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Macroeconomic Policy

Monetary Policy of RBI

www.rbi.org.in

Monetary Policy
Outline:
Objectives of Monetary Policy
Types of Monetary Policy
Instruments of Monetary Policy and their Mechanism
Monetary Policy Framework of Central Bank
LAF, MSS, MSF
The Transmission Mechanism,
Recent Monetary Policy

MonetaryPolicy:
Definitions,ObjectivesandTypes

Monetary Policy: RBI


RBI was established on April 1, 1935 with RBI Act 1934, the
recommendations of
HiltonYoung Commission. It was
nationalized in 1949.
Main Role of RBI
1. Supply of Money to the Economy
2. Lender of Last Resort
3. Regulator of Financial system
4. Financial advisor to State Governments

Monetary Policy: Making Process in India


Headedby
TheRBIGovernor
Assistedby
TheRBIDeputyGovernors
Guidedby
TheBoardofDirectors
SeveralStandingCommitteesorGroupsoftheBoard
TechnicalAdvisoryCommitteesandStandingCommittees
AdhocWorkingGroups
BoardofFinancialSupervision
FormulatesMonetaryPolicyoncein6month.
1.AprilSeptember :SlackSeasonPolicy
2.October March :BusinessSeasonPolicy
Reviewthesameonquarterlybasis
LAFandMSSdonedailybasisduringtheofficehrs.

Monetary Policy: Meaning


Monetary
Policy
Involves
Policies
That influences
the cost(interest rate )
and
availability of money and credit.
Monetary Policy is essentially a program of action undertaken
by the monetary authorities, generally the Central Bank, to
control and regulate the cost and supply of money and
credit with the public with a view to achieving predetermined
macroeconomic goals.

Monetary Policy: Objectives

Monetary Policy: Types


Expansionary ( Easy) Policy

Contractionary ( Tight) Policy

Aim
Encouraging spending on
goods and services by
expanding supply of credit and
money.

Aim
Preventing Inflation by
contracting the Money Supply.

Tools
Lowering the Policy Rate
(bank rate or repo rate)
Lowering the reserve
requirements ( CRR, SLR)
Purchasing the Govt. securities
from the market

Tools
Increasing the Policy Rate
(bank rate or repo rate)
Increasing the reserve
requirements ( CRR, SLR)
Selling the Govt. securities from
the market

Monetary Policy: Types

Monetary Policy: Types

MonetaryPolicy:
OperatingFrameworkandInstruments

Monetary Policy: Operating Framework

Monetary Policy: Operating Framework


Operating
Procedure

Refers to the tactical decision on or daily implementation


of monetary policy
Covers the choice of
Policy instruments
Operating target
Width a corridor for market interest rates
Nature, extents and frequency of different market operations
The manner of signaling policy intentions

Monetary Policy: Operating Framework


FinalGoal

Intermediate
Target

Operating
Target

Instruments

GDP,
Inflation
Unemployment
MonetaryAggregatessuchasM1,M2,M3
CreditAggregate
MultipleTarget:InterestRate,Inflationrate,
assetsprices,ExchangeRate,fiscaldeficitetc.

ReservesAggregates:suchasBankReserves(=
borrowed+nonborrowedreserves),monetary
base(M0).
ShortTermmoneyMktInterestRates:like
interbankrate,Treasurybillrate

Suchas,bankrate,reporate,CRR,SLR,OMOetc.

Monetary Policy: Instruments

Statutory Liquidity Ratio


(SLR)

Monetary Policy: 1. Quantitative Instruments


Affects the total volume of credit by influencing the credit
creating capacity of the commercial banks
1.Bank Rate
Is the minimum rate at which the Central Bank of a country lends
money to banks and financial institutions against the govt. and
other approved securities .
Bank Rate is also known as discount rate, where rediscounted
eligible bills of exchange or commercial paper. Not so well
developed in India. RBI, NABARD, SIDBI discounts bills of
exchange.
BR FBR CR MS

