money demand and supply

Ahmedabad UniversityH. L. Institute of CommerceS. Y. B.Com. SEMESTER-IIECONOMIC DEVELOPMENT AND FINANCIAL SYSTEM OF INDIA- I(Indian Economy-1)Prof. Sonal Yadav M.A.(Eco.),M.Phil. (Eco)UNIT-1 Demand for and Supply of Money in India

Definitions of Money in IndiaThe term money is derived from the Latin word Moneta, the name of the Roman goddess Juno, in whose temple coins were being minted. Numerous (about 172) things like shells and sheeps, grains and stones, tea and tobacco, ivory and iron, gold and silver have been used as money at different times and different places before the invention of modern days metallic and paper money.Definitions given by different economists Seligman defines money as a thing that possesses general acceptability. Walker says that money is what money does. Prof. Hicks says that money is defined by its functions. Crowther defines money as anything that is generally acceptable as a means of exchange (i.e. as a means of settling debts) and which, at the same time, acts as a store of value. Kent defines money as anything which is commonly used and generally accepted as a medium of exchange or as a standard of value. Robertson defines money as anything which is widely accepted in the payment for goods in the discharge of other kinds of business obligations. Keynes defines money as anything by the delivery of which price contracts and debt contracts are discharged and in the shape of which a store of general purchasing power is held. To modern economists, however, the crucial function of money is that it serves as a store of value.( currency, demand deposits of banks, bonds, government securities, time deposits with banks, equity shares etc)Functions of Money: Money performs five important functions1. It serves as a medium of exchange2. It is used as a store of value3. It is a standard for measuring values4. Money serves as a standard for deferred payments5. It transfers valueDistinction between Money and Near-Money1. Money refers to coins, currency notes and demand deposits of banks in modern economy.Near -money refers to the financial assets like time deposits, bills of exchange, government bonds, shares etc.2. Money bears 100% liquidity. Pure money, i.e. cash, is readily and immediately acceptable means of payment.Near-money lacks such 100% liquidity characteristics.3. Holding of pure money is regarded as cash balances which earns no interest. Thus, money is not an income earning asset.Near-money is an income earning asset.4. Pure money or currency money functions as a unit of account and a common measure of value. Prices are expressed in terms of money.A near-money has no such function. On the contrary, the value of near-money, any financial asset, is expressed in terms of currency money- a unit of account.5. Money and near-money, both, acts as a store of value. But the latter one is better store of value because it earns income too along with being a store of value. So, quite often, people may have a greater inclination to hold financial assets rather than to hold bare cash balances as a store of value.Significance of supply side:The value of money is determined by the demand for and the supply of money. The most vital thing about the supply of money is that its supply should match the demand for it. If supply of money keeps on exceeding the demand for money, the economy would lend itself in inflation with continuously rising prices. If the supply of money falls short of demand for money, the economy would sink into depression. The test of chief monetary authority i.e. the central bank lies in its efficacy to maintain correct supply of money in the economy. Supply of MoneyThe money supply is a key variable in policy formulations. In a broad sense, the term money supply refers to the total stock of domestic means of payment which is held by the public. In other words, money supply refers to the stock of money held by the public in disposable form only. Thus, money supply is the quantity of stock of money in circulation. Definition: Money supply refers to the amount of money which is in circulation in an economy at any given time.It follows that, at a point of time, the total stock of money and total supply of money differ in an economy. Stock of money held by the public is considered as money supply and the rest that lies with the money-creating agencies (i.e. central bank, commercial banks and state treasury) is not a part of money supply.Money supply is a stock as well as flow concept. When money is viewed, at a point of time, it is the stock of money held by the public on a particular date. It refers to total of currency notes, coins and demand deposits with banks that is held by the public.When viewed over a period of time, money supply becomes a flow concept. A unit of money is spendable as well as re-spendable. Thus, it may be spent several times during a given period, passing from one hand to another. The average number of times a unit of money circulating from one hand to another in the spending process during a given year is referred as the velocity of circulation of money. The flow of money is measured by multiplying a given stock of money held by the public with the velocity of circulation of money. According to Fisher, it is MV + MV where,M=legal tender money M=Credit/Bank moneyV= Velocity of legal tender money V=Velocity of credit/bank money

In the modern economy, the total quantity of money held by the public in spendable form generally comprises ofa. Currency money, i.e. coins and paper notes in circulation issued by the government and the commercial banks (legal tender money)b. Demand deposits of the commercial banks (bank money)Composition of Money Supply If we see the components of money supply, we can see bank deposits form bulk of the money supply. Within deposits, it is time deposits which form around 3/4thof the money supply. While,the share of both demand and time deposits is around 85% of money supply. Money supply increases with the growth in deposits.

