Indian Economy since Independence- edited by
Uma Kapila
7. Indian Economy- Dutt and Sundaram
8. Economics- Samuelson and Nordhaus
 List of Websites
 www.rbi.gov.in
 www.livemint.com
 www.bloomberg.com
 www.timesofindia.com
 www.thehindu.com
 Thank You
 Q&A