Monetary Policy

RBI and Monetary Policy in India

 Monetary Magnitudes
• M1 = Currency with public+
Demand deposits with banks+
Other Deposits with RBI
• M2 = M1+ Post Office Deposits
• M3 = M1+ Time Deposits with Banks
• M4 = M3+ Total Post Office Deposits
 What is Monetary Policy?
• The term monetary policy refers to actions taken
by central banks to affect monetary magnitudes
or other financial conditions.
• Monetary Policy operates on monetary
magnitudes or variables such as money supply,
interest rates and availability of credit.
• Monetary Policy ultimately operates through its
influence on expenditure flows in the economy.
• In other words affects liquidity and by affecting
liquidity, and thus credit, it affects total demand
in the economy.
 Credit Policy
• Central Bank may directly affect the money
supply to control its growth.
• Or it might act indirectly to affect cost and
availability of credit in the economy.
• In modern times the bulk of money in developed
economies consists of bank deposits rather than
currencies and coins.
• So central banks today guide monetary
developments with instruments that control over
deposit creation and influence general financial
conditions.
• Credit policy is concerned with changes in the
supply of credit.
• Central Bank administers both the Credit and
Monetary policy
 Aims of Monetary policy
• MP is a part of general economic policy of the
govt.
• Thus MP contributes to the achievement of the
goals of economic policy.
• Objective of MP may be:
Full employment
Stable exchange rate
Healthy BoP
Economic growth
Reasonable Price Stability
Greater equality in distribution of
income & wealth
Financial stability
 Price Stability: The Dominant
Objective
• There is convergence of views in developed and
developing economies, that price stability is the
dominant objective of monetary policy.
• Price stability does not mean complete year-to-
year price stability which is difficult to attain.
• Price stability refers to the long run average
stability of prices.
• Price stability involves avoidance of both
inflationary and deflationary pressures.
 Contd..
• Price Stability contributes improvements in the
standard of living of people.
• It promotes saving in the economy while
discouraging unproductive investment.
• Stable prices enable exports to compete in
international markets and contribute to the
strengthening of BoP.
• Price stability leads to interest rate stability, and
exchange rate stability (via export import
stability).
• It contributes to the overall financial stability of
the economy.
Instruments
Operation of Monetary
1. Discount Rate
(Bank Rate) Policy
2.Reserve Ratios Operating
Target
3. Open Market
Operations
• Monetary Base
• Bank Credit Intermediate
• Interest Rates Target
•Monetary
Aggregates(M3)
Ultimate
•Long term Goals
interest rates
•Total Spending
• Price Stability
Etc.
Instruments of Monetary Policy
• Variations in Reserve Ratios
• Discount Rate (Bank Rate)
(also called rediscount rate)
• Open Market Operations (OMOs)
• Other Instruments
 Variations in Reserve Ratios
• Banks are required to maintain a certain percentage
of their deposits in the form of reserves or balances
with the RBI
• It is called Cash Reserve Ratio or CRR
If RBI decides to increase the percent of this, the
available amount with the banks comes down. RBI is
using this method (increase of CRR rate), to drain out
the excessive money from the banks.
Since reserves are high-powered money or base
money, by varying CRR, RBI can reduce or add to the
bank’s required reserves and thus affect bank’s ability
to lend.
 Discount Rate (Bank Rate)
• Discount rate is the rate of interest charged by the
central bank for providing funds or loans to the
banking system.
• Funds are provided either through lending directly or
rediscounting or buying commercial bills and treasury
bills.
• Raising Bank Rate raises cost of borrowing by
commercial banks, causing reduction in credit volume
to the banks, and decline in money supply.
• Variation in Bank Rate has an effect on the domestic
interest rate, especially the short term rates.
• Market regards the increase in Bank rate as the
official signal for beginning of a tight money situation.
Open Market Operations (OMOs)
• OMOs involve buying (outright or
temporary) and selling of govt securities
by the central bank, from or to the public
and banks.
• RBI when purchases securities, pays the
amount of money by crediting the reserve
deposit account of the seller’s bank, which
in turn credits the seller’s deposit account
in that bank.
 Repo Rate
• Whenever the banks have any shortage of
funds they can borrow it from RBI. Repo
rate is the rate at which our banks borrow
rupees from RBI. A reduction in the repo
rate will help banks to get money at a
cheaper rate. When the repo rate
increases borrowing from RBI becomes
more expensive.
July 28th, 2009
MUMBAI - Following are the highlights of the first quarterly up
* Bank rate retained at 6 percent
* Repo rate unchanged at 4.75 percent
* Reverse repo rate unchanged at 3.25 percent
* Cash reserve ratio unchanged at 5 percent
* Statutory liquidity ratio unchanged at 24 percent
* Inflation forecast hiked to 5 percent from 4 percent
* Negative inflation only a statistical phenomenon
* Balance between liquidity and inflation main concern
* India’s growth now forecast at 6 percent with upward bias
* More scope for cutting rates by commercial banks
* Money supply may grow 18 percent this fiscal
* Policy will ensure enough commercial credit
Reserve Bank's annual policy review highlights
April 21st, 2009 MUMBAI - The following are the highlights of the annual monetary policy review rele
the country's central bank,
Tuesday: * Repo rate cut by 25 basis points to 4.75 percent *
Reverse repo rate cut by 25 basis points to 3.25 percent *
Cash reserve ratio remains unchanged *
GDP growth for 2009-10 to be around 6 percent *
GDP growth for 2008-09 at 6.5-6.7 percent *
Annual rate of inflation to be four percent by end of March 31, 2010
•Inflation to turn negative in early part of 2009-10 *
• Negative inflation may not persist beyond mid-2009-10 *
•Consumer price inflation to be in positive territory this fiscal *
•Banks can open ATMs without prior approval *
• Foreign currency convertible bond buyback limit increased to $100 million *
•External commercial borrowing ceiling relaxation extended *
•Current foreign bank policy to remain, review to happen once world economy recovers *
•Money supply growth for 2009-10 forecast at 17 percent *
• Government's market borrowing schemes will infuse liquidity worth Rs.1.2 trillion in first half of 200