copy of monetary-policy

8/7/2019 Copy of Monetary-Policy

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MONETARY POLICYMONETARY POLICY


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ContentsContents IntroductionIntroduction ObjectivesObjectives ScopeScope

Instruments of Monetary PolicyInstruments of Monetary Policy Quantitative MeasuresQuantitative MeasuresQualitative MeasuresQualitative Measures

Controlling InflationControlling Inflation

Monetary Policy of IndiaMonetary Policy of India


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INTRODUCTIONINTRODUCTION

Monetary Policy is essentially aMonetary Policy is essentially aprogramme of action undertaken by theprogramme of action undertaken by theMonetary Authorities, generally theMonetary Authorities, generally theCentral Bank, to control and regulate theCentral Bank, to control and regulate the

supply of money with the public and thesupply of money with the public and theflow of credit with a view to achievingflow of credit with a view to achievingpre-determined macro-economics goals.pre-determined macro-economics goals.

At the time of inflation monetary policyAt the time of inflation monetary policy

seeks to contract aggregate spending byseeks to contract aggregate spending bytightening the money supply or raisingtightening the money supply or raisingthe rate of return.the rate of return.


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OBJECTIVESOBJECTIVES

To achieve price stability by controllingTo achieve price stability by controlling

inflation and deflation.inflation and deflation.

To promote and encourage economicTo promote and encourage economic

growth in the economy.growth in the economy.

To ensure the economic stability at fullTo ensure the economic stability at full

employment or potential level of output.employment or potential level of output.


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SCOPE OF MONETARY POLICYSCOPE OF MONETARY POLICY

The scope of Monetary policy depends onThe scope of Monetary policy depends on

two factorstwo factors

1.1. Level of Monetization of the Economy -Level of Monetization of the Economy -In this all economic transactions are carried outIn this all economic transactions are carried outwith money as a medium of exchange . This iswith money as a medium of exchange . This is

done by changing the supply of and demand fordone by changing the supply of and demand formoney and the general price level. It is capablemoney and the general price level. It is capableof affecting all economics activities such asof affecting all economics activities such asProduction, Consumption, Savings, InvestmentProduction, Consumption, Savings, Investmentetc.etc.

2.2. Level of Development of the CapitalLevel of Development of the CapitalMarketMarketSome instrument of Monetary Policy are workSome instrument of Monetary Policy are workthrough capital market such as Cash Reservethrough capital market such as Cash Reserve

Ratio (CRR) etc. When capital market is fairlyRatio (CRR) etc. When capital market is fairlydeveloped then the Monetary Policy effects thedeveloped then the Monetary Policy effects the


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The open market operations is sale and purchase ofThe open market operations is sale and purchase ofgovernment securities and Treasury Bills by thegovernment securities and Treasury Bills by thecentral bank of the country.central bank of the country.

When the central bank decides to pump money intoWhen the central bank decides to pump money into

circulation, it buys back the government securities,circulation, it buys back the government securities,bills and bonds.bills and bonds.

When it decides to reduce money in circulation it sellsWhen it decides to reduce money in circulation it sellsthe government bonds and securities.the government bonds and securities.

The central bank carries out its open marketThe central bank carries out its open marketoperations through the commercial banks.operations through the commercial banks.


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Discount rate or bank rate is the rate at whichDiscount rate or bank rate is the rate at whichcentral bank rediscounts the bills of exchangecentral bank rediscounts the bills of exchangepresented by the commercial bank.presented by the commercial bank.

The central bank can change this rate increaseThe central bank can change this rate increaseor decrease depending on whether it wants toor decrease depending on whether it wants toexpand or reduce the flow of credit from theexpand or reduce the flow of credit from the

commercial bank.commercial bank.


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A rise in the discount rate reduces the net worthA rise in the discount rate reduces the net worthof the government bonds against whichof the government bonds against whichcommercial banks borrow funds from the centralcommercial banks borrow funds from the centralbank. This reduces commercial banks capacitybank. This reduces commercial banks capacityto borrow from the central bank.to borrow from the central bank.

When the central bank raises its discount rate,When the central bank raises its discount rate,commercial banks raise their discount rate too.commercial banks raise their discount rate too.Rise in the discount rate raises the cost of bankRise in the discount rate raises the cost of bank

credit which discourages business firms to getcredit which discourages business firms to gettheir bill of exchange discounted.their bill of exchange discounted.


