BCom Monetary Policy of India Notes Study Material

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BCom Monetary Policy of India Notes Study Material

MEANING OF MONETARY POLICY

Monetary Policy refers to those measures, which are taken by the Reserve Bank of India to regulate the supply of money and credit in order to achieve the socio-economic objectives of the economy. Generally, monetary policy is concerned with the supply of money, the cost of money, or the rate of interest and the availability of money. It is the policy statement through which the Reserve Bank of India (RBI) targets a key set of indicators to ensure price stability in the economy. (BCom Monetary Policy of India Notes Study Material)

These factors include:

(i) Money supply (commonly referred to as M3)

(ii) Interest rates

(iii) Inflation.

Besides, the monetary policy also provides a platform for the apex bank to announce norms for financial bodies governed by the RBI such as banks, financial institutions, non-banking finance companies, residual non-banking companies, nidhis, and primary dealers in the money market, and authorized dealers in the foreign exchange market. (BCom Monetary Policy of India Notes Study Material)

The monetary policy has an important effect on GDP, rate of inflation, and growth. The monetary policy also influences the business prospects, the availability of credit, and its cost. Investment decisions are also determined by monetary policy because aggregate demand and supply can be regulated by controlling and regulating the money supply in the system.

Finally, we can say that the role and purpose of monetary policy are properly managing the money stock in the system for the realization of economic goals. D. C. Rowan has defined monetary policy as a “discretionary act undertaken by the authorities designed to influence (a) the supply of money, (b) the cost of money or rate of interest, (c) the availability of money.”

H.C. Johnson defines monetary policy as “policy employing Central Bank’s control of the supply of money as an instrument for achieving the objectives of general economic policy.”

OBJECTIVES OF MONETARY POLICY

The banking system in India is functioning within the orbit of the monetary credit policy of the RBI.

The followings are the main objectives of monetary policy:

1. A Suitable Price Governance: Price stability is the first objective of monetary policy. If a country wants to avoid too much inflation in prices, it may design its monetary policy in such a manner that the prices remain stable. However, rising prices at a low rate may be found desirable from the point of view of production. So, if the basic aim of the economy is to improve the level of investment, employment, and output, monetary policy would be geared towards this end and this would allow the supply of money to increase in such a manner that prices rise in a gradual manner. (BCom Monetary Policy of India Notes Study Material)
2. To Accelerate Economic Growth: It is a long-term objective of monetary policy. Through monetary policy, Government ensures the adequate flow of the moon into desirable investment channels like infrastructure, buildings, and industries In this tune, the Reserve Bank of India has made the allocation of funds to respective sectors according to the planning requirements and for day-to-day development.
3. Exchange Rate Stability: It is an important objective of monetary The RBI tries to maintain stability in the exchange rate through expansion in exports, reduction in imports, and discourage outward capital movement. Normally exchange stability is not possible without price stability. (BCom Monetary Policy of India Notes Study Material)
4. Attainment of Full Employment: It is desirable to the attainment of employment in the economy. It can be pursued through an increase in rate of saving and investment. A balanced monetary policy helps to maintain a price-stability economy and creates a positive environment for investment that facilitates employment opportunities in the economy.
5. Economic Equality and Social Justice: Monetary policy aims at providing more funds to priority sectors like agriculture, medium and small enterprises, weaker section of society, etc. to promote economic equality and social justice.

INSTRUMENTS OF MONETARY POLICY

The RBI has used the following instruments to carry out its objective of monetary policy:

(A) Quantitative Instruments

(i) Bank Rate: Bank rate refers to the interest rate at which the Central Bank (RBI) gives short-term loans to other banks against the backing of approved securities. In a broader sense, “it refers to the minimum rate at white the Central Bank provides financial accommodation to commercial banks in the discharge of its functions as a lender of the last resort.”

It is an important instrument through which RBI regulates the money supply. In case of inflation RBI. increases Bank rate. Higher Bank rates make credit costly, resulting in shrinkage of credit. During deflation, RBI decreases bank rates and it facilitates cheap credit facilities by commercial banks in the market. It increases the money supply and accelerates economic growth.

