Monetary policy

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Monetary policy

  1. 1. CONTENT Sr. No. Topic Page No. 1. Introduction to Reserve Bank of India 1 2. Objective of Reserve Bank of India 3 3. Function of the Reserve Bank of India 5 4. Introduction to Monetary Policy 10 5. Meaning and Monetary Policy Content of 12 6. How s the Monetary Policy is different from Fiscal Policy? 15 7. Objectives of Monetary Policy 17 8. Role of Monetary Policy in Developing Economy 19 9. Scope Monetary Policy in under-develop countries 22 10. Efficiency of Monetary Policy 24 11. Limitation Monetary Policy 29 12. Major Issue of Indian Monetary Policy in Retrospect and Prospect 33 13. Instruments Monetary Policy 36 14. A Capsule of Monetary policy and Credit Control Measures 1994-95 41 15. Highlights of Monetary policy 44 16. Current Scenario 46 18. A Visit in Reserve Bank of India 48 19. A Visit in Central Bank 50 20. Conclusion 51 21. Bibliography 52
  2. 2. Executive summary Introduction The bi-annual Monetary and Credit Policy is a statement that determines the supply of money in the economy and the rate of interest charged by banks. Through this policy, the Reserve Bank of India seeks to ensure price stability for the economy. Economic reforms initiated in India since mid 1991 also encompassed reforms in monetary and credit policy of the Reserve Bank of India. Hence the reforms in monetary and credit policy were introduced to operate in a market oriented financial system. Importance and significance of Monetary Policy The monetary and credit policy gains importance to individuals due to announcements in the interest rates. Earlier, depending on the rates announced by the RBI, the interest costs of banks would immediately, either, increase or decrease. A reduction in interest rates would force banks to lower their lending rates and borrowing rates. So if you want to place a deposit with a bank or take a loan, it would offer it at a lower rate of interest. Rational of the study • The study enables us to know about the reforms that to play in the monetary and credit policy. • It leads to overall knowledge development • It helps to improve research ability.
  3. 3. Hypothesis The hypothesis being put forth for this study about reforms in Monetary and Credit policy the Monetary Policy are to maintain price stability and ensure adequate flow of credit to the productive sectors of the economy. The monetary policy affects the real sector through long and variable periods while the financial markets are also impacted through short- term implications. Expected Contribution Expectations from the study are that it may contribute of monetary and policy as part of financial sector reforms, a number of steps have been taken to enhance the effectiveness of monetary policy, and these include, improvement in the payments and settlement systems, development of secondary market in government securities with a diversification of investor base, reduction in non-performing assets, introduction of ALM guidelines, and reduction in the overall transactions costs. In particular, the recent initiatives of RBI to develop money market and debt markets should contribute to improving the transmission mechanisms of monetary policy.
  4. 4. Introduction to Reserve Bank of India The Reserve Bank of India is the apex financial institution of the country’s monetary system. The Reserve Bank of India is a Banker’s Bank. The Reserve Bank of India (RBI), as India’s central bank, was established on 1st April, 1935 under the Reserve Bank of India Act, 1934. Origin of the RBI There has been a long series of efforts to establish a central bank in our country. The earliest attempt may be tracked to 1773, when Warren Hastings, the Governor of Bengal(later Governor General), felt the need for a central bank in the country and recommended that a “General Bank” in Bengal and Bihar be founded. The Report of the Chamberlain Commission in 1913 also raised the issue of the founding of a central bank in the country. As a supplement to this report, Professor J.M. Keynes chalked out into effect, owing to the outbreak of the First World War. In 1921, the Imperial Bank of India was set-up by the amalgamation of the three Presidency Banks, which performed a few central banking functions, though primarily it reminded as a commercial bank. Specifically, the Imperial Bank as a banker to the government and in some capacity as banker’s bank till the establishment of the Reserve Bank of India in 1935. The founding of central bank of India was again stressed by Royal Commission on Indian Currency and Finance (popularly known as the Hilton- Young Commission) in 1926. The Commission suggested the name “Reserve Bank of India” for the country’s central bank. In January 1927, a bill to this effect was introduced in the Legislative Assembly, but was dropped on constitutional grounds. In 1931 the Indian Central Banking Enquiry Committee made recommendation for the establishment of a Reserve Bank.
  5. 5. The question of starting a central bank in the country again received serious attention with the publication of White Paper on Indian Constitutional Reforms. It insisted that the British make the transfer of responsibility from the Central Government of Indian hands provides a Reserve Bank, free from political influences, is founded and it operated successfully. Eventually, a fresh bill to this effect was introduced in the Legislative Assembly ON September 8, 1993. The bill was passed and received the assent of the Governor-General on March 6, 1934 and became the Reserve Bank of India Act, 1934.