BR is Bank rate, FBR is Funds Borrowed by Banks, CR is Credit, MS


is Money Supply
As of today 15/ 11/2015. Bank rate is 7.75 %

Bill Rediscounting

Monetary Policy: 1. Quantitative Instruments


2. Cash Reserve Ratio (CRR)
All scheduled & nonscheduled commercial banks (i.e. public & private
sector, foreign banks, urban co-operative banks, Regional rural banks )
are required to hold as reserves either in cash or as deposits with RBI, some
amount of their total of Net Demand and Time Liabilities (NDTL), on a
fortnightly basis. The amount of which shall not be less than 4% or greater
than 20% of the their NDTL.
They are required to maintain minimum CRR balances upto 70 per cent of the
total CRR requirement on all days of the fortnight with effect from the
fortnight beginning December 28, 2002.
CRR RR ERCR MS

(RR- required reserve, ER- excess reserve, CR- credit,)


(Excess reserve means in an above CRR & SLR, to meet unforeseen withdrawal)
CRR rule doesn't apply to Non Banking Financial Companies (NBFC),
Mutual funds or Insurance Companies
As of today 15/ 11/2015. CRR is 4%

Monetary Policy: 1. Quantitative Instruments


3.Statutory Liquidity ratio (SLR)
SLR is that amount which a commercial bank has to
maintain with RBI in the form of cash, gold or approved
Govt. securities. SLR should lies in between 22-40%.
The quantum is specified as some percentage of the total of
Net Demand and Time Liabilities(NDTL) of a bank.
This percentage is fixed by RBI. The date which is taken to
calculate the demand and time liabilities of the bank is the
last Friday of the preceding fortnight.
SLR is maintained on daily basis.
As of today 15/ 11/2015. SLR is 21.5%

Monetary Policy: 1. Quantitative Instruments


4. Open Market Operations
=>Sale and purchase of a variety of asset such as foreign exchange, gold,
govt securities by the central bank
a. Out right OMO
- The outright sale of any of the assets by the Central bank from its own
account leads to absorption of the liquidity and reduction in money
supply from the market forever by impounding the resources of
financial institutions in these securities
- The outright purchase implies Injections of the liquidity

BR-banks reserve, GS Govt Securities


b. Repo or reverse repo operation
It is a contract in which a participants acquires funds by selling the
securities , such as treasury bills, and simultaneously agrees to buy them
back or repurchase the same at a specified time and price/repo rate.
As of today 15/ 11/2015. Repo Rate is 6.75 and Reverse Repo is 5.75%

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Monetary Policy: 2. Qualitative Instruments


Affects the types of credit extended by the banks affect the composition of
bank portfolio.

Monetary Policy: 2. Qualitative Instruments

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Inflation vs interest rates since 2010

Repo

CPI

MonetaryPolicy:
OperatingProcedureinIndia:LAF,MSSandMSF

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Monetary Policy: Objective, Target and Instruments in India


Objective:
PriceStability(P)
Financialstability(F)
EmploymentGrowth(E)
RealoutputGrowth(Y)
IntermediateTarget:
Credit,moneysupply,
Multipletargetsuchasinterestrate,
exchangerate,fiscaldeficit,inflationrateetc.
Instruments:

Preindependence:bankrate,OMO
1970s:CRR,SLR,OMO
1990s:Directtoindirect,repo,reverserepo
2000s:EmergenceofLAF,MSS,MSF

Monetary Policy: Regimes in General


MonetaryPolicy TargetMarketVariable

LongTermObjective

Credit
Aggregates

Thegrowthofcreditinthe
bankingsector,priority sector
lending

Growthrate ofoutputand
pricelevel

Monetary
Aggregates

Thegrowthinmoneysupply(Mo, AgivelevelofchangeinCPI
M1, M3 etc.)

GoldStandard

Thespotpriceofgold

Lowinflationmeasuredby
goldprice

Exchange Rate
Targeting

Thespotpriceofthecurrency

Thespotpriceofthe
currency

Multiple
Indicator
Approach

Usuallyinterestrate alongwith
fiscaldeficit,tradedeficit,
inflationrate,exchangerateetc.

Price stability,financial
stability,unemployment
rate

Inflation
Targeting

Interestrateonovernightdebt

Agivenrateofchangein
CPI,WPI

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Monetary Policy: Evolution of Objective & Operating


Procedure in India Decadewise
Year

MPObjectives

Intermediate
Target

Instrumentsandsteps

1930
1950

Regulates demandand
supplyofcredit

Credit Aggregates

Bankrate, ReserveRequirements,OMO

1950s

PstabilitywithGrowth

BankratechiefInstruments, Money&Credit
importantfordev.