(ii) Open Market Operations: Open market operations refer to the sale and purchase of securities, short-term commercial bills, and foreign exchange in the RBI. To increase the money supply, the central bank purchases Govt. Securities from banks and the public. Conversely, when the central bank sells securities to the banks, the deposits in the banks would get reduced resulting in a contraction of credit and a reduction in the money supply. Thus OMO causes direct pumping in or draining out the legal tender money from the market.

(iii) Cash Reserve Ratio: The variation in the cash reserve ratio is another instrument of credit control. As per the RBI Act, 1934, commercial banks have to keep a certain minimum cash reserve with the RBL So, so commercial banks maintain a certain percentage of their deposits in the form of balances with the Central bank which is known as the Cash Reserve Ratio (CRR). The method of CRR is one of the most effective and direct methods of credit control. (BCom Monetary Policy of India Notes Study Material)

In a situation of inflation or excess of demand, RBI increases the Cash Reserve Ratio. This will reduce cash deposits with commercial banks and it minimizes credit creation. During the depression Reserve Bank of India reduces the CRR so that the credit creation power of commercial banks shall increase. At present, the CRR rate is 4% as of Sept. 2014. (BCom Monetary Policy of India Notes Study Material)

(iv) Statutory Liquidity Raito: As per the RBI Act, 1934 all commercial banks have to maintain (under section 24 of the Banking Regulation Act, 1949) liquid assets in the form of cash, gold, and unencumbered approved securities equal to not less than 25% on their total demand and time deposit liabilities. (BCom Monetary Policy of India Notes Study Material)

In a situation, of inflation or excess demand, RBI raises the SLR. The result is the reduction in surplus cash reserves of commercial banks which reduces the credit facilities of commercial banks. On the other hand, RBI reduces the SLR rate it creates an expansionary effect on the credit position of banks. The current SLR is 21.5% w.e.f. 03/02/2015. (BCom Monetary Policy of India Notes Study Material)

(v) Repo Rate and Reverse Repo Rate: Repo rate is the rate at which RBI lends to commercial banks generally against commercial securities. Reductions in repo rate help the commercial banks to get money at a cheaper rate and an increase in repo rate discourage the commercial banks to get money as the rate increases and become expensive. (BCom Monetary Policy of India Notes Study Material)

The reverse repo rate is the rate at which RBI borrows money from commercial banks. The increase in the reverse repo 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 of 30th September 2015, the repo rate is 6.75%, and the reverse repo rate is 6.25%. (BCom Monetary Policy of India Notes Study Material)

(B) Qualitative Credit Control

This is also called ‘Selective Credit Control. It refers to regulating credit to a specific commodity or area not for the whole economy. The following measures are to be taken for selective control:

(i) Regulation of Marginal Requirements on Loans: Reserve Bank of India fixes the marginal money to be kept by commercial banks while lending loans. The basic aim of this method is to restrict the use of credit to purchase or carry securities. By regulation of marginal requirements, RBI increases margin money against those commodities whose prices were rising. A higher margin is used in price rises while a lower margin is used in deflationary situations. (BCom Monetary Policy of India Notes Study Material)

In other words, under regulatory effort, the Reserve Bank can control credit by increasing the margins and expand credit by reducing the margin requirements.

(ii) Regulation of Consumer Credit: It is another method of selective credit control to check the inflationary pressure in the economy. Under which credit control restrictions are imposed on consumer credit given to the consumers for the purchase of durable goods. Consumer credit schemes are offered by banks for easy purchase of consumer durable goods. For this a certain amount is paid by the customer in cash and the balance amount is financed by the bank through bank credit repayable in monthly installments over a period of time.

The RBI can control credit through banks by increasing down payments and reducing the number of installments. On contrary, it can expand credit creation by reducing down payments and increasing down payments, and increasing the number of installments.

(iii) Rationing of Credit: It is another instrument of selective credit control. Under this method, the Reserve Bank of India determines the credit limit for different purposes for member banks. If the member banks seek more loans than the quota which is fixed for them, they will have to pay a higher rate of interest to the RBI than the prevailing bank rate. (BCom Monetary Policy of India Notes Study Material)

(iv) Credit Authorization Scheme (CAS): This scheme was introduced by the RBI in November 1965. Under this scheme, commercial banks have sought authorization from the Reserve Bank before sanctioning bank loans exceeding Rs.1 crore or more to any single party. The amount of this limit has been changed from time to time and it was raised to Rs. 6 crore with effect from April 1986.