RBIs Measure of Money Supply: Holding a measure of the liquidity approach to money, the RBI sums up the following assets as aggregate money resources. Currency (C) Demand Deposits of Banks (DD) Other Deposits of the RBI (OD) Post Office Savings deposits Time deposits of banks Time deposits of post officeBased on two fundamental functions of money, namely, medium of exchange and store of value, the RBI undertakes four measures of money stock, relevant for the formulation of its monetary policy. These measures are commonly expressed in symbolic terms as: M1, M2, M3, and M4. It is arranged in the descending order of liquidity. Concept of M1: M1 is defined in traditional sense. It is usually referred as narrow moneyM1= C+DD+OD, whereC= Currency (coins +paper) with the publicDD= Demand deposits with all banks- commercial as well as co operativeOD= Other deposits held with the RBI such as (1) deposits of institutions like IDBI, IFCI, SFCs, NABARD, UTI etc. (2) balance of foreign capital banks and governments IMF A/c no. II, IBRD etc. (3) compulsory deposits. These (OD) constitute a very small portion (less than 1%) of the total money supply.M1 implies superior liquidity. It is also considered as the reserve money / high powered money/base money. It is fundamentally useful in devising monetary-fiscal policy to control the stock of base money in the economy.Concept of M2: M2 is an extension of M1. It is wider concept of money stock in India. It is measured as follows.M2= M1+ POSBD where, POSBD= Post Office Saving Bank DepositsPost office being government agencies POSBD command greater public confidence in comparison to bank deposits. In rural areas where banking facilities are absent, post office saving banks plays an important role in mobilisation of rural savings.A major difference between bank demand/savings deposits and savings deposits with post offices is that the former are subject to the cheque system, whereas the later are not. Hence, for transaction demand for money as a medium of exchange bank deposits have greater liquidity than the POSBD.Therefore, as a policy variable M1 receives greater attention of the monetary authorities than M2.Concept of M3: M3 is broad money concept. It is based on Milton Friedmans approach of defining money which includes time deposits besides demand deposits and currency money as the components of money supply. M3 is measured as follows.M3= M1+TD where, TD refers to time deposits with all banks.Concept of M4: M4 is an extended measure of M3 as aggregate monetary resource of the country. It is measured as follows:M4= M3 + TPOD where, TPOD includes savings and time deposits of the public with the post office.Components of Money Supply in India (Annual) (` crore)YearCurrency in Circulation CB+CPDemand DepositsTime DepositsReserve MoneyNarrow Money(M1)Broad Money(M3)

1999-00 1970611496817823782805553417961124174

2000-01 2182051662709337713033113794501313220

2001-02 25097417919910755123379704228431498355

2002-03 28247319875712443793690614735811717960

2003-04 32702825862614269604365125787162005676

2004-05 36866128699815958874891356497902245677

2005-06 42957840742318931045719588264152719519

2006-07 50409947760423421137088909679553310068

2007-08 590801578372286204692830211558374017882

2008-09 691153581247351083598800112531844764019

2009-107995497179704113430115565314892685602698

2010-119496597228564865771137682416383456504116

2011-1210680597049125624966142717217342347359200

Source: Reserve Bank of India, Handbook of Statistics on Indian Economy-2010-11Note: Data for 2011-12 are provisional

Trends in the Money Supply (1990-2012)

Money supply (M3) has increased continuously in India during the planning period. It has increased by 50% during 1950-1960, by two times (doubled) during 1960-1970, by three times during 1970-1980, by four times during 1980-1990 and by three and a half times during 1990-2001 and by more than six times during 2000-12. As a result of fast increase in money supply, general price level has increased continuously in India since the beginning of the 3rd Five Year Plan. There has been inflation (demand-pull and cost-push) for most of the time.

There has been notable change in relative importance of various components of money supply also. This is natural because during the process of economic growth peoples preferences for various financial assets has changed.

Let us now examine the changes in M1 i.e. narrow money and M3 i.e. broad money in India during 2001-2012. This will give us an idea about the changes in the different components of money supply and also the relative importance of different sources of money supply and other liquid assets (also called near money.)

From the above table it becomes clear that there is fast increase in the supply of money because of increase in production, exports and higher growth rate. As compared to 2000-01, there has been increase in the currency in circulation by more than 5 times in 2011-12. Total bank deposits (time and demand) have increased with the increase in the income level of people and also because of increase in the banking facilities. There is fast increase in the amount of time deposits as compared to demand deposits. The share of time deposits in total bank deposit was more than 80% in 2009-10.

During the last decade, broad money (M3) has increased much faster than narrow money (M1). This is because people are keeping bank money increasingly in form of time deposits. The amount of broad money (M3) has increased from `1124174 crores in 1999-00 to `7359200 crores in 2011-12 of which time deposits with the banks were `5624966 crores. M3 shows a jump of more than six times over this period. One can very easily establish a close link between inflationary situation prevailing in India and the increase in the currency (M3).

% change in the components of money supply in 2011-12 as compared to 1999-2000YearCurrency in CirculationDemand DepositsTime DepositsReserve MoneyNarrow MoneyBroad Money

2011-12441.99370.94618.95408.69407.38554.63

Along with the increase in money supply, there has also been a significant expansion of bank credit. It is this phenomenal rise in the total money supply, which by exerting pressure on demand and unmatched by a corresponding increase in the production and supply of wage goods which has been a significant cause for inflationary price rise.

Money supply growth outpaces nominal GDP growth during Q1 in 2012The gap between money supply growth and GDP growth was much higher in First Quarter (Q1) of Financial/fiscal Year (FY11) and has been steadily decreasing, implying an easing of restrictive monetary conditions.The chart shows that money supply growth has always been below the quarterly nominal GDP growth between Quarter 4(Q4) of fiscal 2010 (FY10) and Q4 of FY11. That was the result of the Reserve Bank of Indias (RBI) monetary tightening measures. As is seen from the chart, prior to Q4 of FY10, money supply growth was much higher than the quarterly nominal GDP growth, except for a blip during Q2 of FY10.

