SL.NoTopicsPAGE NO.
1Introduction About RBI History of RBI Structure of RBI
2347
2Monetary policy in State of economy Global Economic Domestic
Economic
999
3Monetary Policy Meaning Objectives Tools of monetary policy New
methods adopted by RBI 1314141525
4Affect of monetary policy Change in CRR,SLR and Bank Rate View
by Ex-PM Thought of Ex governor of RBI
282929
5Challenges To Monetary Policy30
6Monetary Policy in different countries31
7Bibliography36
INTRODUCTION
The Annual Policy for 2013-14 is formulated in an environment of
incipient signs of stabilisation in the global economy and
prospects of a turnaround, albeit modest, in the domestic
economy.
In the advanced economies (AEs), near-term risks have receded,
aided by improving financial conditions and supportive
macroeconomic policies. But this improvement is yet to fully
transmit to economic activity which remains sluggish. Policy
implementation risks and uncertainty about outcomes continue to
threaten the prospects of a sustained recovery. Emerging and
developing economies (EDEs) are in the process of a multi-speed
recovery. However, weak external demand and domestic bottlenecks
continue to restrain investment in some of the major emerging
economies. Inflation risks appear contained, reflecting negative
output gaps and the recent softening of international crude and
food prices.
Domestically, growth slowed much more than anticipated, with
both manufacturing and services activity hamstrung by supply
bottlenecks and sluggish external demand. Most lead indicators
suggest a slow recovery through 2013-14. Inflation eased
significantly in Q4 of 2012-13 although upside pressures remain,
both at wholesale and retail levels, stemming from elevated food
inflation and ongoing administered fuel price revisions. The main
risks to the outlook are the still high twin deficits accentuated
by the vulnerability to sudden stop and reversal of capital flows,
inhibited investment sentiment and tightening supply constraints,
particularly in the food and infrastructure sectors.
ABOUT RBI
TheReserve Bank of India(RBI) is India'scentral banking
institution, which controls themonetary policyof theIndian rupee.
It was established on 1 April 1935 during theBritish Rajin
accordance with the provisions of the Reserve Bank of India Act,
1934. The share capital was divided into shares of 100 each fully
paid, which were initially owned entirely by private
shareholders.Following India's independence in 1947, the RBI was
nationalised in the year 1949.The RBI plays an important part in
the development strategy of theGovernment of India. It is a member
bank of theAsian Clearing Union. The general superintendence and
direction of the RBI is entrusted with the 21-member Central Board
of Directors: the Governor(currently Dr. Raghuram Rajan), four
Deputy Governors, twoFinance Ministryrepresentative, ten
government-nominated directors to represent important elements from
India's economy, and four directors to represent local boards
headquartered at Mumbai, Kolkata, Chennai and New Delhi. Each of
these local boards consists of five members who represent regional
interests, as well as the interests of co-operative and indigenous
banks.The bank is also active in promoting financial inclusion
policy and is a leading member of theAlliance for Financial
Inclusion (AFI).
CD Deshmukh Raghuram Rajan(1st Indian governor of rbi) (present
governor rbi)
HISTORY
19351950
The Reserve Bank of India was founded on 1 April 1935 to respond
to economic troubles after theFirst World War.RBI was
conceptualized as per the guidelines, working style and outlook
presented by Dr Ambedkar as written in his book The Problem of the
Rupee Its origin and its solution. in front of the Hilton Young
Commission.The bank was set up based on the recommendations of the
1926 Royal Commission on Indian Currency and Finance, also known as
the HiltonYoung Commission. The original choice for the seal of RBI
was The west india Company Double Mohur, with the sketch of the
Lion and Palm Tree. However it was decided to replace the lion with
the tiger, the national animal of India. The Preamble of the RBI
describes its basic functions to regulate the issue of bank notes,
keep reserves to secure monetary stability in India, and generally
to operate the currency and credit system in the best interests of
the country. The Central Office of the RBI initially established in
Calcutta (now Kolkata), but was permanently moved to Bombay (now
Mumbai) in 1937. The RBI also acted as Burma's central bank, except
during the years of theJapanese occupation of Burma(194245), until
April 1947, even though Burma seceded from the Indian Union in
1937. After thePartition of Indiain 1947, the Bank served as the
central bank forPakistanuntil June 1948 when theState Bank of
Pakistancommenced operations. Though originally set up as a
shareholders bank, the RBI has been fully owned by theGovernment of
India since its nationalization in 1949.
19501960In the 1950s the Indian government, under its first
Prime MinisterJawaharlal Nehru, developed a centrally planned
economic policy that focused on the agricultural sector. The
administration nationalized commercial banksand established, based
on the Banking Companies Act of 1949 (later called the Banking
Regulation Act), a central bank regulation as part of the RBI.
Furthermore, the central bank was ordered to support the economic
plan with loans.
19601969As a result of bank crashes, the RBI was requested to
establish and monitor a deposit insurance system. It should restore
the trust in the national bank system and was initialized on 7
December 1961. The Indian government founded funds to promote the
economy and used the slogan "Developing Banking". The government of
India restructured the national bank market and nationalized a lot
of institutes. As a result, the RBI had to play the central part of
control and support of this public banking sector.
19691985In 1969, theIndira Gandhi-headed government nationalized
14 major commercial banks. Upon Gandhi's return to power in 1980, a
further six banks were nationalized. The regulation of the economy
and especially the financial sector was reinforced by the
Government of India in the 1970s and 1980s.The central bank became
the central player and increased its policies for a lot of tasks
like interests, reserve ratio and visible deposits.These measures
aimed at better economic development and had a huge effect on the
company policy of the institutes. The banks lent money in selected
sectors, like agri-business and small trade companies.The branch
was forced to establish two new offices in the country for every
newly established office in a town.Theoil crises in 1973 resulted
in increasinginflation, and the RBI restricted monetary policy to
reduce the effects.