However, in such a case, a system of post-sanction scrutiny called Credit Monetary Arrangements (CMA) has been introduced to monitor and scrutinize all sanctions of bank loans exceeding 35 crores to any single party and 2 crores in case of term loans.

(v) Moral Persuasion: It is also a selective credit control measure of RBI. Under this, the Reserve Bank persuades, member banks to follow the policy guidelines regarding excessive control over credit in general or advances against particular commodities or unsecured advances. To achieve this objective regular meetings and discussions are held with representatives of commercial banks.

FIRST BI-MONTHLY MONETARY POLICY STATEMENT, 2015-16

RBI Governor Raghuram Rajan kept the benchmark repo rate or the rate at which the Central Bank lends money to banks, unchanged at 7.5%, in the first bi-monthly monetary policy review of 2015-16. (BCom Monetary Policy of India Notes Study Material)

Following are the highlights of RBI’s first bi-monthly monetary policy statement, 2015-16 (April 2007):

(1) Short-term lending rate (repo) unchanged at 7.5%.

(2) Cash Reserve Ratio unchanged at 4%.

(3) Retains Statutory Liquidity Ratio at 21.5%.

(4) Estimates GDP at 7.8% in Fy’ 16 up from Fy’ 15.

(5) Forecast CPI inflation at 5.8% by March 2016.

(6) 100% CPI inflation to dip to 4% in Aug. 2015.

(7) Hailstorms in March affected 17% of the rabi crop sown area.

(8) Future rate cuts will depend on an interest rate deduction by banks.

(9) State cooperative banks to be allowed to set up off-site Mobile ATMs without prior approval from RBI.

(10) RBI to formulate a scheme for market making by primary dealers in semi-liquid and illiquid G-sectors.

RBI’S SECOND BI-MONTHLY MONETARY POLICY STATEMENT FOR 2015-16

Following are the highlights of RBT’s second bi-monthly monetary policy statement for 2015-15:

(1) Short-term lending rate (repo) cut by 0.25 percent to 7.25 percent (Current repo rate is 6.75% w.e.f. 30th Sep. 2015).

(2) Cash reserve ratio unchanged at 4 percent.

(3) Statutory liquidity ratio retained at 21.5 percent.

(4) Inflation is expected to rise 6 percent by January 2016.

(5) Strong food policy management is needed to keep inflation and inflationary expectations under check.

(6) Growth forecast lowered to 7.6 percent for 2015-16 from 7.8 percent projected in April.

(7) Banks asked to pass on the benefit of rate cuts to borrowers.

(8) Targeted infusion of bank capital into PSU banks needed to ensure credit flows to productive sectors.

AN EVALUATION OF MONETARY POLICY

The RBI’s monetary policy has been characterized as one of controlled expansion. But monetary policy has become a target of serious criticism. It is said that the RBI has failed both in the expansion and control of money and credit in our economy with regard to the expansion of credit. It is said that the major component of the increase in money supply was the Reserve Bank’s credit to the Central Government. (BCom Monetary Policy of India Notes Study Material)

The inability of the Reserve Bank to regulate credit to the Central Government due to both legal and practical considerations has been interpreted by the Committee (Sukhamoy Chakravarty Committee) as an important factor in the Reserve Bank’s helplessness in controlling the rise in the money supply. (BCom Monetary Policy of India Notes Study Material)

For the role of RBI in controlling inflation, it is said that the monetary policy operated by RBI did not play any effective role in controlling inflation in the economy. The growth of the money supply in recent years was much higher than the growth in output. So, the average annual rise of prices of nearly 10 percent during this period. (BCom Monetary Policy of India Notes Study Material)

Besides this, the Reserve Bank may not have an effect on deficit financing and shortage of goods. Lastly, the Apex Bank has no power over the non-banking financial institutions and indigenous bankers who continue to play a considerable role in financing, trade, and industry. True, RBI has been less proactive, conservative and a stooge in the hands of the Central Government but it is the same RBI that has saved the economy and maintained a steady growth rate. (BCom Monetary Policy of India Notes Study Material)

BCom Monetary Policy of India Notes Study Material

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