When money supply growth is higher than the GDP growth, the implication is, there is excess liquidity, which could spill over into either higher asset prices or higher prices of goods and services, thus resulting in higher inflation. To avoid the danger of inflation, the RBI governor increased the bank rate by a higher-than-expected i.e. from 6% to 9.5% on 14/02/12.

Demand for Money/Sources of Money SupplyNet bank credit to government: It is divided into two categories:1. RBIs credit to government: RBI lends to government for short-term expenditure management.2. Other banks credit to government: This represents the total of commercial and cooperative banks investments in government securities, including treasury bills.There is persistent increase in Net bank credit to government. Within this category, the other banks credit to government has declined but RBIs credit to government has increased in the recent past. Therefore, the total funds used by government have risen. The government continues to use higher percentage of financial resources available in the economy in every quarter.Bank credit to commercial sector: It is also divided into two categories1. RBIs credit to commercial sector2. Other banks credit to commercial sector: Loans given by commercial and cooperative banks to commercial sector. Also includes investments by banks in securities (shares, bonds etc) issued by commercial sector.If we analyse where money supply is going, around 60% goes as credit to commercial sector. With Indian economy expected to grow, the share of this category is likely to increase.Net foreign exchange assets of banking sector: 1. Sum of RBIs foreign exchange and foreign assets held by commercial and cooperative banks. The percentage of foreign assets held by banks is very small. RBI holds majority of the foreign assets as part of its forex reserve. In 1991-92, the share of Net Foreign Exchange Assets of the Banking sector increased by 100.60 % as compared to 1990-91. Again, in 1993-94, the Net Foreign Exchange assets of the banking sector increased by 123.43% as compared to the previous year. This was due to the new economic policy (globalisation and liberalisation) declared by the government.

Demand for Money (Annual) (` crore)YearNet Bank Credit to GovernmentBank Credit to Commercial SectorNet Foreign Exchange Assets of the Banking Sector

2000-01 511955679218249820

2001-02 589565759647311035

2002-03 676523898981393715

2003-04 7429041016151526586

2004-05 7524361275912649255

2005-06 7594161688681726194

2006-07 8276262128862913179

2007-08 89951825789901295131

2008-09 127719930133371352184

2009-10166918634914091281464

2010-11198389642366761393343

2011-12236954749594261543780

Source : RBI

Trends in the demand for Money (2000-2012)

If we analyse the above table and chart, we can see that funds from the central bank to the government went up by Rs 37,7681 crore (`1277199-`899518) (41.99%) in 2008-09 as compared to 2007-08, while it increased by only Rs 71892 crore a year earlier. This is because of various stimulus packages announced by the government to tackle the slowdown in the economy. The bank credit to government increased further by `385651 crore in 2011-12. This is also due to the high amount of government expenditure in the developing economy which is responsible for the increase in the bank credit to government. The net bank credit to commercial sector increased from 2578990 in 2007-08 to 301337 in 2008-09 which means 16.84% increase compared to 2007-08. However, it has declined from 21.14% in 2007-08 to 16.84 % in 2008-09. With Indian economy expected to grow, the share of this category has increased in 2011-12 and is likely to increase further.There was very small change in the amount of the net foreign exchange assets of the banking sector in 2008-09 as compared to 2007-08 due to decrease in the amount of exports mainly because of the global recession. However, in 2011-12 the amount has increased and will increase further with increase in the amount of exports.

Monetary Policy of RBIMonetary policy is designed and directed to achieve different macro-economic goals, depending on the basic problems and the nature of economy of the country, from time to time. In the Indian context, the prime objective of monetary policy is to help accelerate economic development in an environment of reasonable price stability.Objectives of monetary policy in India1. To promote savings and tap potential savings2. To mobilise savings for capital formation and for the growth in investment projects3. To provide incentives to investment and thus, to prepare an investment climate conducive to the fulfilment of plan objectives4. To provide extensive credit to cater the growing needs of agriculture, industry, trade, commerce and other productive activities, thereby promoting overall economic growth5. To curb the inflationary spiral. To maintain an appropriate structure of relative prices and general price stability6. To promote growth without any financial impediments

