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“In Inflation everything gets more

valuable except money”

Inflation Is An Account Of
Flawed Monetary Policies

• Inflation is a rise in the general level of prices of

goods and services in an economy over a period
of time.

• Too much money chasing few goods

Tools to measure inflation

Two major tools….

1. W.P.I Wholesale Price Index
It is based on 465 specified consumer goods.
2. C.P.I Consumer Price Index
It is based on consumer itself.
Wholesale Price Index (WPI)

• Captures the price of goods at the wholesale

level procured by the shopkeeper.
• Does not include services and non-tradable
• WPI Basket can be divided into three
groups having different weights:
Manufactured goods (63.75%), Primary
produces (22%) and energy (14.25%)
• Available on a weekly basis, with a shorter
time lag of two weeks.
• In India, we rely on WPI to measure
Consumer Price Index (CPI)

• Captures the price of goods and services at

the consumer level.
• In India, we have four CPI indices for four
different groups: CPI for agricultural
labourers, rural labourers, industrial
workers, and urban non-manual employees.
• Are available on a monthly basis, after a
much longer time lag compared to WPI.
• The US relies on the CPI to measure
Why is WPI preferred over CPI?

• It is available on a weekly basis, with a

shorter time lag of two weeks.
• CPI index uses different baskets of goods
and services which reflect the consumption
pattern of different groups of consumers.
Different indices may show different
patterns of increase in prices.
Monetary Policy

Definition: Monetary policy is the process by which the

government, central bank, or monetary authority of a country
controls (1) the supply of money, (2) availability of money,
and (3) cost of money or rate of interest, in order to attain a set
of objectives oriented towards the growth and stability of the
A policy is referred to as contractionary if it reduces the size
of money supply or raises the interest rate.
A policy is referred to as expansionary if it increases the size
of the money supply, or decreases the interest rate.
“RBI ka usool”
• “…. To regulate the issue of Bank Notes and keeping of reserves
with a view to securing monetary stability in India and generally
to operate the currency and credit system of the country to its

• Elements of financial system-British rule-1757 to 1947

Rbi-1935-Pvt bank, 1949- Nationalized, broader scope
• Major initiatives of RBI were to:
Credit to industry, agriculture and small business
Penetrating rural areas, promoting agricultural and industrial credit ,
Fostering savings through deposit insurance & postal schemes
Credit guarantee corporations to cover loans to small traders , transporters ;

and self employed people.

• Nationalized 14 major pvt. Banks in 1969 & 6 more in 1980
• Branches exploded from 7000 in 1969 to 60000 in 1994
“Dada's & their dadagiri………….”
• M D Patra: develop money markets, setup National Housing
Bank, catalyze the flow of credit through commercial banks.

• U S Pailiwal: adopt IMF stabilization program, Rupee being

devalued, launch the programme of economic reforms.

• S V Raghavan: introductions of new institutions & instruments,

establishing unified exchange rate, historic memo – between bank
& govt – cap – adhoc treasure bills.

• Salim Gangabharan: weathering Asian crisis, improving

transparency & central bank communications, strengthening
BOP&FOREX, low inflation & soft interest rates.
What are the objectives of Indian
monetary policy ?
• Maintain price stability

• Flow of credit to the productive sectors of the


• Stability for the national currency

• Growth in employment and income

What are the tools of Indian monetary
policy ?


Evolution Of Monetary Policy In
• After the crisis in 1991 , stabilization went simultaneously with
structural reforms

• Change in context fundamentally altered the manner in which

monetary policy began to be formulated

• Macroeconomic and price stability received greater emphasis .

• Continuous rebalancing of priority between growth and price


• Financial stability ascended the hierarchy of monetary

policy objectives in mid 1990s.
• The operating framework of monetary policy formation
underwent a transformation during the 1990

interventions in Monetary target
1970s and 1980s feedback in
early 1990s

• In mid 1990s RBI switched to a multiple indicator approach

Monetary changes
• Growing market orientation of monetary

• From direct to more indirect and market – based monetary policy


• Initially CRR and SLR requirements locked away nearly 70 per

cent of bank deposits

• The SLR was brought down from 38.5 per cent of in early 1992
to 25 per cent in mid -1994

• CRR reduced to 5 per cent from 15 per cent after 1991.


