RBI’s Monetary Policy

5/20/2018 RBIs Monetary Policy

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RBIs

Monetary

Policy

DR B K MUKHOPADHYAY

presents


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PolicyBank Money

Banks create money by writing an accounting voucher Debit. Loan A/c

Credit Customers Deposit A/c

Amount of loan credited in Deposit A/c is rarely withdrawn in cash as most

payment are made by cheques on another bank account.

(Deposit) money thus created keeps circulating within the banking systemas book entries

Banks do not need you to deposit cash to give a loan. Loans are self-

funding

It needs cash deposit only meet the probabilistic event of cash being

withdrawn The banking system needs very little cash injection from outside, especially

if banks are willing to lend among themselves freely

Banks are mainly in business of creating money; much less in that of

savings intermediation


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Bank Money

If acceptance of (cash) deposits is seen as

similar to buying cash; and making loans as

selling cash, then banks are in the business of

short-selling cash Greater the credit creation higher the cash-short

position (leverage)

Credit creation makes financial system fragile

CRR and SLR act as margin money with a

centralized clearing house and limits the

capacity of banks to roll over the same cash for

making loans


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Bank Money

Bank credit is repayable

Bank credit is money + anti-money

For sustaining demand over a period of time

fresh credit > repayment

Leading to inexorably increasing debt to GDP

ratio

Excessive credit can be inflationary, and oftenresults in asset inflation

Central banks have a strong motivation to to limit

bank credit beyond whats considered safe


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Central Bank (sovereign) Money

Does not increase leverage in the financial

sector

Results in long term and often permanent

money creation & increase in demand Results in creating liquidity in the economy

Strong inflationary bias

Central banks creates money when govt.borrows from it

Controlling inflation requires restriction on deficit

monetization


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The need for more money

Expanding economy needs expansion in

money

Excessive bank money (credit) leads to

financial fragility and asset booms

Excessive central bank money leads to

inflation

Constraining either can affect growth


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Conflicted objectives of the

central banks How much bank money and sovereign

money should be created so as to

Promote credit creation for increasing

demandRestrain credit creation for financial stability

Promote deficit monetisation for demandmanagement (i.e. when credit creation has

not been successful in promoting demand)Restrain deficit monetisation to control

inflation


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Twin policy tools of central bank

Monetary policy:

Dealing with money creation and the

proportion of bank money and sovereign

money in the total money

Prudential regulations:

Mitigating the effects of leverage resulting

from banks credit creationEnsuring overall financial stability


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Objectives of Monetary Policy

Developed Economies Australia: Stability of the currency, maintenance of full

employment and economic prosperity and welfare.

Canada:Low and stable inflation.

ECB:Price stability primary objective. Without prejudice to the

objective of price stability, also support the general economicpolicies with a view to contributing to a high level of employment and

sustainable and non-inflationary growth.

Japan:Price stability and to ensure the stability of the financialsystem.

New Zealand: Maintaining a stable general level of prices. UK:Monetary stabilitymeaning stable prices and confidence in

the currencyand financial stability.

USA:Maximum employment, stable prices and moderate long-terminterest rates.


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Objectives of Monetary Policy

Developing Economies

China:Stability of the currency and thereby promote economicgrowth.

India:Price stability, credit availability, growth, financial stability

Indonesia:Achieve and maintain currency stability by maintaining

monetary stability and by promoting financial system stability.

Malaysia:Safeguard the value of the currency, promote monetarystability and a sound financial structure and influence the credit

situation to the advantage of the country.

Mexico:Price stability. Russia:Stability of currency, development of banking system and

efficient settlement system.

South Africa:Financial stability.

Thailand:Maintain monetary stability


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The basis of monetarism

Fishers quantity equation

Money value of transactions = Quantity of money x

Velocity of Money

Nominal GDP = Quantity of Money x

Velocity of Money

Velocity of money constant Globally, money stock has expanded much faster than

output

Velocity of money describes a U curve (?)


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Declining velocity of money

A safe conclusion: velocity of money is notconstant


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Interest rate as policy target

The decline of money stock and the rise of interest rateas operating targets of monetary policy

Emergence of Taylor like rules


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RBIs mandate

RBI Acts states the rationale of the

establishment of RBI in following terms:

"to regulate the issue of Bank Notes and

keeping of reserves

with a view to securing monetary stability

in India and generally to operate thecurrency and credit system of the country

to its advantage".