19851991A lot of committees analysed the Indian economy between
1985 and 1991. Their results had an effect on the RBI. TheBoard for
Industrial and Financial Reconstruction, theIndira Gandhi Institute
of Development Researchand theSecurity & Exchange Board of
Indiainvestigated the national economy as a whole, and the security
and exchange board proposed better methods for more effective
markets and the protection of investor interests. The Indian
financial market was a leading example for so-called "financial
repression" (Mackinnon and Shaw).TheDiscount and Finance House of
Indiabegan its operations on the monetary market in April 1988;
theNational Housing Bank, founded in July 1988, was forced to
invest in the property market and a new financial law improved the
versatility of direct deposit by more security measures and
liberalization.
19912000The national economy came down in July 1991 and the
Indian rupee was devalued.The currency lost 18% relative to the US
dollar, and theNarsimham Committeeadvised restructuring the
financial sector by a temporal reduced reserve ratio as well as the
statutory liquidity ratio. New guidelines were published in 1993 to
establish a private banking sector. This turning point should
reinforce the market and was often calledneo-liberal.The central
bank deregulated bank interests and some sectors of the financial
market like the trust and property markets. This first phase was a
success and the central government forced a diversity
liberalisation to diversify owner structures in 1998. TheNational
Stock Exchange of Indiatook the trade on in June 1994 and the RBI
allowed nationalized banks in July to interact with the capital
market to reinforce their capital base. The central bank founded a
subsidiary companytheBharatiya Reserve Bank Note Mudran Limitedin
February 1995 to produce banknotes.
Since 2000TheForeign Exchange Management Actfrom 1999 came into
force in June 2000. It should improve the item in 20042005
(National Electronic Fund Transfer).TheSecurity Printing &
Minting Corporation of India Ltd., a merger of nine institutions,
was founded in 2006 and produces banknotes and coins.The national
economy's growth rate came down to 5.8% in the last quarter of
20082009 and the central bank promotes the economic
development.
Structure
Central Board of DirectorsThe Central Board of Directors is the
main committee of the Central Bank. TheGovernment of Indiaappoints
the directors for a 4-year term. The Board consists of a Governor,
and not more than 4 Deputy Governors, 15Directors to represent the
regional boards, 2 from the Ministry of Finance and 10 other
directors from various fields..
GovernorsThe current Governor of RBI isRaghuram Raja. There are
3 Deputy Governors, Deputy GovernorH R Khan,Dr Urjit PatelandR
Gandhi. Dr. Urjit Patel became Deputy Governor in January 2013. Two
of the Deputy Governors are traditionally from RBI ranks, and are
selected from the Bank's Executive Directors. As for the rest, one
is nominated from among the Chairpersons of Public Sector Bank, and
the other is an economist of repute.
Supportive bodiesThe Reserve Bank of India has four regional
representations: North in New Delhi, South in Chennai, East in
Kolkata and West in Mumbai. The representations are formed by five
members, appointed for four years by the central government and
servebeside the advice of the Central Board of Directorsas a forum
for regional banks and to deal with delegated tasks from the
central board.The institution has 22 regional offices.TheBoard of
Financial Supervision(BFS), formed in November 1994, serves as a
CCBD committee to control the financial institutions. It has four
members, appointed for two years, and takes measures to strength
the role of statutory auditors in the financial sector, external
monitoring and internal controlling systems.TheTarapore
committeewas set up by the Reserve Bank of India under the
chairmanship of former RBI deputy governor S. S. Tarapore to "lay
the road map" tocapital account convertibility. The five-member
committee recommended a three-year time frame for complete
convertibility by 19992000.On 1 July 2007, in an attempt to enhance
the quality of customer service and strengthen the grievance
redressal mechanism, the Reserve Bank of India created a
newcustomer service department.
Offices and branchesThe Reserve Bank of India has four zonal
offices.It has 19 regional offices at most state capitals and at a
few major cities in India. Few of them are located
inAhmedabad,Bangalore,Bhopal,Bhubaneswar,Chandigarh,Chennai,Delhi,Guwahati,Hyderabad,Jaipur,Jammu,Kanpur,Kolkata,Lucknow,Mumbai,Nagpur,Patna
andThiruvananthapuram. It also has 9 sub-offices located
inAgartala,Dehradun,Gangtok,Kochi,Panaji,Raipur,Ranchi,Shillong,ShimlaandSrinagar.The
bank has also two training colleges for its officers, viz. Reserve
Bank Staff College at Chennai and College of Agricultural Banking
atPune. There are also fourZonal Training
CentresatMumbai,Chennai,Kolkataand New Delhi.
Monetary policy at the state of Economic
Global economic
Global economic activity remains subdued amidst signs of
diverging growth paths across major economies. In the US, a slow
recovery is taking hold, driven by improvements in the housing
sector and employment conditions. However, the pace of recovery
remains vulnerable to the adverse impact of the budget
sequestration which will gradually gain pace in the months ahead.
Japans economy stopped contracting in Q4 of 2012. There has been
some improvement in consumer confidence on account of monetary and
fiscal stimulus along with a pick-up in external demand on the back
of a weakening yen. In the euro area, recessionary conditions,
characterised by deterioration in industrial production, weak
exports and low domestic demand, continued into Q1 of 2013. High
unemployment, fiscal drag and hesitant progress on financial sector
repair have eroded consumer confidence.
Growth in several EDEs rebounded from the moderation in 2012 as
domestic demand rose on a turnaround in the inventory cycle and
some pick-up in investment. Among BRICS countries, growth
accelerated in Brazil and South Africa, while it persisted below
trend in China, Russia and India.Inflation has remained benign in
the AEs in the absence of demand pressures, and inflation
expectations remain well-anchored. The EDEs, on the other hand,
present a mixed picture. While inflation has picked up in Brazil,
Russia and Turkey, it has eased in China, Korea, Thailand and
Chile.
Reflecting a pessimistic demand outlook, crude oil prices eased
in March-April 2013 from the elevated levels prevailing through
2012. Non-energy commodity prices have been easing through Q1 of
2013 on softening metal prices and decline in food prices.
Domestic Economic
With the expansion of only 4.5 percent in Q3 of 2012-2013, the
lowest in 15qudters, cumulative GDP growth for 2 the period
April-December 2012 declined to 5.0 per cent from 6.6 per cent a
year ago. This was mainly due to the protracted weakness in
industrial activity aggravated by domestic supply bottlenecks, and
slowdown in the services sector reflecting weak external demand.
