Monetary Policy

Monetary policy

Monetary policy is a regulatory policy by which the central bank or monetary authority of a country controls the supply of money, availability of bank credit and cost of money, that is, the rate of Interest.

Monetary policy is the process by which monetary authority of a country, generally a central bank controls the supply of money in the economy by its control over interest rates in order to maintain price stability and achieve high economic growth. In India, the central monetary authority is the Reserve Bank of India (RBI). is so designed as to maintain the price stability in the economy.

Monetary policy is the process of drafting, announcing, and implementing the plan of actions taken by the central bank, currency board, or other competent monetary authority of a country that controls the quantity of money in an economy and the channels by which new money is supplied.

Monetary policy consists of the management of money supply and interest rates, aimed at meeting macroeconomic objectives such as controlling inflation, consumption, growth, and liquidity. This is achieved by actions such as modifying the interest rate, buying or selling government bonds, regulating foreign exchange (forex) rates, and changing the amount of money banks are required to maintain as reserves.

B)OBJECTIVES OF MONETARY POLICY OF INDIA :-

The main objective of monetary policy in India is ‘growth with stability’. Monetary Management regulates availability, cost and use of money and credit. It also brings institutional changes in the financial sector of the economy. Following are the main objectives of monetary policy in India :-

Growth With Stability :-

Traditionally, RBI’s monetary policy was focused on controlling inflation through contraction of money supply and credit. This resulted in poor growth performance. Thus, RBI have now adopted the policy of ‘Growth with Stability’. This means sufficient credit will be available for growing needs of different sectors of economy and at the same time, inflation will be controlled with in a certain limit.

Regulation, Supervision And Development Of Financial Stability :-

Financial stability means the ability of the economy to absorb shocks and maintain confidence in financial system. Threats to financial stability can come from internal and external shocks. Such shocks can destabilize the country’s financial system. Thus, greater importance is being given to RBI’s role in maintaining confidence in financial system through proper regulation and controls, without sacrificing the objective of growth. Therefore, RBI is focusing on regulation, supervision and development of financial system.

Promoting Priority Sector :-

Priority sector includes agriculture, export and small scale enterprises and weaker section of population. RBI with the help of bank provides timely and adequately credit at affordable cost of weaker sections and low income groups. RBI, along with NABARD, is focusing on microfinance through the promotion of Self Help groups and other institutions.

Generation Of Employment :-

Monetary policy helps in employment generation by influencing the rate of investment and allocation of investment among various economic activities of different labour Intensities.

External Stability :-

With the growth of imports and exports India’s linkages with global economy are getting stronger. Earlier, RBI controlled foreign exchange market by determining eaxchange rate. Now, RBI has only indirect control over external stability through the mechanism of ‘managed Flexibility’, where it influences exchange rate by buying and selling foreign currencies in open market.

Encouraging Savings And Investments :-

RBI by offering attractive interest rates encourage savings in the economy. A high rate of saving promotes investment. Thus the monetary management by influencing rates of interest can influence saving mobilization in the country.

Redistribution Of income And Wealth :-

By control of inflation and deployment of credit to weaker sectors of society the monetary policy may redistribute income and wealth favouring to weaker sections.

Regulation Of NBFIs:-

Non – Banking Financial Institutions (NBFIs), like UTI, IDBI, IFCI plays an important role in deployment of credit and mobilization of savings. RBI does not have any direct control on the functioning of such institutions. However it can indirectly affects the policies and functions of NBFIs through its monetary policy.

A non-bank financial institution is a company that offers financial services, but does not hold banking licences and therefore cannot accept deposits. NBFIs are not supervised by a national or international banking regulatory agency. However, operations of non-bank financial institutions are often still covered under the country’s banking regulations.

Monetary operations

Monetary operations involve monetary techniques which operate on monetary magnitudes such as money supply, interest rates and availability of credit aimed to maintain Price Stability, Stable exchange rate, Healthy Balance of Payment, Financial stability, Economic growth. RBI, the apex institute of India which monitors and regulates the monetary policy of the country stabilizes the price by controlling Inflation.RBI takes into account the following monetary policies:

Open Market Operations

An open market operation is an instrument 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 control 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.

(A government bond or sovereign bond is an instrument of indebtedness issued by a national government to support government spending. It generally includes a commitment to pay periodic interest, called coupon payments, and to repay the face value on the maturity date)

( What are government securities, or g-secs? :

These are debt instruments issued by the government to borrow money. The two key categories are treasury bills – short-term instruments which mature in 91 days, 182 days, or 364 days, and dated securities – long-term instruments, which mature anywhere between 5 years and 40 years.)

Cash Reserve Ratio

Cash Reserve Ratio is a certain percentage of bank deposits which banks are required to keep with RBI in the form of reserves or balances.

Higher the CRR with the RBI lower will be the liquidity in the system and vice versa. RBI is empowered to vary CRR between 15 percent and 3 percent. But as per the suggestion by the Narsimham committee Report the CRR was reduced from 15% in the 1990 to 5 percent in 2002. As of September 2014, the CRR is 4.00 percent.[3]

Statutory Liquidity Ratio

Every financial institution has to maintain a certain quantity of liquid assets with themselves at any point of time of their total time and demand liabilities.( Time liabilities refer to the liabilities which the commercial banks are liable to repay to the customers after an agreed period, and demand liabilities are customer deposits which are repayable on demand.) These assets have to be kept in non cash form such as G-secs precious metals, approved securities like bonds etc. The ratio of the liquid assets to time and demand liabilities is termed as the Statutory liquidity ratio.There was a reduction of SLR from 38.5% to 25% because of the suggestion by Narshimam Committee. The current SLR is 21.5%(w.e.f.03/02/15).[5]

Bank Rate

The bank rate, also known as the discount rate, is the rate of interest charged by the RBI for providing funds or loans to the banking system. This banking system involves commercial and co-operative banks, Industrial Development Bank of India, IFC, EXIM Bank, and other approved financial institutes. 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. Increase in the bank rate is the symbol of tightening of RBI monetary policy. As of 3 February 2015, the bank rate is 8.75%.

Credit Ceiling

In this operation RBI issues prior information or direction that loans to the commercial banks will be given up to a certain limit. In this case commercial bank will be tight in advancing loans to the public. They will allocate loans to limited sectors. Few example of ceiling are agriculture sector advances, priority sector lending.

Credit Authorization Scheme

Credit Authorization Scheme was introduced in November, 1965 when P C Bhattacharya was the chairman of RBI. Under this instrument of credit regulation RBI as per the guideline authorizes the banks to advance loans to desired sectors.[7]

Moral Suasion

Moral Suasion is 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.

Repo Rate

Repo rate is the rate at which RBI lends to commercial banks generally against government securities. Reduction in Repo rate helps the commercial banks to get money at a cheaper rate and increase in Repo rate discourages the commercial banks to get money as the rate increases and becomes expensive.

Reverse Repo Rate

Reverse Repo rate is the rate at which RBI borrows money from the commercial banks. The increase in the Repo rate will increase the cost of borrowing and lending of the banks which will discourage the public to borrow money and will encourage them to deposit. As the rates are high the availability of credit and demand decreases resulting to decrease in inflation. This increase in Repo Rate and Reverse Repo Rate is a symbol of tightening of the policy.