1960s

Price Stabilitywith
Growth

BankRate,Prioritysectorlending,bank
nationalization,

1970s

Price Stability

1980s

Pstability,growth,
employment:

1990s

PandFinancialStability,
(liberalizationand
globalizationpolicy,
automatic monetization
offiscaldeficitremoved)

MonetaryTargeting
(Mo,M1, M3etc)

IncreaseinM0,Monetaryexpansion,CRR,SLR,
OMO
Creditimportant,CRR,SLR is regulated,interest
ratederegulated,ChakravartyCommittee
Report(1985)workingofMonetarySystem

2000s

PandFinancialStability,
Growth

Shiftfromdirectto
IndirectInstruments
MultipleIndicator
Approach,suchas
interestrate,exchange
rate,fiscaldeficit,
inflationrate

2010

P stability,growthand
employment

ThinkingofInflation
Targeting

ShortterminterestratesuchasBankrate,repo
rate,OMO,moreflexibilityinthe operating
system

(NarasimhamCommitteeReportonBanking
SectorrecommendedLAF(1998)andMSS
LAF,MSS:reporate,reversereporateetc.
LAFandMSF:reporate,reversereporate,MSF
rateetc.

MPOperatingProcedure:LiquidityAdjustmentFacility(LAF)
What is LAF ?
LAF is a facility to inject and absorb liquidity on short term basis to evenout the
mismatch between D & S in short-term funds.
Operates through repo rate, reverse repo rate which provide a corridor for the call
money rate and other short term interest rates, supported by OMO.
What is Liquidity ?
(i) Macroeconomics: Extent of mismatch bt. D & S of Money Supply; overall
monetary conditions
(ii) Finance: ease of undertaking financial assets; bid- ask spread
(iii) Central bank: Monetary base (C+R)

Repo- repurchase agreement:- An agreement involving the sale of securities by one


party to another (by banks to RBI) with a promise to repurchase the securities at a
specified price on a specified date. Injection of liquidity

Reverse Repo- reverse repurchase agreement:-Involves the purchase of securities


between parties (by banks from RBI) with promise to sell them back at a given date
in the future. Absorption of Liquidity.
Collateralized borrowing and lending (e.g.-T-Bills , etc)

Call Money Rate- Short-tem funds transfer between FIs-Inter bank rate
No collateral

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MPOperatingProcedure:LiquidityAdjustmentFacility(LAF)
LAF was introduced to
Do away with the deficiencies of refinance system
Multiplicity of the rates at which liquidity was made available
The funds under LAF to be used by the banks for their day-to-day
mismatches in liquidity
Objective of LAF
i. Provision of adequate credit for growth and investment with
price stability
ii. Phasing out of non-bank financial intermediaries from call
market. (Aug 6,2005) and make call money market as pure
interbank market,
iii. Send policy signals and influence the interest rates in other
financial market
iv. Try to keep call money rate in between repo and reverse repo
rate.

MPOperatingProcedure:LiquidityAdjustmentFacility(LAF)

Graph of Overnight Cash Rates


Cha rt-5: M o vem en t of Call M one y Rate and LAF Corridor

25.00

Ca ll Mon ey

Re v erse Repo

Repo

15.00

10.00

5.00

5-Feb -06

5- Oc t-05

5- J un-05

5-F eb- 05

5- O c t-04

5- J un-04

5-Feb- 04

5 -O c t-03

5- J un-03

5-Feb- 03

5- Oc t-02

5-J un-0 2

5-F eb-0 2

5- O c t-01

5- J un-01

5-Feb- 01

5- O c t-00

0.00
5- J un-00

P er cent

20.00

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MPOperatingProcedure:LiquidityAdjustmentFacility(LAF)