The Central Statistics Office (CSO)s advance estimate of GDP growth
for 2012-13 of 5.0 per cent implies that the economy would have
expanded by 4.7 per cent in Q4.
The growth of industrial production slid to 0.6 per cent in
February 2013 from 2.4 per cent a month ago, mainly due to
contraction in mining and electricity generation and slowing growth
in manufacturing. Consequently, on a cumulative basis, growth in
industrial production decelerated to 0.9 per cent during 2012-13
(April-February) from 3.5 per cent in the corresponding period of
the previous year. The Reserve Banks order books, inventories and
capacity utilisation survey (OBICUS) suggest that capacity
utilization remained flat. Rabi production, particularly of pulses,
is expected to be better than a year ago. However, it may not fully
offset the decline in kharif output. Consequently, the second
advance estimates of crop production (kharif and rabi) for 2012-13
indicate a decline of 3.5 per cent in relation to the final
estimates of the previous year. The composite purchasing managers
index ( P M I ) , Which encompasses manufacturing and services,
fell to a 17-month low in March 2013. Thus, most recent indicators
suggest that growth in Q4 of 2012-13 would have remained low.
On the demand side, the persisting decline in capital goods
production during April 2012 February 2013 reflects depressed
investment conditions. The moderation in corporate sales and
weakening consumer confidence suggest that the slowdown could be
spreading to consumption spending.
Headline inflation, as measured by the wholesale price index
(WPI), moderated to an average of 7.3 per cent in 2012-13 from 8.9
per cent in the previous year. The easing was particularly
significant in Q4 of 2012-13, with the year-end inflation recording
at 6.0 per cent. Notwithstanding the moderation in overall
inflation, elevated food price inflation was a source of upside
pressure through the year owing to the unusual spike in vegetable
prices in April 2012 followed by rise in cereal prices on account
of the delayed monsoon and the sharp increase in the minimum
support price (MSP) for paddy. Fuel inflation averaged in double
digits during 2012- 2013 largely reflecting upward revision in
administered price and the pass through high international crude
price to freely priced items. Non food manufactured products
inflation ruled above the comfort level in the first half of
2012-13 but declined in the second half to come down to 3.5 per
cent by March, reflecting easing of input price pressures and
erosion of pricing power.
Largely driven by food inflation, retail inflation, as measured
by the new combined (rural and urban) consumer price index (CPI)
(Base: 2010=100), averaged 10.2 per cent during 2012-13. Even after
excluding food and fuel groups, CPI inflation remained sticky,
averaging 8.7 per cent. Other CPIs also posted double digit
inflation.Significantly , inflation expectations polled by the
Reserve Banks urban households survey, showed slight moderation in
Q4 of 2012-13, even as they remained in double digits, reflecting
high food prices. Wage inflation in rural areas, which rose by an
average of close to 20 per cent over the period April 2009 to
October 2012, declined modestly to 17.4 per cent in January 2013.
House price inflation, as measured by the Reserve Banks quarterly
house price index, continued to rise on a y-o-y basis.
An analysis of corporate performance during Q3 of 2012-13, based
on a common sample of 2,473 non - government non - financial
companies, indicates that growth of sales as well as profits
decelerated significantly.Early results of corporate performance in
Q4 indicate continuing moderation in sales though profit margins
increased slightly.
Money supply (M3) growth was around 14.0 per cent during Q1 of
2012-13 but decelerated thereafter to 11.2 percent by end-December
as time deposit growth slowed down. There was some pick up in
deposit mobilisation in Q4, taking deposit growth to 14.3 per cent
by end-March. Consequently, M3 growth reached 13.3 per cent by
end-March 2013, slightly above the revised indicative trajectory of
13.0 per cent.
Non food credit growth decelerated from 18.2 per cent at the
beginning of 2012-13 and remained close to 16.0 per cent for the
major part of the year. By March 2013, non-food credit growth
dropped to 14.0 per cent, lower than the indicative projection of
16.0 per cent, reflecting some risk aversion and muted demand.
While the Reserve Banks credit conditions survey showed easing of
overall credit conditions, there was some tightening for sectors
such as metals, construction, infrastructure, commercial real
estate, chemicals and finance in Q4 of 2012-13.
The total flow of resources to the commercial sector from banks,
non-banks and external sources was higher at `12.8 trillion in
2012-13 as compared with `11.6 trillion in the previous year. This
increase was accounted for by higher non-SLR investment by
scheduled commercial banks (SCBs), increase in credit flow from
NBFCs, gross private placement and public issues by non-financial
entities, and higher recourse to short-term credit from abroad and
external commercial borrowings.
In consonance with the cuts in the policy repo rate and the cash
reserve ratio (CRR) during 2012-13, the modal term deposit rate
declined by 11 basis points (bps) and the modal base rate by 50
bps. While the decline in the term deposit rate occurred mostly
during the first half, the modal base rate softened by 50 bps to
10.25 per cent in two steps of 25 bps each during Q1 and Q4 of
2012-13. During Q4, 39 banks reduced their base rates in the range
of 5-75 bps. The weighted average lending rate of banks declined by
36 bps to 12.17 per cent during 2012- 13(up to February).
Liquidity remained under pressure throughout the year because of
persistently high government cash balances with the Reserve Bank
and elevated incremental credit to deposit ratio for much of the
year. The net average liquidity injection under the daily liquidity
adjustment facility (LAF), at `730 billion during the first half of
the year, increased significantly to `1,012 billion during the
second half. In order to alleviate liquidity pressures, the Reserve
Bank lowered the CRR of SCBs cumulatively by 75 bps on three
occasions and the statutory liquidity ratio (SLR) by 100 bps during
the year. Additionally, the Reserve Bank injected liquidity to the
tune of `1,546 billion through open market operation (OMO) purchase
auctions. The net injection of liquidity under the LAF, which
peaked at `1,808 billion on March 28, 2013 reflecting the year-end
demand, reversed sharply to `842 billion by end-April 2013.