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The cash reserve ratio is the percentage of totalThe cash reserve ratio is the percentage of totaldeposits which commercial banks are required todeposits which commercial banks are required tomaintain in the form of cash reserve with the centralmaintain in the form of cash reserve with the centralbank.bank.

The objective of cash reserve is to prevent shortage ofThe objective of cash reserve is to prevent shortage of

cash for meeting the cash demand by the depositors.cash for meeting the cash demand by the depositors.

By changing the CRR, the central bank can change theBy changing the CRR, the central bank can change themoney supply overnight.money supply overnight.

When economic conditions demand a contractionaryWhen economic conditions demand a contractionary

monetary policy, the central bank raises the CRR. Andmonetary policy, the central bank raises the CRR. Andwhen economic conditions demand monetarywhen economic conditions demand monetaryexpansion ,the central bank cuts down the CRR.expansion ,the central bank cuts down the CRR.


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In India ,the RBI has imposed another reserveIn India ,the RBI has imposed another reserverequirement in addition to CRR. It is calledrequirement in addition to CRR. It is calledstatutory liquidity requirement.statutory liquidity requirement.

The SLR is the proportion of the total depositsThe SLR is the proportion of the total depositswhich commercial banks are statutorily requiredwhich commercial banks are statutorily requiredto maintain in the form of liquid assets into maintain in the form of liquid assets in

addition to cash reserve ratio.addition to cash reserve ratio.


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When there is a shortage of institutional creditWhen there is a shortage of institutional creditavailable for the business sector, the large andavailable for the business sector, the large and

financially strong sectors or industries tend to capturefinancially strong sectors or industries tend to capture

the lions share in the total institutional credit.the lions share in the total institutional credit.

As a result the priority sectors and essential industriesAs a result the priority sectors and essential industries

are of necessary funds.are of necessary funds.

Below two measures are generally adopted:Below two measures are generally adopted:

Imposition of upper limits on the credit available toImposition of upper limits on the credit available to

large industries and firmslarge industries and firms

Charging a higher or progressive interest rate on theCharging a higher or progressive interest rate on thebank loans beyond a certain limit.bank loans beyond a certain limit.


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The banks provide loans only up to a certainThe banks provide loans only up to a certain

percentage of the value of the mortgagedpercentage of the value of the mortgaged

property.property.

The gap between the value of the mortgagedThe gap between the value of the mortgaged

property and amount advanced is called Lendingproperty and amount advanced is called Lending

Margin.Margin.

The central bank is empowered to increase theThe central bank is empowered to increase thelending margin with a view to decrease the banklending margin with a view to decrease the bank

credit.credit.


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The moral suasion is a method of persuadingThe moral suasion is a method of persuading

and convincing the commercial banks toand convincing the commercial banks to

advance credit in accordance with the directivesadvance credit in accordance with the directives

of the central bank in overall economic interestof the central bank in overall economic interest

of the country.of the country.

Under this method the central bank writes letterUnder this method the central bank writes letter

to hold meetings with the banks on money andto hold meetings with the banks on money and

credit matterscredit matters.


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An Expansionary Policy increases the total supplyAn Expansionary Policy increases the total supplyof money in the economy while a Contractionaryof money in the economy while a Contractionary

Policy decreases the total money Supply into thePolicy decreases the total money Supply into the

market.market.

Expansionary policy is traditionally used toExpansionary policy is traditionally used to

combat a recession by lowering interests rates.combat a recession by lowering interests rates.

Lowered interest rates means lower cost of creditLowered interest rates means lower cost of credit

which induces people to borrow and spendwhich induces people to borrow and spendthereby providing steam to various industriesthereby providing steam to various industries

and kick start a slowing economy.and kick start a slowing economy.


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A Contractionary Policy results in increasingA Contractionary Policy results in increasinginterest rates to combat inflation.interest rates to combat inflation.

An Economy growing in an uninhibited mannerAn Economy growing in an uninhibited manner

leads to inflationleads to inflation

Hence increasing interest rates increase the costHence increasing interest rates increase the cost

of credit thereby making people borrow less.of credit thereby making people borrow less. Due to lesser borrowing the amount of money inDue to lesser borrowing the amount of money in

the system reduces which in turn brings downthe system reduces which in turn brings down

inflation.inflation.

A Contractionary Policy is also known as TIGHTA Contractionary Policy is also known as TIGHTPOLICY as it tightens the flow of money in orderPOLICY as it tightens the flow of money in order

to contain Inflationary forces.to contain Inflationary forces.