• Interest rate deregulation was initiated after


• 1990 1994 1995-97 2003

All sectors
The minimum Banks were
Specific The ceiling on
Rate prescription advised
interest rate Rates on
Withdrawn to announce a
Prescription deposits
bank free benchmark
Were were
To charge PLR PLR
abolished removed
Impact on Economy
25 bps hike in REPO rate by RBI to limit the Inflation
to 5-5.5%
Interest Rate:
Hike in REPO rate signals hike in interest rates a year
govt. sec would expected to lie in the range of 7-8% at
the end of the fiscal year.
Exchange Rate:
Hike in REPO rate is not expected to impact the
exchange rate directly
Impact on financial Services
• Increases in term deposits
• Increases in industrial credit as well as
overall credit
• Increases in provisioning requirements for
standard assets of banks
• Reduction in interest rates ceilings on
NR(E)Ra and FCNR(B) deposits
FCNR(B): Foreign Currency Non-Resident (Banks).
NR(E) RA: Non-Resident (External) Rupee Accounts.
Third quarter review of Monetary policy
•GDP was raised from 8% GDP 8.5-9%
•Two stage hike in CRR
•Further hike in REPO rate REPO RATE 7.5%
due to increased cash flow
 Increase in reserves RATE
 Increase in net foreign CRR 5.5%
•Inflation was largely due to INFLATION 5 - 5.5%
primary sector
•Oil prices stabilized towards MONEY 20%
the end of the financial year SUPPLY
Monetary Policy for 07-08
• Decline in GDP growth GDP 8.5%
projection. Inflation 4.5-5%

• No change in major rates

Bank Rate 6%
• Basic objective is price
Stability Reverse REPO 6%
• Growth has been given a rate
REPO rate 7.75%
• Expected future hike in C.R.R 6.5
• Housing loans M3 expansion 17-17.5%
• Liberalization of FOREX
“The whole thing is that ke bhaiya sabse
bada rupaiya
Int rate ceiling on FCNR deposit Ceiling on overseas investment for
reduced 50 bps to LIBOR – 75 mutual funds increased from $3 to
bps $4 billion

Int rate ceiling on NRE deposit Prepayment of ECB’s up from $300

reduced 50 bps to LIBOR/SWAP million to $400 million

Overseas investment limit for Indian Remittance limit up from $50000 to

JV’s enhanced from 200 to 300% of $100000 per year for individuals
net worth

Limit for Portfolio Investment Increase limits from $1M to $10M

Abroad enhanced from 25% to 35% for consultancy for infrastructure
of net worth projects
Indian Interest Rates
Cash Reserve Ratio (CRR)

• All scheduled commercial banks are

required to maintain a fortnightly average
daily cash reserve equivalent with RBI.
• RBI is empowered to vary this ratio
between 3 and 15 per cent.
• Increase in CRR means that banks have less
funds available and money is sucked out of
Repo Rate / Bank Rate

• REPO RATE is the rate at which the RBI

lends short-term money to the banks.
• BANK RATE is the rate at which the RBI
lends money to other banks or financial
Expansionary Policy – RBI lowers
repo/bank rate
Contractionary Policy- RBI raises
repo/bank rate
Open Market Operations

• The buying or selling of bonds by the RBI

in the open market
• Expansionary Policy- RBI buys bonds
(gives banks new reserves)
• Contractionary Policy- RBI sells bonds
(drains reserves from banks)
Statutory Liquidity Ratio

• The ratio of liquid assets to demand and

time liabilities is known as Statutory
Liquidity Ratio.
• Present SLR is 25%, RBI is empowered to
increase this ratio upto 40%.
• An increase in SLR also restrict the bank’s
leverage position to pump more money into
the economy.

• The Reserve Bank of India (RBI) released

its Annual Monetary Policy Statement for
2007-08 on April 24, 2007 in which it
clearly laid out its dominant objectives – to
manage the surging capital inflows and
contain inflation. On both counts there is a
confrontation between the RBI and the
Ministry of Finance and monetary policy is
compromised as a result.
• If monetary policy is to contain any
semblance of inflation fighting, then the
short-term interest rate in the economy has
to exceed two percent in real terms. In other
words, the short-term interest rate must
exceed 11%. This simple calculation tells us
that RBI has been behind the curve in
understanding and attacking inflation.
• RBI has acted too little and too late.
Inflation spiked up in December 2007, but
in early 2008, RBI was pursuing the policy
of buying USD on a massive scale,
injecting rupees in the economy, and
driving down interest rates in the local
economy. Even now - a full eight months
into the inflation crisis - policy rates remain
negative in real terms. So while there is a
lot of hawkish talk from RBI, we should
remain skeptical about the extent to which
RBI is actually concerned about inflation.
“Inflation is when you pay Rupee Five
hundred for the Rupee Hundred haircut
you used to get for Rupee fifty when you
had hair.”