The revised estimates (RE) of central government finances for
2012-13 show that the gross fiscal deficit-GDP ratio at 5.2 per
cent was around the budgeted level and within the target set out in
the revised roadmap. Budget estimates (BE) for 2013-14 place the
gross fiscal deficit-GDP ratio at 4.8 per cent. The envisaged
correction is expected to be achieved through a reduction of
0.6percentage points in the revenue deficit-GDP ratio.
On the back of the policy rate reduction and the announcement of
a slew of reform measures by the Government and a firm commitment
to fiscal consolidation, the 10-year benchmark yield eased from
8.79 per cent on April 3, 2012 to 7.79 per cent on April 30,
2013.
The current account deficit (CAD) came in at an all-time high of
6.7 per cent of GDP in Q3 of 2012-13. There are indications that it
may have narrowed in Q4. The narrowing was largely on account of
the trade deficit declining, with exports returning to positive
growth after contracting in the first three quarters and non-oil
non-gold imports and gold imports declining. Even as the CAD
expanded, the surge in capital inflows in the second half of the
year ensured that it could be fully financed.
Monetary policyMonetary policyis the process by which monetary
authority of a country, generally a central bank controls the
supply of money in the economy by exercising its control over
interest rates in order to maintain price stability and achieve
high economic growth.In India, the central monetary authority is
theReserve Bank of India(RBI). is so designed as to maintain the
price stability in the economy.
1. Slack season policy April September2. Busy season policy
October march
Role of RBI
One of the most important functions of central banks is
formulation and execution of monetary policy. In the Indian
context, the basic functions of the Reserve Bank of India as
enunciated in the Preamble to the RBI Act, 1934 are:to regulate the
issue of Bank notes and the keeping of reserves with a view to
securing monetary stability in India and generally to operate the
currency and credit system of the country to its advantage.
Thus, the Reserve Banks mandate for monetary policy flows from
its monetary stability objective. Essentially, monetary policy
deals with the use of various policy instruments for influencing
the cost and availability of money in the economy. As macroeconomic
conditions change, a central bank may change the choice of
instruments in its monetary policy. The overall goal is to promote
economic growth and ensure price stability.
Monetary Policy Meaning.
Monetary policy is the macroeconomic policy laid down by the
central bank. It involves management of money supply and interest
rate and is the demand side economic policy used by the government
of a country to achieve macroeconomic objectives like inflation,
consumption, growth and liquidity.
Reserve Bank of India states that
Monetary policy refers to the use of instruments under the
control of the central bank to regulate the availability, cost and
use of money and credit
Objectives
Price StabilityPrice Stability implies promoting economic
development with considerable emphasis on price stability. The
centre of focus is to facilitate the environment which is
favourable to the architecture that enables the developmental
projects to run swiftly while also maintaining reasonable price
stability.
Controlled Expansion Of Bank CreditOne of the important
functions of RBI is the controlled expansion of bank credit and
money supply with special attention to seasonal requirement for
credit without affecting the output.
Promotion of Fixed InvestmentThe aim here is to increase the
productivity of investment by restraining non essential fixed
investment.
Restriction of InventoriesOverfilling of stocks and products
becoming outdated due to excess of stock often results is sickness
of the unit. To avoid this problem the central monetary authority
carries out this essential function of restricting the inventories.
The main objective of this policy is to avoid over-stocking and
idle money in the organization
Promotion of Exports and Food Procurement OperationsMonetary
policy pays special attention in order to boost exports and
facilitate the trade. It is an independent objective of monetary
policy.
Desired Distribution of CreditMonetary authority has control
over the decisions regarding the allocation of credit to priority
sector and small borrowers. This policy decides over the specified
percentage of credit that is to be allocated to priority sector and
small borrowers.
Equitable Distribution of CreditThe policy of Reserve Bank aims
equitable distribution to all sectors of the economy and all social
and economic class of people
To Promote EfficiencyIt is another essential aspect where the
central banks pay a lot of attention. It 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.
Reducing the RigidityRBI tries to bring about the flexibilities
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.
Element of monetary policyQuantitative measure:-1. bank rate2.
open market operations3. cash reserve ratio4. statuary reserve
ratioQualitative measures1. rationing of credit2. moral suasion3.
direct action4. regulation in consumer credit5. change in margin
requirement
Quantitative measure
Open Market OperationsAn open market operation is
aninstrumentofmonetary policy which involves buying or selling of
governmentsecurities from or to the public andbanks. This mechanism
influences the reserve position of the banks, yield ongovernment
securities and cost of bank credit. The RBI sellsgovernment
securitiesto contract 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.
OMOs is an actively used technique of monetary control in the
US, the UK and many other countries. Through the open market sales
and purchases of government securities, the RBI can affect the
reserve position of banks, yields on government securities, and
volume and cost of bank credit. However, it is the technique least
used by the bank, through it has wide powers to it. There is no
reaction the quality or maturity of government securities which it
can buy or sell or hold. Technically, the bank can conduct OMOs in
treasury bill, state government, central government securities;
but, in practice they are conducted only in central government
securities of all maturities.
Process of open marketSince most money now exists in the form of
electronic records rather than in the form of paper, open market
operations are conducted simply by electronically increasing or
decreasing (creditingordebiting) the amount of base money that a
bank has in its reserve account at the central bank. Thus, the
process does not literally require new currency. However, this will
increase the central bank's requirement to print currency when the
member bank demands banknotes, in exchange for a decrease in its
electronic balance.When there is an increased demand for base
money, the central bank must act if it wishes to maintain the
short-term interest rate. It does this by increasing the supply of
base money. The central bank goes to the open market to buy a
financial asset, such asgovernment bonds. To pay for these assets,
bank reserves in the form of new base money (for example newly
printed cash) are transferred to the seller's bank and the seller's
account is credited. Thus, the total amount of base money in the
economy is increased. Conversely, if the central bank sells these
assets in the open market, the amount of base money held by the
buyer's bank is decreased, effectively reducing base money.The
process works because the central bank has the authority to bring
money in and out of existence. They are the only point in the whole
system with the unlimited ability to produce money. Another
organization may be able to influence the open market for a period
time, but the central bank will always be able to overpower their
influence with an infinite supply of money.