Graph of Overnight Cash Rates

MPOperatingProcedure:LiquidityAdjustmentFacility(LAF)
Full-fledged LAF Introduced in Three phases
Fist Phase began on June 5, 2000
ACLF and Level-II support to PDs was replaced by variable repo auctions with same
day settlements
CLF and ECR for banks and Level-I to PDs was replaced by variable rate auctions (
May 2001)
CLF was withdrawn in October 2002
Second Phase March 29, 2004 a revised LAF scheme was operationalized
The repo rate was reduced to 6.percent and unified to the Bank Rate.
The 1-day reverse repo was phased out, and in its place the 7-day fixed rate reverse
repo on a daily basis and the 14-day variable rate reverse repo on a fortnightly basis
were introduced. But RBI reintroduced the 1- day fixed rate reverse repo in August
2004 while continuing others two as usual.
Oct 29, 2004 repo and reverse repo renamed as per international usage.
Third Phase
Full-fledged LAF began with the full computerization of the Public Debt Office (PDO)
and the introduction of the Real Time Gross Settlement (RTGS)
Repo auctions are now mainly carried out through electronic transfer
Full fledged LAF is an essential tool for adjusting marginal liquidity not total liquidity

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MPOperatingProcedure:LiquidityAdjustmentFacility(LAF)
Modus Operandi of LAF

MPOperatingProcedure:LiquidityAdjustmentFacility(LAF)
Modus Operandi of LAF
Tenor:Underthescheme,ReverseRepoauctions(forabsorption)andRepo
auctions(forinjection)areconductedonadailybasis(exceptSaturdays).
MinimumbidSize :Rs.5crandinmultipleofRs.5cr
Eligiblesecurities: ReposandReverseReposintransferableCentralGovt.
datedsecuritiesandtreasurybills.
MajorPlayers
Banks:Allcommercialbanks(exceptRRBs)havingsubstantialTreasury
Bills,Central/StateGovernmentsecuritiesapprovedbyRBI
PrimaryDealershavingcurrentaccountandSecurityGeneral Ledger
(SGL)accountwithRBI
DiscountandFinanceHouseofIndia(DFHI):EstinApril1988.Itisan
authorizedinstitutionbyRBItoundertakerepotransactions(bothbuying
andselling)intreasurybillsandalleligibledatedgovernmentsecuritiesto
impartgreaterliquiditytotheseinstruments.SinceNovember13,1995,
DFHIisanaccreditedprimarydealer

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MPOperatingProcedure:LiquidityAdjustmentFacility(LAF)

MPOperatingProcedure:LiquidityAdjustmentFacility(LAF)

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MPOperatingProcedure:MarketStabilizationScheme(MSS)
MarketStabilizationScheme(MSS)
MOU signed between GOI and RBI on MSS on March 25, 2004
MSS is Operational since April 1, 2004.
Absorb excess liquidity in the market which might arises due to
heavy inflow of foreign capital (FII) through both Govt Treasury
Bills and dated Govt. Securities (Adhoc treasury bills) on daily
basis.
Unlike OMO, under MSS the govt securities are not owned by
RBI. The GOI issue T Bills and or dated securities under the
MSS in addition to its normal borrowing to absorb liquidity from
the system.
Sale of these securities are held under MSS account

Monetary Policy: RBIs Liquidity Management


Table 1: Reserve Banks Liquidity Management Operations: Annual Variations (` billion)
2002 2003 2004 2005 2006 2007- 2008- 2009- 2010- 2011Item
-03 -04 -05 -06 -07 08
09
10
11
12
425 941 797 -3131,232 3,046 -1,668 -1,008 -1,111 -2,636
A. Autonomous Drivers of Liquidity (1+2+3+4)
1 RBIs net Purchase from Authorised Dealers
2 Currency with the Public
Cash balances of the Centre with the Reserve
Bank
4 Others (residual)$

7901,406 911 3291,190 3,121 -1,786 -120

76 -1,045

-308 -434 -413 -558 -707 -856 -970 -1,020 -1,443 -1,148
-36 -178

5 -227

-12 -266

604

-20

-21 147 294 143 761 1,047

484

152

18 -576
238

133

B. Management of Liquidity (5+6+7+8)

-414 -754 -608 579 -301 -1,253 2,352 1,322 1,756 2,794

5 Liquidity impact of LAF Repos


6 Liquidity impact of OMO (net) *

24 -371 153 121 364


-538 -418 -29 107 -51

7 Liquidity impact of MSS


8 First round liquidity impact due to CRR change

0
100

212 -518
59 1,045

0 -642 351 -339 -1,054


35

-90

27

0 -275 -470 1,023 -360 -125

795

C. Bank Reserves # (A+B)


11 187 189 266 931 1,793
(+): Injection of liquidity into the banking system.
(-): Absorption of liquidity from the banking system.