In the growing economy like India, the central bank (RBI) is not expected to be very rigid about the quantity of money. Normally it should follow a policy of controlled expansion of money supply. Judging by this criterion, the policy of RBI does not seem to be quite satisfactory. Over the years while meeting the demand for money made by the central government for meeting its budgetary deficits the RBI has actively contributed to creating inflationary pressures. Only when the price situation appeared to be somewhat out of control, it undertook various monetary control measures in somewhat ad hoc manner for preventing further rise in prices. For about three decades from 1962 to 1991 the RBI had employed both quantitative as well as qualitative measures of credit control. The bank aimed at assisting economic growth in an environment of price stability. The emphasis was on, controlled Monetary Expansion. This implied two aspects of the policy Expansion in the supply of money and Reasonable restriction on the expansion of credit (i.e. creation of credit) by the commercial banks.Instruments of credit control:I. Quantitative credit controls andII. Qualitative credit controlThe instruments of quantitative credit control areBank rate: It is a discount rate- a rate at which RBI lends to the commercial banks against commercial bills of exchange. Bank Rate plays an important role in regulating and channelling the credit flows. As an instrument of credit control it directly affects the supply of credit by making it costlier or cheaper. An increase in the Bank rate act as a signal for tight (dear) credit policy and a decrease in the Bank Rate indicate cheap money policy. Bank Rate is also a reference rate and therefore affects the entire structure of interest rates in the economy. Until 1962 it had pursued the cheap money policy to provide necessary inducement to invest in the private sector. When in the early 1960s inflationary pressures considerably increased, this policy was given up and the bank rate was raised number of times and was finally fixed at 6% in 1965. Upward revision in the bank rate once again became necessary in the early 1970s when general price level recorded an unprecedented increase. Within the period of three and a half years beginning from January 1971 the bank rate was raised thrice. It was fixed at 9% in July 1974. For few years the price situation did not cause much anxiety and as such the need for further rise in the bank rate was not felt. However, when monetary expansion in 1979-80 generated fresh inflationary pressures, the bank rate was raised to 10% in July 1981.Note: Pl. check the table on the page no. 14 to 20 for further details.

It is observed from the table thatI. Bank Rate has continuously gone up since the establishment of RBI till 1991, except in 1968 when it went down.II. Bank Rate was 7% in 1973, i.e. twice what it was in 1951.III. Bank Rate was raised by 2% in 1974 to check the severe inflation.Economic crisis reached its zenith in 1991. Our foreign exchange reserves were nearly exhausted and we were forced to sell gold to Bank of England to meet international payments obligations. Bank Rate was raised twice during the year. It reached the peak level of 12%. This period may be called the dear money policy period. This was believed to be necessary to counteract the inflationary pressure.IV. After 1997, the Bank Rate was lowered.V. The rise and fall in Bank Rate during four months of 1998 are indicative of quick adjustments to the changing need of the economy.VI. Since 1998, Bank Rate has been falling with only one exception in July 2000. Bank Rate after 2003 has remained constant at 6% which is half of what it was in 1991.In India, the bank rate changes were not a very efficient method to regulate the supply of credit and money. The situation has, however, changed since the introduction of economic reforms in the early 1990s. As a part of financial sector reforms the RBI has taken steps to strengthen the bank rate as a policy instrument for transmitting signals of monetary and credit control. It now serves as a reference rate for other rates in the financial markets. With this new role assigned to the bank rate it has been brought down to 6.0% per annum in phases. However, it increased to 10.25% in July 2013 and again brought down to 8.75% in October 2013.Open Market Operations (OMO)OPEN Market operations imply direct sale and purchase of securities and bills in the market to control the volume of credit. In practice, however, the term is applied, in most countries, to the purchase or sale of government securities only by the central bank. Open market operations have a direct effect on the availability and cost of credit. The open market operations policy has two dimensionsa. It directly increases or decreases the loanable funds or the credit-creating capacity of banksb. It leads to changes in the prices of government securities and the term structure of interest ratesWhen the central bank sells securities in the open market, other things being equal, the cash reserves of commercial banks decrease to the extent that they purchase these securities. In effect, the credit creating base of commercial bank is reduced and hence credit contracts. In short, the open market sale of securities by the central bank leads to a contraction of credit and reduction in the quantity of money in circulation. When central bank purchases securities in the open market, it leads to an expansion of credit. Thus, on account of open market operations, the quantity of money in circulation changes. However, in view of the underdeveloped security market in India, the RBI has rarely used OMO as a sharp weapon of credit control. In general, open market operations have been used in India more to assist the government in its borrowing operations and to maintain orderly conditions in the government securities market than for influencing the availability and cost of credit. The RBI has generally been involved with a selling aspect of the OMO policy with a view to check the lendable resources of commercial banks.In India, the technique of open market operations as an instrument of credit control was developed much later. In fact, the need for open market operations was felt only when the bank rate policy turns out to be a rather weak/ineffective instrument of monetary control due to the underdeveloped money market.At present the RBI Act authorises the RBI to conduct purchase and sale operations in the government securities, treasury bills and other approved securities. The RBI is empowered to buy and sell short term commercial bills. However, due to absence of organised bill market in the country this provision has served little purpose. But at the same time with the expansion of banking sector this instrument is becoming more effective tool to control money supply in the economy.

OMO to check volatility in the forex market In order to contain volatility in the forex market, the RBI has instituted several measures as follows. For effective liquidity management, RBI announced that it will auction Government of India Cash Management Bills (government bonds) worth Rs 22,000 crore every week. This measure was a part of a continuing effort to arrest the slide in the rupee which started in the month of July-August 2013. To restore stability in the foreign exchange market, the Marginal Standing Facility and bank rates were raised to 10.25 per cent and restricted access by way of repo window to Rs 75,000 crore. The central bank also conducted open market sales of government securities of Rs 2,500 crore and rationalised gold imports by making it mandatory on all nominated banks to ensure that at least one-fifth of the imported metal is exclusively made available for exports. The RBI directed banks to draw only 50 per cent of their total deposits in overnight borrowings and maintain a 99 per cent average cash reserve ratio every day.