How open market operation are conductedIndias Open Market
Operation is much influenced by the fact that it is a developing
country and that the capital flows are very different from those in
developed countries. Thus Reserve Bank Of India, being the Central
Bank of the country, has to make policies and use instruments
accordingly. Prior to the 1991 financial reforms, RBIs major source
of funding and control over credit and interest rates was the CRR
(Cash reserve ratio) and the SLR (Statutory Liquidity Ratio). But
after the reforms, the use of CRR as an effective tool was
de-emphasized and the use of open market operations increased. OMOs
are more effective in adjustingmarket liquidity.
The two traditional type of OMOs used by RBI:1. Outright
purchase (PEMO): Is outright buying or selling of government
securities. (Permanent).2. Repurchase agreement (REPO): Is short
term, and are subject to repurchase. However, even after sidelining
CRR as an instrument, there was still less liquidity and skewedness
in the market. And thus, on the recommendations of the Narsimham
Committee Report (1998), The RBI brought together aLiquidity
Adjustment Facility(LAF). It commenced in June, 2000, and it was
set up to oversee liquidity on a daily basis and to monitor market
interest rates. For the LAF, two rates are set by the RBI: repo
rate and reverse repo rate. The repo rate is applicable while
selling securities to RBI (daily injection of liquidity), while the
reverse repo rate is applicable when banks buy back those
securities (daily absorption of liquidity). Also, these interest
rates fixed by the RBI also help in determining other market
interest rates.India experiences large capital inflows every day,
and even though the OMO and the LAF policies were able to withhold
the inflows, another instrument was needed to keep the liquidity
intact. Thus, on the recommendations of the Working Group of RBI on
instruments of Sterilization (December, 2003), a new scheme known
as the Market stabilization scheme (MSS) was set up. The LAF and
the OMOs were dealing with day to day liquidity management, whereas
the MSS was set up to sterilize the liquidity absorption and make
it more enduring.According to this scheme, the RBI issues
additional T-bills and securities to absorb the liquidity. And the
money goes into the Market Stabilization scheme Account (MSSA). The
RBI cannot use this account for paying any interest or discounts
and cannot credit any premiums to this account. The Government, in
collaboration with the RBI, fixes a ceiling amount on the issue of
these instruments.[12]But for an open market operation instrument
to be effective, there has to be an active securities market for
RBI to make any kind of effect on the liquidity and rates of
interest.
Cash Reserve Ratio
Cash Reserve Ratio is a certain percentage ofbank depositswhich
banks are required to keep with RBI in the form of reserves or
balances .Higher the CRR with the RBI lower will be theliquidityin
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 October 2013, the CRR is 4.00 percent.
Every commercial bank has to keep certain minimum cash reserves
with RBI. Consequent upon amendment to sub-Section 42(1), the
Reserve Bank, having regard to the needs of securing the monetary
stability in the country, RBI can prescribe Cash Reserve Ratio
(CRR) for scheduled banks without any floor rate or ceiling rate,
[Before the enactment of this amendment, in terms ofSection 42(1)
of the RBI Act, the Reserve Bank could prescribe CRR for scheduled
banks between 5% and 20% of total of their demand and time
liabilities]. RBI uses this tool to increase or decrease the
reserve requirement depending on whether it wants to effect a
decrease or an increase in the money supply. An increase in Cash
Reserve Ratio (CRR) will make it mandatory on the part of the banks
to hold a large proportion of their deposits in the form of
deposits with the RBI. This will reduce the size of their deposits
and they will lend less. This will in turn decrease the money
supply. The current rate is 4.00%.. -25 basis points cut in Cash
Reserve Ratio(CRR) on 17 September 2012, It will release Rs 17,000
crore into the system/Market. The RBI lowered the CRR by 25 basis
points to 4.25% on 30 October 2012, a move it said would inject
about 175 billion rupees into the banking system in order to
pre-empt potentially tightening liquidity. The latest CRR is 4%
Statutory Liquidity RatioEvery 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 can be cash, precious metals, approved securities like bonds
etc. The ratio of the liquid assets to time and demand liabilities
is termed as theStatutory liquidity ratio.There was a reduction of
SLR from 38.5% to 25% because of the suggestion by Narshimam
Committee. The current SLR is 23%.
Apart from the CRR, banks are required to maintain liquid assets
in the form of gold, cash and approved securities. Higher liquidity
ratio forces commercial banks to maintain a larger proportion of
their resources in liquid form and thus reduces their capacity to
grant loans and advances, thus it is an anti-inflationary impact. A
higher liquidity ratio diverts the bank funds from loans and
advances to investment in government and approved securities.The
latest SLR as on 14/12/13 is 22.50% In well-developed economies,
central banks use open market operationsbuying and selling of
eligible securities by central bank in the money marketto influence
the volume of cash reserves with commercial banks and thus
influence the volume of loans and advances they can make to the
commercial and industrial sectors. In the open money market,
government securities are traded at market related rates of
interest. The RBI is resorting more to open market operations in
the more recent years. Generally RBI uses three kinds of selective
credit controls:1. Minimum margins for lending against specific
securities.2. Ceiling on the amounts of credit for certain
purposes.3. Discriminatory rate of interest charged on certain
types of advances.Direct credit controls in India are of three
types:1. Part of the interest rate structure i.e. on small savings
and provident funds, are administratively set.2. Banks are
mandatory required to keep 23% of their deposits in the form of
government securities.3. Banks are required to lend to the priority
sectors to the extent of 40% of their advances.
Bank Rate PolicyThebank rate, also known as the discount rate,
is the rate of interest charged by the RBI for providing funds
orloansto 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 rediscounting
or buying money market instruments like commercial bills
andtreasury bills. Increase in Bank Rate increases the cost of
borrowing by commercial banks which results into 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 1 January 2013, the bank rate was 8.75% and
as on 21 June 2014 bank rate is 9%.
In India, the bank rate is the rate at which theReserve Bank of
Indialends to commercial banks and other financial institutions for
meeting shortfalls in their reserve requirements, for long-term
purposes. The current Bank rate is overnight rate + 200basis
points.