803

5 1,070 579
824 784 1,420

684

853
314

645

158

$: Includes standing facilities, etc.


*: Includes oil bonds but excludes purchase of government securities on behalf of state governments.
#: Includes vault cash with banks and adjusted for first round liquidity impact due to CRR change.
Note: Data pertain to March 31.

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MPOperatingProcedure:MarginalStandingFacility(MSF)
MarginalStandingFacility(MSF)
1. The weighted average overnight call money rate was explicitly recognized as the
operating target of MP. Repo rate was made the only one independently varying
policy rate.
2. A new Marginal Standing Facility ( MSF) was introduced since May 9, 2011,
under which scheduled commercial banks could borrow overnight at their discretion
up to 1% (2% (wef 17/4/2012))of their NDTL outstanding at the end of the second
preceding fortnight at 100 basis point above the repo. But for the intervening
holidays, the MSF facility will be for one day except on Fridays when the facility
will be for three days or more, maturing on the following working day. In the event,
the banks SLR holdings fall below the statutory requirement up to one per cent of
their NDTL, banks will not have the obligation to seek a specific waiver for default
in SLR compliance arising out of use of this facility .
3. The Facility will be available on all working days in Mumbai, excluding Saturdays
between 3.30 P.M. and 4.30 P.M.
As of today 15/ 11/2015. MSF Rate is 7.75%

MPOperatingProcedure:MarginalStandingFacility(MSF)
4. Revised corridor is fixed with 200 basis point at which lower corridor is reverse repo
and upper one is MSF rate and mid one is repo rate.

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MPOperatingProcedure:Marginal StandingFacility(MSF)

MPOperatingProcedure:Marginal StandingFacility(MSF)

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Monetary Policy: LAF and MSF

Monetary Policy: Difference Between LAF and MSF


LAF

MSF

Liquidityadjustmentfacility

Marginalstandingfacility

Minimumbiddingamountis5cr.

1cr.

AllclientsofRBIareeligibletobid.

Onlyscheduledcommercialbankscan
bid.

Bankcannotsell
BankcanselltheGovernmentsecurity
Government securitytoRBIthatis
fromitsSLRquotatoRBI.
partofbanksSLRquota.
Bankcanborrowanyamountof
moneyaslongasithasthe
securitiestosell.

Bankcanmaximumborrowupto 2%of
itsNDTL.

Supposereporateisr%

MSFlendingrateisalways(r+1)%

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MonetaryPolicyandEconomicActivity:

Monetary Policy and Economic Activity

Meaning: the general conceptual framework within which the


analysis of monetary policy disturbance may be undertaken is
known as MPTM, whereas the routes through which this
disturbance influence goal variables (real economy) are its
channel.
Types: money supply, interest rate, other assets price, credit
and uncertainty and expectations.

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Monetary Policy: How its works ( Keynesian View)

1. Money Supply
Mechanism

Money supply channel

M Y

2. Interest Rate Mechanism

Interest rate channel

i) M r I Y
ii) M r C Y
iii) M rC I Y

3. Assets Price Mechanism

Exchange rate
Equity price

M r E TI Y

Tobins q theory
Wealth effect
Net worth channel
Liquidity channel
Stock market channel
Real assets price channel
4. Credit Mechanism

Bank Lending channel

Balance sheet channel

5. Uncertainty and
Expectations Mechanism

Uncertainty and expectations


channel

M Pe q I Y ,
M PeW C I Y
M Portfolio liquidity Likelihood of financial
distress Consumer durable spending Y.
M Portfolio liquidity Likelihood of financial
distress Consumer durable spending Y.
M e Pe I Y ,
(i) M housing and land prices q I Y
ii)Mhousing and land priceswealth C Y
M bank depositsbank loans I Y

i) M Peadverse selection and moral hazard


lending I Y
ii)M i net cash flowadverse selection and
moral hazard Lending I Y.
i) M * C Y,
ii) M R* I Y,

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Monetary Policy and Economic Activity


Monetary Transmission Mechanism in India
Upto 1980s
Since 1989
After 1990s

: both money supply and credit


: Interest rate
: Financial sector Reforms
: multiple channel: interest rate channel,
exchange rate channel and other assets
price channel become prominent.