  6. 6. Objectives of RBI The preamble to the Reserve Bank of India Act, 1934 spells out the objectives of the Reserve Bank as: “to regulate the issue of Bank notes and the keeping of reserve with a view to securing monetary stability in India and generally to operate the currency and credit system of the country to its advantages. Prior to the establishment of the Reserve Bank, the financial system was totally inadequate on account of the inherent weakness of the dual control of currency by the Central Government and of credit by the Imperial Bank of India. The RBI regulates the financial policy and develops banking facilities throughout the country. Hence, the Reserve Bank of India was established with this primary object in view. Another object of the Reserve Bank has been to remain free from political influence and be in successful operation for maintaining financial stability and credit. The fundamental object of the Reserve Bank of India is to discharged purely central banking functions in the Indian money market, i.e., to act as the note- issuing authority, banker’s bank and banker to government, and to promote the growth of the economy within the framework of the general economic policy of the government, consistent with the needs of price stability. A significant object of the Reserve Bank of India has also to assist the planned process of development of Indian economy. Besides the traditional central banking functions, with the launching of the five-year plans in the country, the Reserve Bank of India has been moving ahead in performing a host development and promotional functions, which are normally beyond the purview of a traditional central bank.
  7. 7. The Reserve Bank of India, as such, aims at the promotion of monetisation and monetary integration of the economy, filling in the “credit gaps” in the financial infrastructure, creating to the financial needs of the economy with appropriate sectorial allocation, as well as supporting the planners in the efficient and productive deployment of investible funds with a view to attain the macro- economic goals of maximization of growth with stability and social justice.
  8. 8. Function of the RBI The Reserve Bank of India performs all the typical functions of a good central bank. In addition, it carries out a variety of developmental and promotional function attuned to the course of planning in the country. Its major functions may be stated as follows: 1. Issuing currency notes, i.e., to act as a currency authority. The Reserve Bank has the sole right to issue currency notes, except one rupee notes which are issued by the Ministry of finance. The RBI follows a minimum reserve system in the note issue. Initially, it used to keep 40 percent of gold reserves in its total assets. But, since 1957, it has to maintain only Rs. 200 crores. As such, India has adopted the “managed paper currency standard.” As currency authority, the Reserve Bank provides different denominations of currency for facilitating the transactions of the Central and State Governments, and caters to the exchange an remittance needs of the public, banks as well as the Governments departments. 2. Serving as banker to the government. The Reserve Bank of India serves as a banker to the Central Government and the State Government. It is obligatory function as a central bank. It provides a full range services to these Governments, such as: • Maintaining and operating of deposit accounts of the Central and State Governments. • Receipts and collection of payments to the Central and State Governments.
  9. 9. • Making payments on behalf of the Central and State Governments. • Transfer of funds and remittance facilities to the Central and State Governments. • Managing the public debt and the issue of new loans and Treasury Bills of the Central Governments. • Providing ways and means for advances to the Central and State Governments to bridge the interval between expenditure and flow of receipts of revenue. Such advances are to be repaid by the government within three months from the date of borrowal. • The Reserve Bank represents the Government of India as member of the International Monetary Fund and the World Bank. 3. Acting as banker’s bank and supervisor. The Reserve Bank of India serves as a banker to the scheduled commercial banks in India. All the scheduled commercial banks keep their accounts with the Reserve Bank. The Reserve Bank of India also serves as ‘a lender of last resort’ rediscounting eligible bills of exchange of commercial banks during the period of credit stringency. The bank can, however, deny rediscounting facility to any bank without assigning any reason therefore. Apart from the bankers’ bank, the Reserve Bank is also entrusted with the responsibility of commercial banks. Under the Reserve Bank of India Act the Banking Regulation Act, 1949, the Reserve Bank of India has been vested with a wide range of powers of supervision an control over commercial and co-operative banks.