Cash Reserve Ratio (CRR):The CRR is the proportion of the public deposits of the bank which they have to keep in the form of cash with the RBI. The CRR is an effective instrument of credit control. Under the RBI Act 1962, the RBI is empowered to determine CRR for the commercial banks in the range of 3% to 15% for the aggregate demand and time liabilities. This technique of credit control was used quite often during the 1970s and 1980s for controlling inflation. In the late 1980s there was rapid growth of liquidity and thus the CRR was raised from 10% to 15%. From July,1989 to March 1993 almost for 4 years the CRR remained unchanged at 15%.

The Narsimham Committee which submitted its report in November 1991 did not favour use of CRR to combat inflationary pressures. In its opinion, a high CRR adversely affected bank profitability and thus pressured banks all the time to charge high interest rates on their commercial sector advances.The CRR was thus brought down from a peak of 15% in 1994-95 to 8% in 2000. The final reduction of CRR was made to 4.5% effective from June 14, 2003. However, in a bid to control inflationary tendencies in the economy, the CRR was subsequently raised in stages. It was increased to 5% in October 2004, 7.5% in October 2007 and further to 8.75% and 9% in July 2008 and August 2008 respectively. After this CRR is falling continuously and it has brought down to 4% since February 9, 2013.Thus, the CRR is raised by the central bank when credit contraction is desired and lowered when credit is to be expanded.Note: Pl. check the table on the page no. 14 to 20 for further details.

Statutory Liquidity Ratio (SLR)The SLR is the percentage of total loans and investments which banks have to invest in government securities. The banking regulation Act 1962 provides for maintaining a minimum statutory liquidity ratio of 25% by the bank against their net demand and time liabilities. The Amendment Act also empowers the RBI to raise the SLR up to 40% if it is considered necessary to control liquidity. Thus the RBI is vested with the power to determine SLR for commercial banks. The RBI used this power to raise SLR quite often during the 1970s and 1980

Effective from September 22, 1990, SLR was made as high as 38.5% of the commercial banks net demand and time liabilities. The SLR remained at this level up to March 31, 1992.There were two reasons why the RBI had raised the SLR for banks.1. It reduced commercial banks ability to create credit and thus eased inflationary pressures.2. It made larger resources available to the state.The Narsimham committee did not favour maintenance of a high SLR. Keeping in view the recommendations of this committee, the government decided to reduce SLR from 38.5% to 25%. The SLR was lowered down to 25% effective from October 1997. Thus, the programme of reducing the SLR to 25% as a part of financial sector reform has been successfully implemented. SLR was further reduced to 24% on 8-11-2008 and 23% in August 11, 2012.Note: Pl. check the table on the page no. 14 to 20 for further details.

Liquidity Adjustment Facility (LAF)Liquidity adjustment facility (LAF) is a monetary policy tool which allows banks to borrow money through repurchase 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. At present repo rate is 7.75%. 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 components 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.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. At present the reverse repo rate is 6.75%The collateral used for repo and reverse repo operations comprise of 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.

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 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.Qualitative Credit Control measures / Selective Credit ControlQualitative/selective credit control measures are generally meant to regulate credit for specific purpose. It is very vital for the government to reduce the flow of bank money to less essential businesses or industries and slow down or halt their growth. At the same time it is necessary to boost priority industries and expand the flow of bank credit to them. This necessitates discriminatory or selective policies. Selective methods of credit control are as follows1. Moral persuasion: Under the policy of moral persuasion the RBI sends request letters to commercial banks in the form of Do and Dont to persuade banks to deliberately pursue certain policies and keep off certain policies as per RBIs instructions. However, particularly in developing countries the central banks do not command effective moral authority. Hence, this measure in practice is of little use.2. Margin over loans: Under the policy of margin over loans RBI increases or decreases the margin to be maintained in the matter of sanctioning loans to various industries as situation demands. Margin can be raised in case of sensitive or speculative areas and reduced for productive or development-oriented industries.3. Credit rationing/credit planning: Under the policy of credit rationing, RBI undertakes detailed micro level planning and instructs commercial banks the norms prescribed for rationing of credit among various claimants. Violation of such norms would be considered as disobedience to its authority in the money market.4. Control of consumers credit: RBI also resorts to curtail bank advances to buy consumers durables like washing machines, refrigerators, air conditioners etc., with a view to tighten bank advances and combat inflationary pressures building within the economy.5. Publicity: The weapon of publicity is also used to prevent misbehaving commercial banks, not operating according to the norms of sound banking. RBI publishes the balance sheets, figures of deposits, lending, structure of investment, reserve ratio percentage etc. for the information and knowledge of the general public. This would expose banks to public scrutiny and deter banks from violating banking rules and norms. However in underdeveloped countries where people are illiterate and banking habit is not developed, this measure does not prove to be fruitful in checking defaulting banks from such dubious practices.6. Direct action: this measure empowers RBI to take actions against defaulting commercial banks. RBI charges penalty interest from such non-cooperating banks to pressurise them to act in tune with its guidelines in the matters of disbursement of bank credit. At times RBI does not hesitate to take even stricter measures against habitual defaulters and refuse to act as the lender of the last resort in case of such banks and do not run to the rescue when they are in difficulties.