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RBIs Framework of Monetary

Policy

Instruments

CRR/SLR

Liquidity Adjustment Facility

RBI refinance rates

Open Market Operations

Moral suasion


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RBIs Framework of Monetary

Policy

Operating targets

Level of cash reserves

Short term interest

rates Intermediate targets

Monetary/credit

targets

Exchange rate

Long term interest rate

Final Objectives

Price Stability

Output

Financial Stability Studies show 6-24

months lag in

attaining the final

objectives


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RBIs Annual Policy

Announced in April of the corresponding

financial year

Reviewed in

July (first quarter)

October (mid-term)

January (third quarter)


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RBIs Annual Policy (2009-10)

Mid-term Review Section I

Macroeconomic and Monetary Developments

Section II

Stance of the monetary policy

Section III

Policy measures


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Macroeconomic and Monetary

Developments

World

Economic

Outlook

revised thegrowth

projections


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Developments

Mixed signals from the US

Much lower contraction of the economy in the2ndquarter (0.7% as against 6.4% in Q1)

Home prices are stabilisingUnemployment rose to 9.8% and expected to

rise further

Weak signals from Europe

Rising unemployment (9.6% as of Aug. 2009)

Unabated economic contraction in Q2 (4.8%)

However output appears to be stabilising


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Developments

Inflation

Rebound in commodity prices, steady crude

prices and rally in gold prices

However CPI in most advanced and EMEs

remained low/negative (except India)

Financial Markets

Share prices have bounced back

Fall in credit offtake mainly due to tightening

of credit standards by banks


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Developments

Domestic

outlook

Lower than

forecasted

growth but

signs of

recovery


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Developments

Agriculture

Deficient rainfall

Low agricultural output hasdisproportionate impact on overalleconomic prospects

Higher food prices lower sense of well-

beingInter-sectoral supply demand linkages

High stock of food grains with publicagencies


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Developments

Industry

Recovery in basic, intermediate and

consumer durables

Capital and non-durable consumer goodsshowing modest recovery

Services

Lower growth

Trade related services showing negative

growth, reflecting contraction in trade


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Developments

Demand Components of GDP


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Developments

Inflation

WPI was negative till June-August, 2009;

1.21% as at 10 Oct 2009

Sharp divergence in CPI and WPI

Different weights

CPI leads WPI

2008 inflation and 2009 inflation are fordifferent reasons

Vegetables 59.3%, Tea 30.7%, Sugar 25.3%


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Developments


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Developments

Fiscal situation


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Developments

Govt. borrowings

Net borrowings in 2008-09 increased by 143%

Net borrowings in 2009-10 increased by 34%

Net borrowings increased in 2009-10 by 226% from2007-08

RBI front loaded the borrowings for 2009-10 in

order to complete the borrowing programme in a

non-disruptive manner 80.4% of the borrowing already completed

Aided by reduction in CRR


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Developments

RM lower due to reduction in CRR

M3higher due to increase in net bank credit to

Government (as against increase in bank credit to

commercial sector and foreign exchange assets)


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Developments

Bank credit

Non-food credit declined

Slow down in credit demand from manufacturing

sector

Slow down in sanction of retail credit

Lower oil prices have led to lower borrowing oil

companies

Sharp decline in credit by private sector and foreignbanks

Rise in banks investment in mutual funds


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Developments

Interest rate Decline in interest rates across the term structure

Trend in interest rates

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

16.00

Oct-

08

Nov-

08

Dec-

08

Jan-

09

Feb-

09

Mar-

09

Apr-

09

May-

09

Jun-

09

Jul-

09

Aug-

09

Sep-

09

Oct-

09

Call Money

CBLO

Market Repo

CD rate

CP rate

91-D TB

10-Yr-Gsec

BPLR of PSBs


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Developments

BOP Greater decline in imports than exports


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Stance of the Monetary Policy

Keep a vigil on the trends in inflation

Monitor the liquidity situation closely and

manage it actively to ensure that credit demands

of productive sectors are adequately met while

also securing price stability and financial stability

Maintain a monetary and interest rate regime

consistent with price stability and financial

stability, and supportive of the growth process


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Measures

Bank rate unchanged at 6%

Repo and reverse repo unchanged at 4.75%and 3.25%

CRR unchanged at 5% SLR hiked back to 25%

Special refinance facilities withdrawn, exportrefinance reduced to 15% of o/s export credit

Special repo facilities discontinued A Financial Stability Unit set up in RBI

Repo in corporate bonds to be started

Permission for centralized credit derivatives


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Measures

STRIPs launched

Banks to maintain CRR for CBLO

PLR to give way to BLR

State Coop Banks and Central Coop Bankto obtain banking license by 2012

RRBs to bring their CRAR to 9% by 2012

Financial inclusion: list BCs expanded Priority Sector Lending Certificates


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Measures

Banks to maintain at least 70% provision

against NPAs

Effective governance of compensation

Adjustment of compensation for all types of

risk

To be symmetric with risk outcomes, and to

be sensitive to the time horizon of risks

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RBI’s Monetary Policy

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