Qualitative measures
Credit Ceiling
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
example of ceiling are agriculture sector advances, priority sector
lending.
Credit Authorization Scheme
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 SuasionMoral 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 and Reverse Repo RateRepo rate is the rate at which
RBI lends to commercial banks 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 ininflation. This increase
in Repo Rate and Reverse Repo Rate is a symbol of tightening of the
policy. As of October 2013, the repo rate was 7.75% and reverse
repo rate was 6.75%. On January 28, 2014, RBI raised repo rate by
25 basis points to 8.00% and reverse repo rate by 25 basis points
to 7.00%.
Characteristic of repo
1. Overnight reposare 1 day loans;2. Term reposhave terms of
greater than 1 dayusually weeks to months.3. The firm that makes
the loan for a repo, usually a bank, has areverse repo position
which is simply the opposite side of a repo.4. Anopen repo is a
contractual relationship that allows the borrower to borrow funds
up to a certain limit, without signing a new contractsomewhat like
an open credit arrangement.
Determinates of Repo rate
The repo rate for a particular transaction depends on the
following factors:
a) Credit quality: like most other securities, the interest rate
varies inversely with the credit quality of the issuerthe higher
the credit quality, the lower the repo rate.
b) Liquidity: greater liquidity lowers trading costs and,
therefore, the repo rate.
c) Delivery: if the collateral must be physically delivered, the
lender will charge a higher repo rate to cover its cost.
d) Collateral availability: if the collateral is a special issue
that is hard to get, the seller of the collateral will be able to
obtain a lower repo rate from a lender that needs the
collateral.
Advantages of repo
1. Repos can provide a variety of advantages to the financial
market in general & in debt markets in particular;
significantly:
2. Repo is a tool for funding transactions.
3. For institutions and corporate entities, repos provide a
source of relatively inexpensive finance.
4. Central banks can use repo and reverse repo as an integral
part of their open market operations with the objective of
injecting/withdrawing liquidity into and from the market and also
to reduce volatility in short term in particular in call money
rates.
Impact of REPO
Inflation : 1. The interest rate channel affects the demand for
goods and services.
2. Higher interest rates normally lead to a reduction in
household consumption.This happens for several reasons.
3. Higher interest rates make it more attractive to save, in
other words to postpone consumption, thus lowering present
consumption.
4. Consumption also falls because existing loans now cost more
in terms of interest payments.
Credit channel:1. The credit channel describes the way in which
monetary policy affects demand via banks and other financial
institutions.
2. If the interest rate rises, banks choose to decrease their
lending and instead buy bonds.
3. This means that households and companies find it more
difficult to borrow money.
4. Companies that are either unable or unwilling to borrow must
cut back their activities, postpone investment and so on, and this
dampens activity in the economy.
Exchange rate:
1. The exchange rate channel describes how monetary policy
affects the value of the currency. 2. Normally, an increase in the
repo rate leads to a strengthening of the currency.
3. In the short term, this is because higher interest rates make
Swedish assets more attractive than investments denominated in
other currencies.4. The result is a capital inflow and increased
demand for kronor, which strengthens the exchange rate.5. Monetary
policy also plays an important part for the exchange rate in the
long term.
Inflation:-
1. The way in which changes in the repo rate affect inflation
and the rest of the economy is known asthe transmission
mechanism.
2. The transmission mechanism is actually not one but several
different mechanisms that interact.
3. Some of these have a more or less direct impact on inflation
while others take longer to have an effect.
4. It is generally held that a change in the repo rate has its
greatest impact on inflation
New method adopted By RBI
Liquidity adjustment facility:-Liquidity adjustment
facility(LAF) is amonetary policytool which allows banks to borrow
money throughrepurchase agreements.LAF is used to aid banks in
adjusting the day to day mismatches in liquidity. LAF consists of
repo and reverse repo operations. Repo or repurchase option is a
collaterised lending i.e. banks borrow money from Reserve bank of
India to meet short term needs by selling securities to RBI with an
agreement to repurchase the same at predetermined rate and date.
The rate charged by RBI for this transaction is called the repo
rate. Repo operations therefore inject liquidity into the system.
Reverse repo operation is when RBI borrows money from banks by
lending securities. The interest rate paid by RBI is in this case
is called the reverse repo rate. Reverse repo operation therefore
absorbs the liquidity in the system. The collateral used for repo
and reverse repo operations are Government of India securities. Oil
bonds have been also suggested to be included as collateral for
Liquidity adjustment facility.Liquidity adjustment facility has
emerged as the principal operating instrument for modulating short
term liquidity in the economy. Repo rate has become the key policy
rate which signals the monetary policy stance of the economy.The
origin of repo rates, one of the component of liquidity adjustment
facility, can be traced to as early as 1917 in U.S financial market
when war time taxes made other sources of lending unattractive .
The introduction of Liquidity adjustment facility in India was on
the basis of the recommendations of Narsimham committee on banking
sector reforms. In April 1999, an interim LAF was introduced to
provide a ceiling and the fixed rate repos were continued to
provide a floor for money market rates. As per the policy measures
announced in 2000, the Liquidity Adjustment Facility was introduced
with the first stage starting from June 2000 onwards. Subsequent
revisions were made in 2001 and 2004. When the scheme was
introduced, repo auctions were described for operations which
absorbed liquidity from the system and reverse repo actions for
operations which injected liquidity into the system. However in
international nomenclature, repo and reverse repo implied the
reverse. Hence in October 2004 when revised scheme of LAF was
announced, the decision to follow the international usage of terms
was adopted.Repo and reverse repo rates were announced separately
till the monetary policy statement in 3.5.2011. In this monetary
policy statement, it has been decided that the reverse repo rate
would not be announced separately but will be linked to repo rate.
The reverse repo rate will be 100 basis points below repo rate. The
liquidity adjustment facility corridor, that is the excess of repo
rate over reverse repo, has varied between 100 to 300 basis points.
The period between April 2001 to March 2004 and June 2008 to early
November 2008 saw a broader corridor ranging from 150-250 and
200-300 basis points respectively. During March 2004 to June 2008
the corridor was narrow with the rates ranging from 100-175 basis
points. A narrow LAF corridor is reflected from November 2008
onwards. At present the width of the corridor is 100 basis points.