Limitations of the Qualitative Instruments of Credit Control1. The selective methods of credit control, by and large, are applicable to commercial banks only and not to non-banking financial institutions and other agencies which also accounts for a sizable portion of the total volume of credit in the economy.2. Many times, it becomes very difficult to make a distinction between productive and unproductive uses of credit.3. It is also difficult for the commercial banks to control the ultimate use of credit.4. It is likely that commercial banks in order to earn profits may manipulate accounts and advance credit to their customers.5. In modern times, a good deal of investment is financed by raising equity capital, use of undistributed profits, borrowing from non-banking financial institutions etc. all these reduce the effectiveness of selective credit control policy.6. If traders and businessmen decide to rely less on banks credit for carrying on their economic activities and resort more to trade credit or accommodation of bills, the efficacy of selective credit control gets weakened to that extent.Obstacles in Implementation of Monetary Policy (Limitations of the monetary policy of RBI)Though the monetary policy is useful in attaining many goals of economic policy, it is not free from limitations. Its scope is limited by certain peculiarities in developing countries such as India. Some of the important limitations of the monetary policy are given below. 1. Absence of well organised money market: Indian money market is not a well-organised and well-integrated market. It is divided into two important segments- organised sector and unorganised sector. The organised sector is completely under the control of RBI but the unorganised sector is still outside the purview of RBI. Thus, the indigenous bankers and the non-banking financial institutions which constitute an important part of the money market and which play a significant role in financing trade and industry have not yet been brought completely within the orbit of RBI. This naturally tends to reduce the efficacy of the monetary policy.2. Existence of non-monetised sector: In many developing countries, there is an existence of non-monetised sector. Barter system is still prevalent in many rural areas. Due to non-monetised sector the progress of commercial bank is not up to the mark. This creates a major bottleneck in the implementation of the monetary policy.3. Excess non-banking financial institutions: There are many non-banking financial institutions (NBFIs) which provide credit in the economy. However, all of them do not come under the purview of the monetary policy and thus nullify the effect of monetary policy.4. Lack of co-ordination between Monetary and Fiscal Policy: An important limitation of this policy is lack of coordination with fiscal policy and also with the overall economic policy. In a situation where a number of factors are operating in the economy which tends to aggravate inflationary pressures, monetary measures by themselves alone cannot meet with the situation. Monetary policy can work effectively only when used in conjunction with all other measures to control inflation. But what has actually happened in our country is that while monetary policy has been directed to control inflation but due to lack of co-ordination with fiscal policy it has not been able to achieve the desired results. Anti-inflationary impact of the monetary policy gets wiped off if the fiscal policy of the government is inflationary.5. Reserve Banks control is limited to banking sector only: Various tools of monetary policy available with Reserve Bank are such that they cover only the commercial banks and in particular the scheduled banks. To the extent that inflationary situation in the economy is the result of bank finance, Reserve Banks general and selective methods of credit control will have their effect. But, if inflationary pressures are the result of say, the pursuit of reckless deficit financing or genuine shortage of goods or due to other factors, Reserve Banks control may not have any effect at all.6. Higher liquidity hinders Monetary Policy: In rapidly growing economy, the deposit base of many commercial bank has expanded. This creates excess liquidity in the system. In such circumstances even if there is increase in CRR and SLR, it does not deter commercial banks from credit creation. Thus, the existence of excess liquidity due to higher deposit base is a hindrance in the way of successful implementation of monetary policy.7. Money not appearing in the economy: Large percentage of money never comes in the main stream economy. Rich people, traders, businessmen and other people prefer to spend rather than to deposit money in the bank. This shadow money is used for buying precious gold, silver, ornaments, land and in speculation. This type of lavish spending give rise to inflationary trend in main stream economy and monetary policy fails to control it. 8. Time lag affects success of monetary policy: The success of monetary policy depends on timely implementation. However, in many cases, unnecessary delay is found in implementation. Or, many times timely directives are not issued by the central bank. Thus, the impact of monetary policy is wiped out. 9. Circulation of unaccounted money: Circulation of unaccounted money, popularly known as the black money, further aggravates the situation and limits the efficacy of the monetary policy.These are major obstacles in the implementation of monetary policy. If these factors are controlled or kept within limit then the monetary policy can give expected results. Thus, though the monetary policy suffers from these limitations, it has an immense significance in influencing the process of economic growth and development.

Questions for Discussion1. Discuss different measures of money supply as proposed by RBI.2. Explain the meaning of money supply at a point of time and over a period of time. Explain the relative importance of the components of alternative measures of money as used by RBI.3. Discuss the factors which determine the supply of money in a country.4. Define money. Discuss the functions of money. Distinguish between money and near money. 5. Write the functions of RBI. Explain the efficacy of the selective methods of credit control.6. What is monetary policy? Mention the objectives of monetary policy in India. Discuss the limitations of this policy.7. Discuss the efficacy of Bank Rate and Open market Operations in controlling credit.8. Discuss changes in Bank Rate in India especially from 1991. What were the broad objectives of these changes?9. Critically examine the monetary policy of RBI.10. What do you mean by Cash Reserve Ratio(CRR) and Statutory Liquidity Ratio (SLR)? What is Narsimham committees viewpoint regarding maintenance of CRR and SLR?

