What is Monetary Policy ?
Monetary policy refers to the policy of the central bank with regard to the use of instruments under its control to achieve the goals specified in the Act. It is the process to controls the supply of money in the economy.The Reserve Bank of India (RBI) is vested with the responsibility of conducting monetary policy with the primary objective of maintaining price stability while keeping in mind the objective of growth.
Objectives of Monetary Policy of India are:-
One of the policy objectives of monetary policy is to stabilise the price level. Both economists and laymen favour this policy because fluctuations in prices bring uncertainty and instability to the economy.
To promote more employment, both in rural and urban areas, RBI adopted the policy of Lead Bank Scheme. But when the system failed, in 1988, Service Area Approach was adopted. Accordingly, each bank branch was ear-market certain area in which the bank will be sole authority to extend credit. This has helped in generating employment in rural, semi-urban and urban areas. RBI has directed commercial banks to extend credit facilities to priority sector which is aimed at increasing employment generation.
Overfilling of stocks and products becoming outdated due to excess of stock often results in sickness of the unit. To avoid this problem the central monetary authority carries out this essential function of restricting the ors of the economy and all social and economic class of people
The aim here is to increase the productivity of investment by restraining non essential fixed investment.
Central bank tries to increase the efficiency in the financial system and tries to incorporate structural changes such as deregulating interest rates, ease operational constraints in the credit delivery system, to introduce new money market instruments etc.
RBI tries to bring about the flexibility in the operations which provide a considerable autonomy. It encourages more competitive environment and diversification. It maintains its control over financial system whenever and wherever necessary to maintain the discipline and prudence in operations of the financial system.
Monetary operations involve monetary techniques which operate on monetary magnitudes such as money supply, interest rates and availability of credit aimed to maintain Price Stability, Stable exchange rate, Healthy Balance of Payment, Financial stability, Economic growth. RBI, the apex institute of India which monitors and regulates the monetary policy of the country stabilizes the price by controlling Inflation.
Instruments of Monetary Policy
These instruments are used to control the money flow in the economy,stated following;
An open market operation is an instrument of monetary policy which involves buying or selling of government securities from or to the public and banks. This mechanism influences the reserve position of the banks, yield on government securities and cost of bank credit. The RBI sells government securities to control the flow of credit and buys government securities to increase credit flow. Open market operation makes bank rate policy effective and maintains stability in government securities market.
Cash Reserve Ratio is a certain percentage of bank deposits which banks are required to keep with RBI in the form of reserves or balances. Higher the CRR with the RBI lower will be the liquidity in the system and vice versa. RBI is empowered to vary CRR between 15 percent and 3 percent. But as per the suggestion by the Narsimham committee Report the CRR was reduced from 15% in the 1990 to 5 percent in 2002. As of September 2015, the CRR is 4.00 percent.
Every financial institution has to maintain a certain quantity of liquid assets with themselves at any point of time of their total time and demand liabilities. These assets have to be kept in non cash form such as G-secs precious metals, approved securities like bonds etc. The ratio of the liquid assets to time and demand assets is termed as the Statutory liquidity ratio.There was a reduction of SLR from 38.5% to 25% because of the suggestion by Narshimam Committee. The current SLR is 21.5%(w.e.f.11/12/15).
The bank rate, also known as the discount rate, is the rate of interest charged by the RBI for providing funds or loans to the banking system. This banking system involves commercial and co-operative banks, Industrial Development Bank of India, IFC, EXIM Bank, and other approved financial institutes. Funds are provided either through lending directly or discounting or buying money market instruments like commercial bills and treasury bills. Increase in Bank Rate increases the cost of borrowing by commercial banks which results in the reduction in credit volume to the banks and hence declines the supply of money. Increase in the bank rate is the symbol of tightening of RBI monetary policy. As of April 05, 2016, the Bank Rate stands adjusted by 75 basis points from 7.75 per cent on September 29, 2015 to 7 per cent.
In this operation RBI issues prior information or direction that loans to the commercial banks will be given up to a certain limit. In this case commercial bank will be tight in advancing loans to the public. They will allocate loans to limited sectors. Few examples of ceiling are agriculture sector advances, priority sector lending.
Credit Authorization Scheme was introduced in November, 1965 when P C Bhattacharya was the chairman of RBI. Under this instrument of credit regulation RBI as per the guideline authorizes the banks to advance loans to desired sectors.
Moral Suasion is just as a request by the RBI to the commercial banks to take so and so action and measures in so and so trend of the economy. RBI may request commercial banks not to give loans for unproductive purpose which does not add to economic growth but increases inflation.
Repo rate is the rate at which RBI lends to its clients generally against government securities. Reduction in Repo rate helps the commercial banks to get money at a cheaper rate and increase in Repo rate discourages the commercial banks to get money as the rate increases and becomes expensive. Reverse Repo rate is the rate at which RBI borrows money from the commercial banks. The increase in the Repo rate will increase the cost of borrowing and lending of the banks which will discourage the public to borrow money and will encourage them to deposit. As the rates are high the availability of credit and demand decreases resulting to decrease in inflation. This increase in Repo Rate and Reverse Repo Rate is a symbol of tightening of the policy.
As of 5 August 2016, the key indicators are: