Monetary policy Quantative techniques

Monetary PolicyMonetary Policy

Manish SharmaManish Sharma

The part of the economic policy which regulates The part of the economic policy which regulates the level of money in the economy in order to the level of money in the economy in order to regulate inflation, improve balance of payments, regulate inflation, improve balance of payments, increase gross national product etc. RBI, in case increase gross national product etc. RBI, in case of India controls the monetary policy.of India controls the monetary policy.

The policy statement traditionally announced The policy statement traditionally announced twice a year through which RBI insures Price twice a year through which RBI insures Price stability for the economy.stability for the economy.– April-September - Slack Season PolicyApril-September - Slack Season Policy– October-March - Busy Season PolicyOctober-March - Busy Season Policy

RBI reserves its right to alter monetary policy to RBI reserves its right to alter monetary policy to time to time depending upon state of economy time to time depending upon state of economy

WHAT IS MONETARY POLICYWHAT IS MONETARY POLICY

How is the Monetary Policy How is the Monetary Policy different from the Fiscal different from the Fiscal

Policy?Policy? The Monetary Policy is different from Fiscal The Monetary Policy is different from Fiscal

Policy as the former brings about a change Policy as the former brings about a change in the economy by changing money supply in the economy by changing money supply and interest rateand interest rate

Fiscal policy is a broader tool with the Fiscal policy is a broader tool with the government to overcome recession and government to overcome recession and control inflation through change in control inflation through change in government revenue and expenditure to government revenue and expenditure to influence the level of national output and influence the level of national output and prices. prices.

Maintain price stabilityMaintain price stability Flow of credit to the productive sector of Flow of credit to the productive sector of

economyeconomy Stability of national currencyStability of national currency Growth in employment & incomeGrowth in employment & income Achieving foreign exchange stabilityAchieving foreign exchange stability Managing suitable level of investment and Managing suitable level of investment and

savingssavings Regulating rate of interest & induce higher level Regulating rate of interest & induce higher level

of investmentof investment Achieving monetary equilibrium to ensure Achieving monetary equilibrium to ensure

equality between demand & supply of money.equality between demand & supply of money.

AIM OF MONETARY POLICYAIM OF MONETARY POLICY

Instruments of Credit Instruments of Credit controlcontrol

Quantitative Credit control: Quantitative Credit control:

Controls the quantity of money in the Controls the quantity of money in the economyeconomy

Qualitative Controls:Qualitative Controls:

Controls the direction of flow of Controls the direction of flow of moneymoney

QUANTITATIVEQUANTITATIVE - Tools - Tools

Bank Rate-The rate at which RBI extends Bank Rate-The rate at which RBI extends credit to comm. Banks .credit to comm. Banks .

PLR-The rate which banks allows their PLR-The rate which banks allows their personal customers.personal customers.

CRR-The percentage of bank’s deposits CRR-The percentage of bank’s deposits which they must keep as cash with RBI. which they must keep as cash with RBI.

SLR-A comm. Bank has to keep a portion SLR-A comm. Bank has to keep a portion of total deposits with itself in liquid assets.of total deposits with itself in liquid assets.

Open Market OperationsOpen Market Operations LAF – Repo & reverse RepoLAF – Repo & reverse Repo MSS – Market stabilization schemeMSS – Market stabilization scheme

BANK RATEBANK RATE

Banks use this rate to price their Long Banks use this rate to price their Long term loans to individual and companiesterm loans to individual and companies

Increase in Bank rate Increase in Increase in Bank rate Increase in lending rate of Commercial Banks lending rate of Commercial Banks Decline in aggregate money expenditure Decline in aggregate money expenditure lowering inflation lowering inflation and vice versa. and vice versa.

This tool now not much in use and This tool now not much in use and remains same since years .remains same since years .

Bank RateBank Rate: : Bank rate is the minimum rate at which Bank rate is the minimum rate at which

the central bank provides loans to the the central bank provides loans to the commercial banks. It is also called the commercial banks. It is also called the discount rate. discount rate.

Usually, an increase in bank rate results in Usually, an increase in bank rate results in commercial banks increasing their lending commercial banks increasing their lending rates. Changes in bank rate affect credit rates. Changes in bank rate affect credit creation by banks through altering the creation by banks through altering the cost of credit. cost of credit.

Quantitative Credit ControlsQuantitative Credit Controls

Bank Rate Bank Rate

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

1940

1952

1953

1981

1990

1991

1997

2001

2007

Years

in %

TRENDSTRENDS OF BANK RATEOF BANK RATE

In 1940’s BR was at low 3% and remained unchanged till 1953.In 1953 RBI adopted policy controlled expansion BR raised to 3.5%.It reached at max. level in 1991 12%.Presently it is 6%

Prime lending Rate:Prime lending Rate: (presently – 12.75-13.25%) (presently – 12.75-13.25%)

PLR or prime lending rate as the rate of interest at which PLR or prime lending rate as the rate of interest at which banks lend to their credit-worthy or favoured customers. banks lend to their credit-worthy or favoured customers. It is treated as a benchmark rate for most retail and It is treated as a benchmark rate for most retail and term loans. term loans.

The RBI does not set these rates, but in a broad way The RBI does not set these rates, but in a broad way stipulates the interest rates in the economy. The banks stipulates the interest rates in the economy. The banks are at liberty to lend at a rate above or below the RBI’s. are at liberty to lend at a rate above or below the RBI’s.