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The RBI makes an adjustment in its lendingThe RBI makes an adjustment in its lending

rate(Repo Rates) in order to influence the costrate(Repo Rates) in order to influence the costof credit. Thereby discouraging borrowing andof credit. Thereby discouraging borrowing andhence reduces brings reduction in the system.hence reduces brings reduction in the system.


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Whenever the liquid in the system increases, theWhenever the liquid in the system increases, the

RBI intervenes to stabilize the system.RBI intervenes to stabilize the system. The Central Bank does this by issuing freshThe Central Bank does this by issuing fresh

bonds and treasury bills in open market. Thisbonds and treasury bills in open market. Thistool was extensively used at the time whentool was extensively used at the time when

dollar inflows into our economy were very high,dollar inflows into our economy were very high,

resulting in rupee appreciatin. Inorder toresulting in rupee appreciatin. Inorder to

stabilize the exchange rates, RBI first boughtstabilize the exchange rates, RBI first bought

additional dollars thereby stabilizing the rate ofadditional dollars thereby stabilizing the rate ofexchange.exchange.


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CRR-CRR- By increasing the CRR, the RBI decreases theBy increasing the CRR, the RBI decreases the

lending capacity of the bank to the extent of thelending capacity of the bank to the extent of the

increase in the ratioincrease in the ratio. E.g of the CRR is increased from 7.5% to 8.5%E.g of the CRR is increased from 7.5% to 8.5%

the banks were deprived of lending to thethe banks were deprived of lending to the

extent of 75 basis points of their deposit valueextent of 75 basis points of their deposit value.


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CENTRAL BANK

SECURITIES AND

TRESURY BILLSBANK RATE

COMMERCIAL BANKS

CORPORATES INDIVIDUALS

SOLD

CASH

INCREASE

LENDINGRATE

CASH RESERVE

RATIO

REDUCED BORROWING OF

LOANS

INCREASEINCRR

%

REDUCE LIQUIDITY

IN MARKET

STATUTORY

LIQUID RATIO


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Historically, the Monetary Policy is announcedHistorically, the Monetary Policy is announced

twice a year April-September and (October-March).twice a year April-September and (October-March).

The Monetary Policy has become dynamic in natureThe Monetary Policy has become dynamic in natureas RBI reserves its right to alter it from time toas RBI reserves its right to alter it from time totime, depending on the state of the economy.time, depending on the state of the economy.

The Monetary policy determines the supply ofThe Monetary policy determines the supply ofmoney in the economy and the rate of interestmoney in the economy and the rate of interestcharged by banks. The policy also contains ancharged by banks. The policy also contains aneconomic overview and provides future forecasts.economic overview and provides future forecasts.

The Reserve Bank of India is responsible forThe Reserve Bank of India is responsible forformulating and implementing Monetary Policy..formulating and implementing Monetary Policy..


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The Monetary Policy aims to maintain priceThe Monetary Policy aims to maintain price

stability, full employment and economic growth.stability, full employment and economic growth.

Emphasis on these objectives have been changingEmphasis on these objectives have been changingtime to time depending on prevailingtime to time depending on prevailingcircumstances.circumstances.


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Review of 2009/10 Monetary policy

The Policy Review projects GDP growth at 6% this FY dueThe Policy Review projects GDP growth at 6% this FY dueto slackening private consumption and investmentto slackening private consumption and investmentdemand.demand.

The RBI set its inflation projection for March 10 at 4%The RBI set its inflation projection for March 10 at 4%(currently at -1.21%). The RBI also projects the CPI to(currently at -1.21%). The RBI also projects the CPI tocome down into the single digit zone.come down into the single digit zone.

Assurance of a non-disruptive borrowing in 2009-10.Assurance of a non-disruptive borrowing in 2009-10.Recently, the Government increased the borrowing planRecently, the Government increased the borrowing planfrom Rs. 2.41 lakh crore to 2.99 Lakh crore because offrom Rs. 2.41 lakh crore to 2.99 Lakh crore because ofample liquidity in the market due to slow credit growth.ample liquidity in the market due to slow credit growth.

The fiscal stimulus packages of the Government andThe fiscal stimulus packages of the Government and

monetary easing and regulatory action of the Reservemonetary easing and regulatory action of the ReserveBank have helped to arrest the moderation in growthBank have helped to arrest the moderation in growthand keep our financial markets functioning normally.and keep our financial markets functioning normally.


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