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Submitted by Paromita Deb (49) SaradaNag (64)

Meaning of 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. The Monetary Policy regulates the supply of money and the cost and availability of credit in the economy. It deals with both the lending and borrowing rates of interest for commercial banks. The Monetary Policy aims to maintain price stability, full employment and economic growth. Monetary policy / monetary management is regarded as an important tool of economic management in India. RBI controls the supply of money and bank credit.

Objectives of Monetary policy..

Growth With Stability :Traditionally, RBIs 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. 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.

External Stability :With the growth of imports and exports Indias linkages with global economy are getting stronger. Earlier, RBI controlled foreign exchange market by determining 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.

Tools of Monetary policyQuantitative tools

1. Bank Rate Policy :Bank rate is the rate at which the Central bank lends money to the commercial banks for their liquidity requirements. Bank rate is also called discount rate. In other words bank rate is the rate at which the central bank rediscounts eligible papers (like approved securities, bills of exchange, commercial papers etc) held by commercial banks. Bank rate is important because it is the pace setter to other market rates of interest. Bank rates have been changed several times by RBI to control inflation and recession.

2. Open market operations :It refers to buying and selling of government securities in open market in order to expand or contract the amount of money in the banking system. This technique is superior to bank rate policy. Purchases inject money into the banking system while sale of securities do the opposite. During last two decades the RBI has been undertaking switch operations. These involve the purchase of one loan against the sale of another or, vice-versa. This policy aims at preventing unrestricted increase in liquidity.

3. Cash Reserve Ratio (CRR) The Gash Reserve Ratio (CRR) is an effective instrument of credit control. Under the RBl Act of, l934 every commercial bank has to keep certain minimum cash reserves with RBI. The RBI is empowered to vary the CRR between 3% and 15%. A high CRR reduces the cash for lending and a low CRR increases the cash for lending. The CRR has been brought down from 15% in 1991 to 7.5% in May 2001. It further reduced to 5.5% in December 2001. It stood at 5% on January 2009. In January 2010, RBI increased the CRR from 5% to 5.75%. It further increased in April 2010 to 6% as inflationary pressures had started building up in the economy. As of March 2011, CRR is 6%.


Statutory Liquidity Ratio (SLR)

Under SLR, the government has imposed an obligation on the banks to ,maintain a ratio to its total deposits with RBI in the form of liquid assets like cash, gold and other securities. The RBI has certain power to fix SLR in the range of 25% and 40% between 1990 and 1992 SLR was as high as 38.5%. The SLR was lowered down to 25% from 10thOctober 1997.It was further reduced to 24% on November 2008. 5.

Repo And Reverse Repo Rates

In determining interest rate trends, the repo and reverse repo rates are becoming important. Repo means Sale and Repurchase Agreement. Repo is a swap deal involving the immediate Sale of Securities and simultaneous purchase of those securities at a future date, at a predetermined price. Repo rate helps commercial banks to acquire funds from RBI by selling securities and also agreeing to repurchase at a later date. Reverse repo rate is the rate that banks get from RBI for parking their short term excess funds with RBI. Repo and reverse repo operations are used by RBI in its Liquidity Adjustment Facility. RBI contracts credit by increasing the repo and reverse repo rates and by decreasing them it expands credit. On May 2011 RBI announced Monetary Policy for 2011-12. To reduce inflation it hiked repo rate to,7.25% and Reverse repo to 6.25%

Qualitative tools of monetary policy

1. Ceiling On Credit The Ceiling on level of credit restricts the lending capacity of a bank to grant advances against certain controlled securities. 2. Margin Requirements :A loan is sanctioned against Collateral Security. Margin means that proportion of the value of security against which loan is not given. Margin against a particular security is reduced or increased in order to encourage or to discourage the flow of credit to a particular sector. It varies from 20% to 80%. For agricultural commodities it is as high as 75%. Higher the margin lesser will be the loan sanctioned. 3. Discriminatory Interest Rate (DIR) Through DIR, RBI makes credit flow to certain priority or weaker sectors by charging concessional rates of interest. RBI issues supplementary instructions regarding granting of additional credit against sensitive commodities, issue of guarantees, making advances etc. . 4. Directives:The RBI issues directives to banks regarding advances. Directives are regarding the purpose for which loans may or may not be given. . Moral Suasion Under Moral Suasion, RBI issues periodical letters to bank to exercise control over credit in general or advances against particular commodities. Periodic discussions are held with authorities of commercial banks in this respect.

Role of RBI in the light of Monetary Policy

3 main objective of RBI

Maintaining price stability
Ensuring adequate flow of credit

to productive sectors liquidity management

Parameters for framing Monetary Policy

Interest rate Fiscal Position Capital Flows Inflation flows Exchange rate

Transactions in foreign exchange

Repo Rate

7.25 per cent

Reverse Repo Rate

The reverse repo rate under the LAF, determined with a spread of 100 basis points below the repo rate, stands adjusted to 6.25 per cent.
Marginal Standing Facility Rate

The Marginal Standing Facility (MSF) rate, determined with a spread of 100 basis points above the repo rate, stands adjusted to 8.25 per cent
Bank Rate

The Bank Rate stands 8.25 per cent

Cash Reserve Ratio

The cash reserve ratio (CRR) of scheduled banks has been retained at 4.0 per cent of their net demand and time liabilities (NDTL).

POLICY MEASURES * Lowers marginal standing facility rate by 75 bps to 9.50 per cent * Raises repo rate (lending rate) by 25 bps to 7.50 per cent * Reverse repo rises to 6.50 per cent. * Cash reserve ratio (CRR) unchanged at 4.00 % * Partially relaxes minimum daily cash balance requirement to 95 per cent of deposits from 99 per cent

Following are highlights of the subsequent revisions of monetary policy statement:

Bringing down inflation to more tolerable levels warrants raising the repo rate by 25 basis points

immediately To contemplate easing cash tightening measures Policy steps to mitigate exchange market pressures, create a conducive environment for revitalisation of sustainable growth Steps intended to address inflationary pressures so as to provide a stable nominal anchor for the economy

Timing, direction of further actions on exceptional measures will be contingent upon exchange market stability, and can be two-way: * Further actions need not be announced only on policy dates * Focus now on internal determinants of rupee, fiscal deficit and domestic inflation, after steps taken to contain current account gap * Growth is trailing below potential and the output gap is widening * Growth could pick up in the second half of the year

Despite good monsoons leading to some moderation in CPI inflation, no room for complacency In the absence of an appropriate policy response, WPI inflation will be higher than initially projected over the rest of the year Further change in the minimum daily maintenance of the CRR not contemplated

* Objective to normalise conduct and operations of monetary policy so as to allow the repo rate to resume its role as operational policy rate

Thank you