TABLE 46 : MAJOR MONETARY POLICY RATES AND RESERVE REQUIREMENTS - BANK RATE, LAF (REPO-REVERSE REPO & Marginal Standing Facility), MSF RATES, CRR, SLR

(Per cent)

Date of y Policy DecisionEffective DateFix Range LAF Rates

Bank RateRepoReverseCash Reserve RatioMarginal Standing FacilityStatutory Liquidity Ratio

15-07-201310.25---10.25-

3-05-20138.257.256.25-8.25-

19-03-20138.507.506.50-8.50-

9-02-2013---4.00--

29-01-20138.757.756.75-8.75-

3-11-2012---4.25--

22-09-2012---4.50--

11-08-2012-----23.00

17-04-20129.008.007.00-9.00-

10-03-2012---4.75--

13-02-20129.50-----

28-01-2012---5.50--

25-10-2011-8.507.50-9.50-

16-09-2011-8.257.25-9.25-

26-07-2011-8.007.00-9.00-

16-06-2011-7.506.50-8.50-

3-05-2011-7.256.25-8.25-

17-03-2011-6.755.75---

25-01-2011-6.505.50---

18-12-2010-----24.00

2-11-2010-6.255.25---

16-09-2010-6.005.00---

27-07-2010-5.754.50---

2-07-2010-5.504.00---

24-04-2010---6.00--

20-04-2010-5.253.75---

19-03-2010-5.003.50---

27-02-2010---5.75--

13-02-2010---5.50--

7-11-2009-----25.00

21-04-2009-4.753.25---

5-03-2009-5.003.50---

17-01-2009---5.00--

5-01-2009-5.504.00---

8-12-2008-6.505.00---

8-11-2008---5.50-24.00

3-11-2008-7.50----

25-10-2008---6.00--

20-10-2008-8.00----

11-10-2008---6.50--

30-08-2008---9.00--

30-07-2008-9.00----

19-07-2008---8.75--

5-07-2008---8.50--

25-06-2008-8.50----

12-06-2008-8.00----

24-05-2008---8.25--

10-05-2008---8.00--

26-04-2008---7.75--

10-11-2007---7.50--

4-08-2007---7.00--

28-04-2007---6.50--

14-04-2007---6.25--

31-03-2007-7.75----

3-03-2007---6.00--

17-02-2007---5.75--

31-01-2007-7.50----

6-01-2007---5.50--

23-12-2006---5.25--

31-10-2006-7.25----

25-07-2006-7.006.00---

8-06-2006-6.755.75---

24-01-2006-6.505.50---

26-10-2005-6.255.25---

29-04-2005--5.00---

27-10-2004--4.75---

2-10-2004---5.00--

18-09-2004---4.75--

14-06-2004------

31-03-2004-6.00----

25-08-2003--4.50---

14-06-2003---4.50--

29-04-20036.00-----

19-03-2003-7.00----

7-03-2003-7.10----

3-03-2003--5.00---

16-11-2002---4.75--

12-11-2002-7.50----

29-10-20026.25-5.50---

27-06-2002--5.75---

15-06-2002---5.00--

28-03-2002-8.00----

5-03-2002--6.00---

29-12-2001---5.50--

3-11-2001---5.75--

23-10-20016.50-----

7-06-2001-8.50----

28-05-2001--6.50---

19-05-2001---7.50--

30-04-2001-8.75----

27-04-2001-9.006.75---

10-03-2001---8.00--

2-03-20017.00-----

24-02-2001---8.25--

17-02-20017.50-----

12-08-2000---8.50--

29-07-2000---8.25--

22-07-20008.00-----

22-04-2000---8.00--

8-04-2000---8.50--

2-04-20007.00-----

20-11-1999---9.00--

6-11-1999---9.50--

8-05-1999---10.00--

13-03-1999---10.50--

2-03-19998.00-----

29-08-1998---11.00--

29-04-19989.00-----

11-04-1998---10.00--

3-04-199810.00-----

28-03-1998---10.25--

19-03-199810.50-----

17-01-199811.00--10.50--

6-12-1997---10.00--

22-11-1997---9.50--

25-10-1997---9.75-25.00

22-10-19979.00-----

26-06-199710.00-----

16-04-199711.00-----

18-01-1997---10.00--

4-01-1997---10.50--

9-11-1996---11.00--

26-10-1996---11.50--

6-07-1996---12.00--

11-05-1996---13.00--

27-04-1996---13.50--

9-12-1995---14.00--

11-11-1995---14.50--

29-10-1994-----31.50

17-09-1994-----33.75

20-08-1994-----34.25

6-08-1994---15.00--

9-07-1994---14.75--

11-06-1994---14.50--

16-10-1993-----34.75

18-09-1993-----37.25

21-08-1993-----37.50

15-05-1993---14.00--

17-04-1993---14.50--

6-03-1993-----37.75

6-02-1993-----38.00

9-01-1993-----38.25

9-10-199112.00-----

4-07-199111.00-----

22-09-1990-----38.50

1-07-1989---15.00--

30-07-1988---11.00--

2-07-1988---10.50--

2-01-1988-----38.00

24-10-1987---10.00--

25-04-1987-----37.50

28-02-1987---9.50--

6-07-1985-----37.00

8-06-1985-----36.50

1-09-1984-----36.00

28-07-1984-----35.50

4-02-1984---9.00--

27-08-1983---8.50--

29-07-1983---8.00--

27-05-1983---7.50--

11-06-1982---7.00--

9-04-1982---7.25--

29-01-1982---7.75--

25-12-1981---7.50--

27-11-1981---7.25--

30-10-1981-----35.00

25-09-1981-----34.50

21-08-1981---7.00--

31-07-1981---6.50--

12-07-198110.00-----

1-12-1978-----34.00

13-11-1976---6.00--

4-09-1976---5.00--

28-12-1974---4.00--

14-12-1974---4.50--

23-07-19749.00-----

1-07-1974---5.00-33.00

8-12-1973-----32.00

22-09-1973---7.00--

8-09-1973---6.00--

29-06-1973---5.00--

31-05-19737.00-----

17-11-1972-----30.00

4-08-1972-----29.00

9-01-19716.00-----

28-08-1970-----28.00

24-04-1970-----27.00

5-02-1970-----26.00

2-03-19685.00-----

17-02-19656.00-----

26-09-19645.00-----

16-09-1964-----25.00

3-01-19634.50-----