Shifts in instruments from direct to indirect,


Bank rate, CRR, SLR, OMO loosed efficiency

Monetary Policy Review Q1 2013-14


DomesticEconomy:
GDPGrowth:duetopersistenceweaknessinindustrialactivityacross
Globe,RBIdownsidestheGDPgrowthprojectionfrom5.7%to5.5%.
Inflation:HeadlineWPIinflationtargetassetbyTheRBItobeachieved
byMarch2014as5%
CurrentAccountDeficit201213is4.8%wellabovethesustainedlevelof
2.5%ofGDPestimatedbytheRBI

MonetaryMeasures
ReporateunderLAFremainedunchangedat7.25%
Reversereporate,determinedwithaspreadof100basispointtobe
remainedunchangedat6.25%
TheMSFrateremainsunchangedat30basispintabovethereporateat
10.25%
Thebankrateremainedat10.25%
TheCRRhastoberetainedat4.00%ofNDTL
SLRtoberetainedta23.00%

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Monetary Policy: Making Process in India


RBIGovernorsandTheirMonetaryPolicyP:AGlimpse

R.N. Malhotra(1985-1990) Develop money market, set up National Housing


Bank,
catalyze the flow of credit through commercial banks
S Venkitramanan(1990-1992) adopt IMF stabilization program, Rupee being
devalued, launch the program of economic reforms,
Dr C Rangarajan(1992-1997) introduction of new institutions and
instruments,
establishing unified exchange rate , historic memo- between banks and
govt -cap-adhoc treasury bills, stop automatic monetization of FD, W& M
advance.
Dr Bimal Jalan (1997-2003): India weathering Asian crisis, improving transparency
and central bank communications, strengthening BOP and FOREX, Low
inflations and soft Interest rates
Dr Y V Reddy(2003-2008): made significant policy contributions in the areas
of
financial sector reforms; trade finance; monitoring of balance of payments
and
exchange rate; external commercial borrowings; centre-state
financial relations; regional planning; and public enterprise reform and
has
been closely associated with institution building.
Dr. D Subbarao (2008-2013): post crisis period quite challenging, reduced repo
rate
several times, highly criticized by MOF, rupee depreciation, high
inflation, high
current A/C deficit, week investment environment.
Dr Raghuram Rajan(2013) inclusive growth and development with financial
stability, more banks in rural area, new bank licenses, increased repo rate,
inflation targeting

Role of RBI during Recession

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Business Cycle: Recession


Economy typically expands for 6-10 years and tends to go into a recession for about
six months to 2 years called as Business cycle

RBIs measures during III QUARTER OF 2007-09

All the Interest rate has been


reduced

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RBI Announces Further Monetary Stimulus Date : 02 Jan 2009

Inareviewofcurrentglobalanddomestic
macroeconomicsituation,theReserveBankhasdecided
totakethefollowingfurthermeasures:
RepoRate
Toreducethereporateundertheliquidityadjustment
facility(LAF) by100basispointsfrom6.5percentto
5.5percentwithimmediateeffect.
Reverse RepoRate
ToreducethereversereporateundertheLAFby100
basispoints from5.0percentto4.0percentwith
immediateeffect.

RBI Announces Further Monetary Stimulus Date : 02 Jan 2009


CashReserveRatio
Toreducethecashreserveratio(CRR)ofscheduledbanksby50basis
pointsfrom5.5percentto5.0percentfromthefortnightbeginning
January17,2009.
ThereductionintheCRRwillinjectadditionalliquidityofaroundRs.
20,000crore tothefinancialsystem.Itisexpected thatthereduction
inthepolicyinterestratesandtheCRRwillfurther enablebanksto
providecreditforproductivepurposesatappropriateinterestrates.
TheReserveBankonitspartwouldcontinuetomaintaina
comfortableliquiditypositioninthesystem.
Thefundamentalsofoureconomycontinuetobestrong.Oncethe
crisisisbehindus,andcalmandconfidencearerestoredintheglobal
markets,economicactivityinIndiawouldrecoversharply.Butaperiod
ofpainfuladjustmentisinevitable.

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How India Avoided Recession of 2007-09


1.

2.

3.

4.

5.

