Monetary Policy ==

8/9/2019 Monetary Policy ==

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MONETARY POLICY

..


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. Objectives of monetary policy:

1. Price stability

2. Credit availability 3. Stability of Exchange Rate

4. Full Employment

5. High Rate of Economic Growth 6. Distribution of Money.


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. Nature of monetary policy:

To ensure price stability in the

economy. Factors include to ensure stability in

the economy:

1. Money supply, commonly referred toas M3.

2. Interest rates

3. Inflation.


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General credit controls:

General credit controls:

General Controls affect the totalquantity of credit and the economygenerally.


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. General control include:

(Tools of Monetary Policy)

(a) Bank Rate (b) Repo Rate

(c ) Reverse Repo Rate

(d) Open Market Operations (e) CRR

(f) SLR

(g) Refinance policy


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. Bank Rate is the rate at which

central bank of the country (in India

it is RBI) allows finance tocommercial banks.

Bank Rate is a tool, which centralbank uses for short-term purposes


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Repo rate Whenever the banks have any shortage

of funds they can borrow it from RBI.

Repo rate is the rate at which ourbanks borrow rupees from RBI.

A reduction in the repo rate willhelp banks to get money at a

cheaper rate. When the repo rate increases borrowing

from RBI becomes more expensive.


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. repo or "repurchase agreement"

Essentially, a repurchase agreement

is an agreement between one partyand another in which the former sellsa security (like a bond) to the latterwith a promise to buy it back after a

particular period.


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. For instance, a bank may enter into

a repo with RBI, selling a security to

RBI and then tell RBI that I will buythis security back from you after 3-months.

RBI tells the bank...OK I will pay Rs.

100 for this security now but whenyou buy it back from me, please payme Rs. 103.


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. Generally, repos are used for

managing domestic liquidity in

the economy. While a bank rate has a direct

impact on borrowing costs forbanks, repo rates have a more of a

fine-tuning(minor change ormodification) impact.


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. Furthermore,

repos are short-term agreements

and are entered into by banks tomeet short-term shortfalls intheir liquidity positions.


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Reverse Repo rate Reverse Repo rate is the rate at

which Reserve Bank of India (RBI)

borrows money from banks. Banks are always happy to lend

money to RBI since their money arein safe hands with a good interest.

An increase in Reverse repo rate cancause the banks to transfer morefunds to RBI due to this attractive

interest rates.


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. Reverse Repo rate is the rate at

which banks park their short-term

excess liquidity with the RB

I. The RBI uses this tool when it feels

there is too much money floatingin the banking system.


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. An increase in the reverse repo

rate means that the RBI will

borrow money from the banks ata higher rate of interest.

As a result, banks would prefer tokeep their money with the RBI


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. Refinance Policy:

The system ofRefinance provided

by RBI to Commercial Banks affectstheir credit.

Over the years, the CommercialBanks dependence on RBI forrefinance has come down except incase ofsubsidized refinance ofagricultural & rural credit.


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. CRR, or cash reserve ratio,

refers to a portion of deposits (as

cash) which banks have tokeep/maintain with the RBI.

This serves two purposes.


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Selective Credit Controls:Selective Credit Controls:

Selective Credit Controls:Selective Credit Controls:

When thereWhen there is a shortage of

institutional credit available for thebusiness sector,

the large and financially strongsectors or industries tend tocapture the lions share in the totalinstitutional credit.


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. As, a result,As, a result, priority sectors and

essential industries are

starved(hungry) of necessary funds, while the bank credit goes to the

non-priority sectors.


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. In order to curb this tendency, the

central bank resorts to credit

rationing measures. Generally two measures are

adopted --------

1. imposition of upper limits on thecredit available to large industriesand firms.


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. 2. Charging a higher or progressive

interest rate on the bank loans

beyond a certain limit. This is done with a view to making

banking credit available to theessential and priority sectors.


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Monetary Policy

TWO important tools

of macroeconomicpolicy are Monetary

Policy andFiscalPolicy.


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.

The Monetary Policyhasbecome dynamic in natureas RBI reserves its rightto alter it from time to

time, depending on thestate of the economy.


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.

The monetary policyregulates the supply of

money and the cost andavailability of credit in theeconomy.


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. It deals with both lending

and borrowing rates of

interest for commercialbanks.


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.

The Monetary Policy aims tomaintain price stability, full

employment and economicgrowth.

THE RBI is responsible forformulating andimplementing Monetary

Policy.


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.

It can increase or decreasethe supply of currency as

well as -----------------------------------interest rate, carryout open market operations,control credit and vary thereserve requirements.


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.

THE Monetary Policy is differentfrom Fiscal Policy as the ---------

-----------------------------------------------Monetary Policy bringsabout a change in the economyby changing money supply and

interest rate.


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.Whereas fiscal policy

is a broader tool withthe government.


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.

THE Fiscal policyTHE Fiscal policy

used to overcomeused to overcomerecessionrecession andand controlcontrol

inflation.inflation.


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.

Def ofFiscal Policy: It maybe defined as the deliberate

change in governmentrevenue and expenditure toinfluence the level ofnational output and prices.


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.

FOR Instance , at the timeof recession the

government can increaseexpenditures or cut taxesin order to generatedemand.


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. ON the other hand, the

government can reduceits expenditures or raisetaxes during inflationary

times.


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.

Fiscal Policy aims at

changing aggregatedemand by suitablechanges in the

government spendingand taxes.


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.

THE annual UnionBudget showcases thegovernments FiscalPolicy.