This corridor is used to contain any volatility in short term
interest rates.
Market stabilization Scheme
This scheme came into existence following a MoU between the
Reserve Bank of India (RBI) and the Government of India (GoI) with
the primary aim of aiding the sterilization operations of the
RBI.Historically, the RBI had been sterilizing the effects of
significant capital inflows on domestic liquidity by offloading
parts of the stock of Government Securities held by it. It is
pertinent to recall, in this context, that the assets side of the
RBIs Balance Sheet (July 1 to June 30) includes Foreign Exchange
Reserves and Government Securities while liabilities are primarily
in the form of High Powered Money (consisting of Currency with the
public and Reserves held in the RBI by the Banking System). Thus,
any rise in Foreign Exchange Reserves resulting from the
intervention of the RBI in the Foreign Exchange Markets (with the
intention, say, to maintain the exchange rate on the face of huge
capital inflows) entails a corresponding rise in High Powered
Money. The Money Supply in the economy is linked to High Powered
Money via the money multiplier. Therefore, on the face of large
capital inflows, to keep the liabilities side constant so as to not
raise the Supply of Money, corresponding reduction in the stock of
Government Securities by the RBI is necessary.The MSS was devised
since continuous resort to sterilization by the RBI depleted its
limited stock of Government Securities and impaired the scope for
similar interventions in the future. Under this scheme, the GoI
borrows from the RBI (such borrowing being additional to its normal
borrowing requirements) and issues Treasury-Bills/Dated Securities
that are utilized for absorbing excess liquidity from the market.
Therefore, the MSS constitutes an arrangement aiding in liquidity
absorption, in keeping with the overall monetary policy stance of
the RBI, alongside tools like the Liquidity Adjustment Facility
(LAF) and Open Market Operations (OMO).The securities issued under
MSS, termed as Market Stabilization Scheme (MSS) Securities/Bonds,
are issued by way of auctions conducted by the RBI and are done
according to a specified ceiling mutually agreed upon by the GoI
and the RBI. They possess all the attributes of existing
Treasury-Bills/Dated Securities and are included as a part of the
countrys internal Central Government debt.The amount raised under
the MSS does not get credited to the Government Account but is
maintained in a separate cash account with the RBI and are used
only for the purpose of redemption/buy back of Treasury-Bills/Dated
Securities issued under the scheme.However, following the global
financial crisis of 2008, that necessitated fiscal stimulus
measures, an amendment to the original MoU between the RBI and the
GoI in February 2009 allowed the Government to convert a portion of
the MSS funds into normal government borrowing for financing its
stimulus expenditure requirements.Treasury-Bills/Securities issued
under MSS are matched by equivalent cash balances that are held by
the Government with the RBI. Such payments are not made from the
MSS account just as receipts due to premium or accrued interest on
these Securities are not credited to it.As and when MSS securities
are issued by the RBI as well as the annual ceiling, when decided,
is notified through a press release. For the fiscal year 2010-11
the annual ceiling for such securities outstanding stand at Rs.
50,000 crore, with a review due when the outstanding reaches the
threshold of Rs. 35,000 crore.
Affect of Monetary Policy
Bank Rate: Lending capacity of commercial bank reduces. Thus
loan becomes EXPENSIVE. Contraction of credit.
CRR/SLR: Reduces reserve for lending. Contacting credit.
Bank Rate: Bank gets loans at cheaper rate. Thus even they lend
at low interests. Expansion of credit.
CRR/SLR: More funds with bank. So more credit to public.
EX-PMs view at the Monetary Policy
I think we expect the Governor to evolve a policy with the help
of professional persons for a national consensus if we have to
carry on with implementing social and economic changes in a complex
economy, The remarks assume significance in the context of the
raging debate over RBI's hawkish policy stance on checking
inflation vis a vis government priority on growth.
"The time has come to look at the possibilities and limitations
of the monetary policy in a globalised economy and dealing with the
constraints of the macro economic problems
Thoughts from the ex-Governor The debate on growth-inflation
balance has been clouded by some "oversimplifications". One such
oversimplification is to say that governments are for growth and
central banks are for price stability. Another oversimplification
is to assert that there is a tension between growth and inflation,
and that one necessarily has to play the trade-off between growth
and inflation in policy making"
Challenges to monetary policy1. The growing importance of assets
and assets price in a globally integration economy complicates the
conduct of monetary policy when it is a focused on and equipped to
address price stability issues.
2. With the growing integration of financial markets
domestically, these is greater activism in liquidity management
with special focus on short end of the market spectrum. As
liquidity management acquires overriding importance, the evolving
solvency conditions of financial intermediaries may get obscured in
the short-run.
3. There is considerably difficulty faced by monetary
authorities in detecting and measuring inflation especially
inflation expectations. Recent experience in regard to impact, if
increases in oil prices show that ignoring the structural or
permanent elements of shocks may slow down appropriate monetary
policy responses ,especially if the focuse is on CORE
INFALTION.
4. Reserve bank faces the dilemma of grappling with the
inherently volatile increasing capital flows relative to domestic
absorptive capacity.
5. In the emerging scenario of large and uncertain capital
flows, the choices of the instrument for sterilization and othe
policy response have been constrained.
6. In the liberalization process, aligning the operation of
large financial conglomerates and foreign institution with local
public policy priorities remains a challenge for domestic financial
regulation.
7. Domestic of all big financial intermediaries increases the
concentration risk.
Monetary policy in other countries The period since the 1990 has
witnesses some convergence in the conduct of monetary policy,
worldwide. The objectives, targets and operating procedures of
monetary policy worldwide have witnessed considerable shifts in
tune with the evaluation of monetary theory, central banking
regimes and the changing macroeconomic conditions over time. By
1970s, most central bank accepted price stability as key objective
of monetary policy. In recent year, beyond the traditional growth
inflation trade-off, financial stability has emerged as another key
objective in the wake of growing financial markets integration as\d
associated uncertainty and volatility arising out of contagion.