Domestic Economy:
Indian economy is mostly domestically driven. Not so much exposed to
export and import.
Indias relatively low level of exports21 percent of GDPhas insulated
the country from the impact of the global recession
Banking Sector
State-dominated banking sector and low risk appetite. Today the
countrys banks are 75 percent government owned.
External Sector
Government control on Capital Flow. Full capital account convertibility
but not current account.
Stock Market Regulation tougher
When the market was booming with voluminous funds from foreign
investors, SEBI imposed tougher rules to limit and to regulate the funds.
Fiscal Measures
India practiced austerity measures to check fiscal deficit and current
account deficit to keep debts low

How India Avoided Recession of 2007-09


6. Monetary Measures : Corrective measures adopted by RBI
Interest Rates
RBI first lowered the interest rates to boost demand or spending during
economic slowdown, CRR, SLR , repo, revere repo were lowered,
Later on to manage inflation and promote growth RBI raised interest rates.
Sub-Prme Loans:
RBI tighten the credit especially housing loans, when property prices was
shooting up very high
RBI didn't encourage sub-prime loans. Mortgages were issued based on just
the borrower's income.
Loan Provision:
When the land values were rising in India, then RBI governor Y.V.Reddy
ordered the banks to stop issuing loans to raw lands. Without this ban,
India would have got trapped in the bubble with its rising middle class income.
Loan amount were released to the customers only after the development
work was started.
Indian banks were tempted heavily by the securitization method adopted by the
US banks for funding money. But, the RBI governor was strict in rejecting the
model. The Indian bankers who were critical of Reddy's tougher rules, later
realized the reason behind the decisions.

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The Design of Monetary Policy


Monetary Targeting VS Inflation Targeting

Most central banks have adopted an inflation rate


target rather than a nominal money growth rate
target.

They think about short-run monetary policy in


terms of movements in the nominal interest rate
rather than in terms of movements in the rate of
nominal money growth.

The Design of Monetary Policy


Money Growth Targets and Target Ranges
Untilthe1990s,monetarypolicy,intheUSandotherOECD
countries,wastypicallyconductedasfollows:
Thecentralbankchoseatargetratefornominalmoneygrowth
correspondingtotheinflationrateitwantedtoachieveinthe
mediumrun.
Intheshortrun,thecentralbankallowedfordeviationsof
nominalmoneygrowthfromthetarget.
Tocommunicatetothepublicbothwhatitwantedtoachievein
themediumrunandwhatitintendedtodointheshortrun,the
centralbankannouncedarangefortherateofnominalmoney
growth.

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The Design of Monetary Policy


Money Growth Targets and Target Ranges
M1 Growth and Inflation:
10-Year Averages since
1970

There is no tight relation between M1 growth and inflationnot even in


the medium run, because of shifts in the demand for money.
When people reduce their bank account balances and move to money
market funds, there is a negative shift in the demand for money.
Frequent and large shifts in money demand created serious problems for
central banks.

The Design of Monetary Policy


Inflation Targeting

In many countries, central banks have defined as their primary


goal the achievement of a low inflation rate, both in the short
run and in the medium run. This is known as inflation
targeting.
Trying to achieve a given inflation target in the medium run
would seem a clear improvement over trying to achieve a
nominal money growth target.
Trying to achieve a given inflation target in the short run
would appear to be much more controversial.

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The Design of Monetary Policy


Inflation Targeting

The result that we have seen that inflation targeting


eliminates deviations of output from its natural level is
too strong, however, for two reasons:

The central bank cannot always achieve the rate of


inflation it wants in the short run.
Like all other macroeconomic relations, the Phillips
curve relation does not hold exactly.

Implication for Business


Monetary Policy aimed at regulating the cost and availability of credit, which is an
Important determinant of the levels of investment.
Changes in bank rate, repo rate, reverse repo rate affects the
cost of credit, funds.
Changes in CRR, SLR affects the availability of credit/ funds.
Expansionary Monetary Policy- injection of money in to the system leads easy
availability of credit,
Contractionary Monetary Policy reverse
Priority Sectors such as agricultural credit exporters, small scale industry etc. look for MP
announcement for respective packages facility
MP changes has also affects stock market. Easy MP boost market sentiments, increases
the trading volumes, helps raising finances for the corporates from the market.
Flexible exchange rate regime and open economy framework of MP affects exchange
rate. Expansionary MP reduces int rate which reduces exchange rate,
Knowledge of MTM helps the managers to assess and predict the impact of MP on the
economy , the financial positions which helps them in adjusting their production and
planning process.

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Thank You All

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