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Role of Monetary policy

A reduction in interest

rates would force banksto lower their lendingrates and borrowingrates.


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.

So if you want to place

a deposit with a bankor take a loan, it wouldoffer it at a lower rateof interest.


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.

On the other hand, ifthere were to be anincrease in interest rates,banks would immediately

increase their lending andborrowing rates.


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.

Since the rates of interestaffect the borrowing costsof corporate and as aresult, their bottom lines

(profits), the monetarypolicy is very importantto them also.


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.

Since the financial sector reformscommenced------------------------

----- the RBI has moved towards a

market-determined interest rate

scenario. This means that banks are free

to decide on interest rates on

term deposits and loans.


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.

Being the central bank,however, the RBI wouldhave a say anddetermine direction on

interest rates as it is animportant tool to controlinflation.


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SOME (Tools of)Monetary

Policy Terms: CRR:

1.It ensures that a portion of bankdeposits is totally risk-free

2.and secondly it enables that RBI

control liquidity in the system, andthereby, inflation.


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.

Besides the CRR, banksare required to invest aportion of their deposits ingovernment securities as

a part of theirstatutoryliquidity ratio (SLR)requirements.


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.

Since 1991, as the economy hasrecovered and sector reforms

increased---------------- the CRR has fallen from 15 per

cent in March 1991 to 5.5 per

cent in December 2001. The SLR has fallen from 38.5 per

cent to 25 per cent over the past

decade.


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.

Lowering of CRR meansthat more money comesinto circulation. CRR iscurrently 5%.


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.

`What impact does a cut inCRR have on interest rates?

From time to time, RBIprescribes a CRR or the

minimum amount of cash thatbanks have to maintain with it.


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.

The CRR is fixed as apercentage of total deposits.

As more money chases thesame number of borrowers,interest rates come down.


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.

Whenever you see anincrease on inflation,there will be an increaseof interest rate also.


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.

CRR and SLR is the same ------------------- they reduce the capacity ofcommercial banks to expandcredit to business and industry andthus are ------ anti-inflationary.


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.

Money Supply (M3)

This refers to the totalvolume of money circulating

in the economy,


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.

and conventionallycomprises -------currencywith the public and demanddeposits (current account +savings account) with thepublic.


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.

The RBI has adopted

four concepts ofmeasuring moneysupply.


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.

The first one is M1, whichequals the sum of currency

with the public, demanddeposits with the public andother deposits with thepublic.


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.

Simply put M1 includes --------------- all coins andnotes in circulation, andpersonal current accounts.


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.

The second, M2, is ameasure of moneysupply,

including M1,

plus personal depositaccounts


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.

plus government

deposits and depositsin currencies other thanrupee.


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.

The third concept M3

or the broad moneyconcept, as it is alsoknown, is quite

popular.


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.

M3 includes net timedeposits (fixed deposits),savings deposits withpost office saving banks

and all the components ofM1.


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.

Statutory Liquidity Ratio(SLR):

Banks in India are required tomaintain 25 per cent of theirdemand and time liabilities in

government securities and certainapproved securities.


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REPO RATE

Whenever the banks haveany shortage of funds they

can borrow it from RBI. Repo rate is the rate at

which our banks borrow

rupees from RBI.or


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.

REPO, the rate at which the RBIlends short-term funds to banks,now stands at 5%

and the REVERSEREPO, the rate atwhich the RBI borrows from banks,now stands at 3.5%.

This is the second rate cut by the RBIthis calendar year.


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.

A reduction in the repo rate willhelp banks to get money at a

cheaper rate. When the repo rate increases

borrowing from RBI becomes

more expensive.


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.

Repo rate is the rate at whichthe RBI borrows from the banks.


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.

while reverse repo rate is theinterest rate earned by a bank for

lending money to the RBI inexchange for Governmentsecurities.


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.

The presentThe present REVERSEREVERSEREPOREPO RATERATE is 3.5%.is 3.5%.

(Dated 05(Dated 05--0303--09)09)


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.

With the rate cuts now, thecost of funds could become

cheaper and liquidity ample.


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.

Open Market Operations :

An important instrument ofcredit control,

the Reserve Bank of India

purchases and sellssecurities in open marketoperations.


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.

Open Market operations isthe buying and selling of

securities (normallyGovernment securities) by acentral bank in the market

in order to increase or decreasethe outstanding supply of bank

reserves.


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.

In times of inflation, RBI sellssecurities to mop up the excess

money in the market. Similarly, to increase the

supply of money, RBI

purchases securities.


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On 10-02-2010

Bank Rate : 6.0%

Repo Rate : 4.75% ,

T

he policy rates, both the repo rate andthe reverse repo rate have beenretained at their current levels.


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.

Reverse Repo Rate : 3.25%

CRR : 5.75% ,

As a result of the CRR increase,about Rs.36,000 crore of excessliquidity will be absorbed from thesystem.

SLR : 25.0%


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.

PLR (Prime lending rate):12.75% ------- 13.25%

Savings Bank Rate : 3.5% Deposit Rate : 7.50% ------

9.60%


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.

Assuming a near zero growth inagricultural production and continuedrecovery in industrial production andservices sector activity,

the baseline projection for GDPgrowth for 2009-10 is now raised to

7.5 per cent.


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.

Looking ahead to 2010-11, ourpreliminary assessment of thebaseline scenario is that the currentgrowth will be sustained.

We shall formally indicate our growthprojection for 2010-11 in April 2010.

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Monetary Policy ==

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