Monetary Policy of India

Tug of War between Inflation

Control and Growth

By : Abhisek Khatua

What is Monetary Policy ?

Important Tool of Economic Policy

Central Bank’s Policy pertaining to the control

of the availability, cost, and use of money and

credit with help of monetary measures in order

to achieve specific goal (economic policy)

“The attitude of the political authority towards

the monetary system of the community underits control” ……..Paul Einzig

Monetary Policy

Currency

Deposits

Credit

Foreign Exchanges

Indian Monetary Policy

Active Policy

Controlled Money Supply

Seasonal Variations

Flexible

Investment & Saving Oriented

Wide Range of Methods of Credit Control

Neutrality of Money

Exchange Rate Stability

Economic Growth

Price Stabilization

Full Employment

BOP Equilibrium

Equal Income Distribution

Features Objectives

Instruments of Monetary Policy

Bank Rate

Open Market Operations

Variations in the reverse requirements

Repo Rate

Liquidity Adjustment Facility

Rationing of Credit

Margin Requirement

Variable Interest Rate

Regulation of Consumer Credit

Licensing

Quantitative Qualitative

Tug of War Begins

Monetary Policy Approach

Tight Monetary Policy

• Govt. sells Securities (OMO)

• CRR, Repo Rate, Bank Rates

Monetary Supply

Interest Rates

Investment Expenditures

Aggregate Demand

Price Level

Expansionary Monetary Policy

• Govt. buys Securities (OMO)

• CRR, Repo Rate, Bank Rates

Monetary Supply

Interest Rates

Investment Expenditures

Aggregate Demand

Aggregate Output

@Source: RBI Reports

Bank Rate : It’s Impact

Central Bank

Commercial /Domestic Bank

Consumer / Customers

Loans & Advances

Loans & Advances

* Decrease Money Supply in Economy

* Inflation Control

* Economic Growth Suffers

* Increase in Money Supply

* Economic Growth Targeted

* Inflation Control Suffers

Bank Rate Trends

Repo Rate

Central Bank

Commercial Banks

Lends Money in the

event of shortfall of funds

Repo Rate Trends

@Source: RBI Annual Report, 2010

Repo Rate and It’s Impact

Repo Rate Increases

Disincentive for Banks to

Borrow money from RBI

Reduces Money Supply

Reduces Inflation

Repo Rate Decreases

Increases Money Supply

Growth Targeted

Trade Off

Reverse Repo Rate and It’s Impact

Reverse Repo Rate Increases

Incentive for Banks

Reduces Money Supply

Reduces Inflation

Reverse Repo Rate Decreases

Disincentive for Banks

Increases Money Supply in the economy

Growth Targeted

Trade Off

Central Bank Commercial Banks

Parks Excess Money

Reverse Repo Rate Trends:

Cash Reserve Ratio

Commercial Banks

***Specified Minimum fraction of Total Deposits of customer

***Hold as Reserve either in Cash or Deposits

Central Bank

Cash Reserve Ratio and It’s Impact

• Higher Cost for Banks

• Higher Cost for Borrowers

• Money Supply Reduces

• Inflation Control

CRR

• Cost Consideration taken cared

• Money Supply Increases

• Growth TargetedCRR

Repo Rate, CRR and MSF Trends

Cash Reserve Ratio Trends

Statutory Liquidity Ratio

Commercial Bank (need to maintain)

Stipulated Proportion of Net Demand and Time Liabilities in the

form of Liquid

Report to Central Bank

Statutory Liquidity Ratio and It’s Impact

Money Supply

Increases

Growth Targeted

Money Supply

Reduces

Inflation Control

Monetary Policy & Its Aspects

• Used as an effective tool to target economic growth.

• Used mainly to control money supply

Monetary Policy Tools

• Determines the total amount of currency floating in the economy.

• Is considered as a major factor for inflation and Growth

Money supply • Rise/fall in general price

level

• Affects the economic growth of the country

Inflation & Growth

Impact of Monetary Policy

Country’s Growth

Inflation

Value of its Currency

Level of Employment

Investment Prospects

DirectlyIndirectly

Philips Curve : Inflation and Unemployment

Historical Perspective of Growth, Inflation and Money Supply

@Source: RBI Perspectives on Inflation in India(Speech by Shri Deepak Mohanty, Executive Director, Reserve Bank of India, delivered at the Bankers Club, Chennai on September 28, 2010

Monetary Policy Framework & Approach of RBI

Instruments

• Reserve Requirements

• Official Interest Rates

• Open Market Operations

• Direct Controls

Operating Targets

• Short Term Interest Rates

• Reserve Aggregates

Intermediate Targets

• Monetary Aggregates

• Inflation

• Exchange Rate

Goals

• Price Stability

• Sustainable Growth

• High Employment

• Financial Stability

Tactics Strategy

Recent Approach

Expectation of Rate cut by .25 to .50 % in interest rate to boost industrial growth and

economy.

FM Mr. Arun Jaitley: “Need to make our economy more competitive with more competitive

interest rates.”

Bankers and Experts: expecting Lowering the Borrowing rate

Bank of Maharastra CMD Mr. Sushil Muhnot: There is a possibility of RBI reducing rate by .50 %

as inflation has been eased.

Industry Chamber: Expects .50 % rate cut (Assocham)

RBI Governor Mr. Raghuram Rajan: (last month): Govt. sticking to fiscal consolidation road

map in Budget comforting, it is a statement showing hope of rate cut.

In 2015 RBI has lowered rates by 1.25 %

Highlights of RBI’s First Bi-Monthly Monetary

Policy Statement(5th April, 2016):

• Money Supply Increase, Growth TargetedRepo Rate Cut by .25% to 6.50%

• Money Supply Increase, Growth TargetedReverse Repo Rate hiked by .25% to 6%

• Stable ImpactCRR unchanged at 4%

• More Money Supply (Bank gets urgent credit at lower cost)MSF rate cut by .75%

• Growth Targeted Monetary Policy (Expansionary)Growth Forecast 7.6%

• Controlled Inflation, but likely to increaseExpects Inflation around 5%

• Upward Pressure of Inflation of 1.5%7th Pay Commission Impact

@Source: economictimes.com

Our Interpretation

RBI: Likes to see Inflation under control - therefore does not cut interest rates when inflation

is high.

Central Govt.: Bends more in favour of higher economic growth - likes to see cut in interest

rates cost of capital goes down economic activities picks up helping economic

growth.

FM Arun Jaitley openly cited: high cost of capital is "one singular factor" slowing down

growth of the manufacturing sector. Also quoted that RBI is a highly professional body to

manage it in a better way

Rajan on other hand said: "Monetary stimulus will not do, The govt. needs to work on

infrastructure"

Recent Monetary Policy is "Welcome Decisions" as there is expected Rate cut by RBI.

Conclusion

MP is management of expectation.

"India’s growth story at least in the short run depends critically on inflation. There is a felt

need that, if to bring down inflation, growth in the short run needs to be compromised then

we should do that. It is important therefore to bring down inflation as quickly as possible

and with as little damage to the growth and employment story as possible.“

[@Kausik Basu Chief Economic Adviser, Govt. India: The Rise of Indian Economy: Fiscal, Monetary and Other Policy challenges ,Journal of the Italian Economic Association] 2012]

References

www.investopedia.com

www.rediff.com/business

www.rbi.com

www.economictimes.com

www.wikipedia.com

www.tradingeconomics.com

www.statisticstimes.com

Thank You