16-09-1962---3.00 % of NDTL--

11-11-1960---(a) 5% of DL, (b) 2% of TL--

6-05-1960---(a) 5% of DL, (b) 2% of TL--

6-03-1960---(a) 5% of DL, (b) 2% of TL--

16-05-19574.00-----

15-11-19513.50-----

16-03-1949-----20.00

28-11-19353.00-----

5-07-19353.50--(a) 5% of DL, (b) 2% of TL--

Note : 1. "-" Indicates No change. 2. Data for cash reserve ratio (CRR) are as percentage of net demand and time liabilities (NDTL) as per Section 42 of the RBI Act, 1934. 3. Till March 29, 1985, banks were required to maintain statutory liquidity ratio (SLR) as a prescribed proportion of demand and time liabilities (DTL) as on every Friday in the following week on a daily basis. Thereafter, it is being maintained daily on a fortnightly basis as a prescribed portion of NDTL as on last Friday of second preceding fortnight. 4. Data for CRR for the following period excludes additional reserve requirements or release/ exemption of CRR on incremental NDTL (i) March 6, 1960 to November 10, 1960, (ii) January 14, 1977 to July 30, 1981; and (iii) November 12, 1983 to April 16, 1993. 5. It was announced that with effect from February 29, 1992, SLR would be based on NDTL as on April 3, 1992. In addition, there will be 30 per cent SLR on the increase in NDTL over April 3, 1992 level which was continued till January 8, 1993. 6. With effect from October 16, 1993 to October 28, 1994, SLR was applicable on NDTL as on September 17, 1993 which was continued till 16.9.1994. In addition, there was 25 per cent SLR on the increase in NDTL over September 17, 1993 level which was continued till August 19, 1994. 7. With effect from October 29, 1994, SLR was applicable on NDTL as on September 30, 1994. In addition, 25 per cent SLR was prescribed on the increase in NDTL over September 30, 1994 level. 8. The Liquidity Adjustment Facility (LAF) system was operating on 'auction based variable rate' during the period from April 27, 2001 to March 28, 2004, moved to 'fixed rate' mode from March 29, 2004 in terms of circular RBI/115/2004 dated March 25, 2004. 9. In order to improve cash management by banks, effective from the fortnight beginning November 6, 1999, prescribed CRR was required to be maintained by every scheduled commercial bank based on its NDTL as on the last Friday of the second preceding fortnight. Further, to facilitate banks to tide over the contingency during the millennium change, it was decided to treat cash in hand maintained by banks for compliance of CRR for a limited period of two months commencing from December 1, 1999 to January 31, 2000. It was also announced that cash in hand, which was counted for CRR purpose during the above period, cannot be treated as eligible asset for SLR purpose simultaneously. 10. Scheduled banks were allowed to avail additional liquidity support under the Reserve Banks liquidity adjustment facility (LAF) to the extent of up to one per cent of their NDTL and seek waiver of penal interest during September 17-November 7, 2008 after which SLR was reduced. Since October 15, 2008, banks were temporarily allowed to avail additional liquidity support to the extent of 0.5 per cent of their NDTL exclusively for the purpose of meeting the liquidity requirements of mutual funds and on November 1, 2008, the limit was increased to 1.5 per cent of their NDTL against their liquidity support for mutual funds and non-banking financial companies. 11. Scheduled banks were allowed to avail additional liquidity support under Reserve Bank's liquidity adjustment facility (LAF) to the extent of up to 0.5 per cent of their NDTL and seek waiver of penal interest during May 28-July 16, 2010 purely as an ad-hoc measure. 12. Till Oct. 28, 2004, nomenclature of Repo indicated absorption of liquidity where Reverse Repo meant injection of liquidity by the Reserve Bank. However, with effect from October 29, 2004 nomenclature of Repo and Reverse Repo has been interchanged as per international usages. The current nomenclature is being followed in this Table.

13. Beginning May 03, 2011 the repo rate became the single independently varying policy rate to single the monetary policy stance. The reverse repo rate continues to be operative but it is now pegged at a fixed 100 basis points below the repo rate and is no longer an independent rate. 14. Marginal Standing Facility (MSF) was introduced in May 2011. Under MSF, SCBs can borrow overnight up to two per cent of their respective NDTL, at a rate, determined with a spread of 100 basis points above the repo rate.

10