The PLR is influenced by RBI’s policy rates — the repo The PLR is influenced by RBI’s policy rates — the repo rate and cash reserve ratio — apart from the bank’s rate and cash reserve ratio — apart from the bank’s policy. In simple words, availability of funds in the policy. In simple words, availability of funds in the banking system and demand for credit by consumers banking system and demand for credit by consumers (both retail and industrial) determine what the PLR (both retail and industrial) determine what the PLR should be. should be.

Quantitative Credit controlsQuantitative Credit controls

CASH RESERVE RATIOCASH RESERVE RATIO

RBI has the power to vary this ratio and there by RBI has the power to vary this ratio and there by use it as an instrument of Credit Control. use it as an instrument of Credit Control. Permissible limit is 3 to 15%(1962)Permissible limit is 3 to 15%(1962)

It is essential for a bank to maintain the ratio or It is essential for a bank to maintain the ratio or otherwise it may not be able to meet the otherwise it may not be able to meet the withdrawal demand of all its depositors, and withdrawal demand of all its depositors, and failure to do so may eventually result in failure of failure to do so may eventually result in failure of the bank.the bank.

Increase in CRR Increase in CRR reduce the excess reserves reduce the excess reserves available to a bank for lending contracting available to a bank for lending contracting Credit Credit

Increase in CRR absorbs Foreign Capital Increase in CRR absorbs Foreign Capital Inflows checking rupees appreciation.Inflows checking rupees appreciation.

TRENDS OF CRRTRENDS OF CRR In beginning it was 5% of demand deposit & 2% of time deposits

Reached max. in 1991,92 after 1993 it followed Narsimham report & decreased.

But from dec.06 it raised 7 times, 250bp to cool credit growth & supply.

STATUTORY LIQUIDITY RATIOSTATUTORY LIQUIDITY RATIO

Statutory Liquidity Ratio Statutory Liquidity Ratio Narsimham committee recommended to Narsimham committee recommended to

reduced it at minimum level. According reduced it at minimum level. According to that it is 25%and remains unchanged.to that it is 25%and remains unchanged.

Khan committee suggested Khan committee suggested abolishment of SLR. abolishment of SLR.

The buying & selling of these securities laid The buying & selling of these securities laid the foundation of the 1992 Harshad Mehta the foundation of the 1992 Harshad Mehta scam.scam.

TRENDS OF SLRTRENDS OF SLR

It was 25% in 1949 after that it increased continuously 32%(1972)--- 35% (1981)---36%(1984)--- 38%(1988).

From 1997 it is constant at 25%

OMOs-Meanings & ObjectivesOMOs-Meanings & Objectives

Open Market Operations-these refer Open Market Operations-these refer to the sale and purchase of Govt. to the sale and purchase of Govt. securities by the RBIsecurities by the RBI

The main objective of these The main objective of these operations has been to stabilizes the operations has been to stabilizes the prices of Govt. securities. The control prices of Govt. securities. The control of inflationary pressures has, however of inflationary pressures has, however been the secondary objectives.been the secondary objectives.

It is used several times after 1991 for It is used several times after 1991 for controlling inflows.controlling inflows.

The RBI conducts open market The RBI conducts open market operations (OMO) by offering to buy or operations (OMO) by offering to buy or sell gilts. sell gilts.

If it feels interest rates are too high, it If it feels interest rates are too high, it may bring them down by offering to may bring them down by offering to buy securities at a lower yield than buy securities at a lower yield than what is available in the market. what is available in the market.

(a) MSS-market stabilization scheme(a) MSS-market stabilization scheme

(b) LAF-Liquidity adjustment facility (b) LAF-Liquidity adjustment facility (repo and reverse repo)(repo and reverse repo)

Open market OperationsOpen market Operations

OMO - TOOLSOMO - TOOLS Repo RateRepo Rate

This is the rate at This is the rate at which the central bank adds which the central bank adds funds to the monetary funds to the monetary market. Present rate 7.75%market. Present rate 7.75%

Reverse Repo RateReverse Repo Rate The rate at which The rate at which

the central bank borrows the central bank borrows funds from the market. It funds from the market. It impacts Govt. bond yields impacts Govt. bond yields and short term bank and short term bank deposits. Present rate 6%deposits. Present rate 6% 0

2

4

6

8

10

12

Repo Rate Reverse Repo rate

EXPERT’S VIEWSEXPERT’S VIEWS

“ “ Monetary policy must accommodate primary Monetary policy must accommodate primary supply shocks and then curbs secondary supply shocks and then curbs secondary effects. The prime aim of Monetary policy effects. The prime aim of Monetary policy should be targeting stability.”should be targeting stability.”

Raghuram C Rajam, economistRaghuram C Rajam, economist

LIST OF BOOKSLIST OF BOOKS

1.1. Economics, ICAIEconomics, ICAI

2.2. Fundamental of Economics- A.S.RajFundamental of Economics- A.S.Raj

3.3. Managerial Economics- Varshney & MaheshwariManagerial Economics- Varshney & Maheshwari

4.4. Macro Economics- TMHMacro Economics- TMH

5.5. Dictionary of Economics- Jain and saakshi.Dictionary of Economics- Jain and saakshi.

6.6. Indian Economy since Independence- edited by Indian Economy since Independence- edited by Uma KapilaUma Kapila

7.7. Indian Economy- Dutt and Sundaram Indian Economy- Dutt and Sundaram

8.8. Economics- Samuelson and Nordhaus Economics- Samuelson and Nordhaus

List of Websites List of Websites

www.rbi.gov.in www.livemint.com www.bloomberg.com www.timesofindia.com www.thehindu.com

Thank YouThank You

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