Although a number of central bank is developed countries such as
the Reserve Bank of New Zealand, Reserve Bank of Australia and the
Bank of England have adopted price stability as their sole
objective by adopting an inflation targeting framework, several
other countries, US and Japan continue to pursue dual objective of
price stability and growth. Similarly, while some emerging markets
economics (EMEs) such as South Africa, Thailand, Korea and Mexico
have emphasized solely price stability by adopting an inflation
targeting framework, some other tends to follow multiple
objectives.As central bank throughout the world could not always
directly target the ultimate objectives, monetary policy focused on
intermediates targets that bear close relationship with the final
objective. The selection of intermediates targets is conditional on
the channel of monetary policy transmission that operates in the
economy. Although countries differ in terms of the choice of
instruments, they could be broadly classified on the basis of their
key operating i.e. Interest rate. In the first category are
countries such as the US, Japan, Canada, and Australia, where the
key operating targets is the overnight inter-bank rate through the
signaling strategies differ. In the case of other developed
countries such as the ECB, the key policy rate is tender rate that
is applicable to regular operations, mainly the refinancing
operations. Some central banks, however in countries such as the
UK, select overnight markets interest as their operating targets
consistent with official Bank rate decided by the MPC. In general,
the maturity of such interest rate varies from 1 to 2 weeks but
could range between 1 or 2 days to 1 month. The operating targets
in the case of several EMEs also are the overnight rate determined
in the interbank markets for settlement balances (Korea and
Malaysia). In order to promote financial stability, central banks,
being the monopolistic suppliers of primary liquidity, have
endeavored to Smoothen the movements in the overnight rate with a
high degree of precision through calibrated modulation of bank
reserves. Central banks have generally refrained from strict
control of interest rate as it deters the development of money
markets. Allowing the volatility in other rate to absorbed
temporary pressure could enable central bank to preserve stability
in other money market policy.The operating procedures of monetary
policy and liquidity management have also changed in response to
the change in the policy environment amidst financial
liberalization. The literature and the central bank own accounts
attribute five main reasons reforms in their operating procedures
in the industrial countries during 1980s and the 1990s(Mehran et
al., 1996).1. Monetary policy instruments were changed to adapt to
the new operational frameworks of respective monetary policy
authorities. 2. With Financial deepening occurring more or less
entirely outside the central bank balance sheets, the share of the
financial systems over which monetary authorities had direct
control was reduced, warranting indirect ( price oriented as
opposed to quality- oriented instruments) ways to control the
non-financial monetary components of liquidity in the financial
systems.
3. In the wake of expansion, diversification and integration of
financial markets all over the world, greater interest rate
flexibility and narrowing of differential between rates of returns
in different currencies warranted instruments that can impart
flexibility to liquidity management in terms of the timing,
magnitude and accuracy.
4. The growing important of expectations in financial markets
favored the adoption of instruments that are better suited for
signaling monetary policy
5. There was a growing urge on the part of central bank to
stimulate money market activity and improved monetary policy
transmission while emphasizing the separation of monetary and
government debt management objectives.
As a result of the changes in the policy environment, the
following trends could be observed at the international level,
particularly during the 1990s. 1. There has been a continuous
reduction in reserve requirements. The marked international trend
towards reduction reserve requirements over the last decade reflect
the conscious policy effort to reduce the tax on intermediation
with a view to reduce the burden of institutions and generate a
level of playing field for both between different types of domestic
institution and increasingly those across national borders.
2. There has been growing emphasis on active liquidity
management driven partly by the pressure of increasingly mobile
international capital and decline in reserve requirements. The main
instruments for liquidity management by the central banks are
discretionary market operation. Standing facilities have become
safety valves rather than the key mechanisms for setting the
interest rate.
3. Among wide array of monetary policy instruments repos have
almost become the main policy tool, which could be consider a major
milestone in the development of money market. It is widely believed
that the growth of the collateralized repo market has played an
important role in enhancing the overall stability of the financial
systems is removing counterparty risk through funded traded credit
protection against risky transaction in unsecured wholesale
financial markets.
4. Greater flexibility in the liquidity management has been
accompanied by a greater transparency in the policy signals
relating to desired interest rate levels, driven by the broader
changes in the economic and political environment, including the
decline I inflation to relatively low level, growing emphasis on
inflation targeting, greater autonomy and accountability of central
bank and growing influence of market forces and expectations in the
formation of interest rates.
Operating procedure of liquidity management in developing
countries CountryobjectiveIntermediaries/Operating TargetsKey
instrument of discretionary liquidityFrequency of market
operations
CRROMOREPOStandingFacilitiesothers
USA To promote maximum sustainable output, employment and stable
price Federal Funds yesyesyesyesDaily
UKPrice stability Overnight market, interest rate, consistent
with bank rateyesyesyesyesOne per week plus one per month (long
term repo)
JapanPrice stability & to contribute to the development of
national eco.Overnight call money market yesyesyesyesMore than one
per day
Australia Mainly price stability, maintenance of full
employment, economic prosperity & welfare cash
rateyesyesyesdaily
CanadaLow & stable inflationOvernight rateyesyesTwice a
day
MexicoPrice stability Bank reserve yesyesyesyesDaily
China Stability of the currency & promote economic growth
Money supply & excess reservesyesyesyesyesPolicy oriented
financial bonds ¢ral bonds1 or 2 per week
India Growth, price & financial stabilityOvernight
rateyesYes yesYes Market stabilization schemes Twice a day repo
MalaysiaMonetary &financial stability for growthOvernight
call rateyesyesyesyesBank Negara billsTwice a day
SingaporePrice stability Weighted exchange rateyesyesyesyesForex
swaps & reserve swaps Twice a day
Bibliography Website:-1. www.RBI.org.in/
2. www.wikipeda.org
3. www.airticlebusiness.com
4. www.indianpolicy.org.in
5. www.vipanronam.com
6. www.kbharti.in
7. www.crunchslideshare.com
Books:-1. Financial institution and markets Mr. Jitendra
Mahakuad
2. Monetary policy and financial stability- Mr. C. Rangrajan
3. Macroeconomic Mr. D. N. Dwivedi
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