  10. 10. 4. Exchange management and control. Under Section 40 of the Reserve Bank of India Act, it is obligatory for the bank to maintain the external value of the rupee. The Reserve Bank of India is the custodian of the country’s foreign exchange reserves. It has authority to enter into foreign exchange transactions both on its own and on behalf of the Government. It is obligatory for the bank to sell and buy currencies of all the member countries of the International Monetary Fund to ensure smooth and orderly exchange arrangements and to promote a stable system of exchange rates. The Reserve Bank of India has restored to the technique of exchange control to allocate its limited foreign exchange resources according to a scheme of priorities. In India, exchange control was introduced under the Defence of India Rules in September, 1939. It was, however, statutorily laid down by the Foreign Exchange Regulation Act of 1947. This has been again stipulated by the Foreign Exchange Regulation Act of 1973. 5. Collection of data their publication. The Reserve Bank of India collects statistical data and economic information through its research departments. It complies data on the working of commercial and co-operative banks, on balance of payments, company and government finances, security markets, prices trends, and credit measures. The bank is the principal sources of certain financial statistics and banking data. It publishes a monthly bulletin, with weekly statistical supplements and banking reports which present a good deal of periodical review and comments pertaining to general economic, financial, and banking developments, including the bank’s monetary policies and measures, adopted for the qualitative and quantitative monetary management.
  11. 11. 6. Miscellaneous development and promotional functions and activities. The function of the Reserve Bank of India are multi-dimensional. The bank performs a number of developmental and promotional functions. Apart from credit regulation, the Reserve Bank effectively channelises credit, especially to priority sectors, such as, agriculture, exports, transport operations, and small scale industries. It makes institutional arrangements for rural and industrial Development Bank of India has been set-up to solve the allied problems of industries. The bank also assists the government in its economic planning. The bank’s credit planning is devised and coordinated with the five-year plans of the country. The Reserve Bank of India has also assisted the emergence an growth of development banking and other term-lending institutions, such as the Unit Trust of India (UTI). 7. Agricultural finance. The Reserve Bank of India in a developing economy like nay be regarded as an engine of growth. It not only regulates bank finance, but deliberately promotes development finance. It has made special efforts in catering to the growing financial needs of agriculture, industry and exports sectors of the country. Agriculture is the king-pin of India’s rural economy. Thus, rural credit – agricultural finance – is the pre-requisite of agricultural growth and development. Since the inception of planning in our country, the Reserve Bank of India has been paying specific, attention to promoting rural/agricultural finance.
  12. 12. 8. Industrial finance. Rapid industrialization is the key to accelerating economic growth and development. Pre requisite of industrial development are M’s: Men, Materials, Machines, Management and Money. Of these money, s the primary essential. Money in industry comes from industrial finance. Rapid industrial development, thus, necessitates an adequate supply of short-term and long-term finance for the purposes of industry’s fixed and working capital. The industrial sector comprising large and medium scale industries s usually urban-oriented. It relies on institutional sources of finance. It resorts to the money market as well as the capital market to secure the required financial assistance. In the Indian economy, small scale industries also have a strategic role to play. Small scale industry s confined to urban, semi-urban as well as rural areas. Small an large industries have their typical borrowing needs – short-term as well as long-term credit. It s gratifying to note that the Reserve Bank has played a significantly active role in the development of institutional agencies for providing industrial finance in the country. The Reserve Bank of India made commendable efforts for broadening the domestic capital market for providing the medium and long-term finance to the industrial sector. 9. Export finance. “Export or perish” has become a slogan for the developing economies, including India, in recent years. India is keen on expanding its exports. The Government of India has devised liberal policies for encouraging and expanding exports by offering a number of concessions to the exporting industries. Growth of exports needs liberal and adequate export credit.
  13. 13. Introduction to Monetary Policy Monetary policy plays a crucial role in molding the economic character of country because money and credit in a modern economy exercise a vital influence upon the course, nature and volume of economic activities. An appropriately conceived monetary policy can significantly aid economic growth by adjusting the money supply to the needs of growth by directing the flow of funds into the desired channels and by making institutional credit available to the specific fields of economic pursuit. Monetary policy can also help in correcting the economic ills of the economy such as inflation or deflation. In short, monetary policy is an important economic tool which can be used to attain many macro-economic goals. Monetary policy refers to “the use of instruments within the control of the central bank to influence the level of aggregate demand for goods and services by regulation of the money supply and credit. The Reserve Bank seeks to control and regulate the flow of credit in the economy such that it can sustain the tempo of development and promote the maintenance of internal price stability. It uses quantitative controlling weapons, such as bank rate policy, open market operations, and the reserve ratio requirement. Since 1956, it has increasingly relied on and resorted to selective credit controls for accelerating the rate of growth and for checking inflationary spurts. With the laps of time, the scope of monetary policy in the country has been considerably widened to make adequate adjustments in the money credit structure in view of the changing needs of the developing economy envisaged under the Five Year Plans.
  14. 14. When is the Monetary Policy announced? Historically, the Monetary Policy is announced twice a year - a slack season policy (April-September) and a busy season policy (October-March) in accordance with agricultural cycles. These cycles also coincide with the halves of the financial year. Initially, the Reserve Bank of India announced all its monetary measures twice a year in the Monetary and Credit Policy. The Monetary Policy has become dynamic in nature as RBI reserves its right to alter it from time to time, depending on the state of the economy.
  15. 15. Meaning and content of Monetary Policy The monetary policy is the policy statement, traditionally announced twice a year, through which the Reserve Bank of India seeks to ensure price stability for the economy. It involves changed in the base rate of interest to influence the rate of growth of aggregate demand, the money supply and ultimately price inflation. Monetarist economists believe that monetary policy is a more powerful weapon than fiscal policy in controlling inflation. Monetary policy also involves changed in the value of the exchanged rate since fluctuations in the currency also impact on macroeconomic activity (incomes, output and prices). Definition Monetary policy is usually defined as the central bank’s policy pertaining to the control of the availability, cost and use of monetary and credit with the help of monetary measures in order to achieve specific goals. Prof. Wrightsman defines monetary policy as “the deliberate effort by the central bank to control the money supply and credit condition for the purpose of achieving certain broad economic objectives.” In essence, monetary policy is an art – the art of central banker in monetary management. In the Indian context, monetary policy comprise those decisions of the government and the Reserve Bank of India which directly influence the volume and composition of money supply, the size and distribution of credit, the level and structure of interest rates, and the direct and indirect effects of these monetary variables upon related factors such as savings and investments and determination of output, income and price.
  16. 16. Monetary policy is only a means to an end and not an end in itself. The aims, objectives and scope of monetary policy are conditioned both severally and collectively by the economics environment and philosophy of time. Monetary policy has to be structured and operated within the institutional framework of the money market of the country. Traditionally, credit control measures and decisions are the constituent elements of a monetary policy. Monetary and credit policies operate on the following inter-related factors: • Availability of credit and its flow; • Volume of monetary; • Cost of borrowings, that is, the rate of interest, and • General liquidity of the economy. There are two facets of monetary policy in a developing economy: (1) positive, and (2) negative. In its positive aspects, it sets out the promotional role of central banking in improving the savings ratio and expanding credit for facilitating capital formation. In its negative approach, it implies a regulatory phase of restricting credit expansion, and allocation according to the absorbing capacity of the economy. • Monetary Policy and the Exchange Rate There is no official exchange rate target for the British economy. The UK has operated a free-floating exchange rate since we suspended our membership of the European exchange rate mechanism in September 1992
  17. 17. and although the Monetary Policy Committee has occasionally discussed the relative merits and de-merits of intervening in the current markets to influence the external value of the pound, the Bank has not done so for over a decade. There are in any case severe doubts about the effectiveness of direct intervention in the foreign exchange markets. • Monetary Policy and Money Supply Targets There are no specific targets for the growth of the money supply (M0, M4) – although data on the growth of the stock of money provides useful information for the MPC on the strength of aggregate demand. Interest rates are not determined with reference to specific targets for the money supply. There are no supply-side controls on the growth of bank lending/credit instead monetary policy in the UK is designed to control the growth in the demand for money through changing the cost of loans and influencing the incentive to save.
  18. 18. How is the Monetary Policy different from the Fiscal Policy? 1. Two important tools of macroeconomic policy are Monetary Policy and Fiscal Policy. 2. The Monetary Policy regulates the supply of money and the cost and availability of credit in the economy. It deals with both the lending and borrowing rates of interest for commercial banks. 3. The Monetary Policy aims to maintain price stability, full employment and economic growth. 4. The Reserve Bank of India is responsible for formulating and implementing Monetary Policy. It can increase or decrease the supply of currency as well as interest rate, carry out open market operations, control credit and vary the reserve requirements. 5. The Monetary Policy is different from Fiscal Policy as the former brings about a change in the economy by changing money supply and interest rate, whereas fiscal policy is a broader tool with the government. 6. The Fiscal Policy can be used to overcome recession and control inflation. It may be defined as a deliberate change in government revenue and expenditure to influence the level of national output and prices. 7. For instance, at the time of recession the government can increase expenditures or cut taxes in order to generate demand.
  19. 19. 8. On the other hand, the government can reduce its expenditures or raise taxes during inflationary times. Fiscal policy aims at changing aggregate demand by suitable changes in government spending and taxes. 9. The annual Union Budget showcases the government's Fiscal Policy.
  20. 20. Objectives of the Monetary Policy The objectives are to maintain price stability and ensure adequate flow of credit to the productive sectors of the economy. Stability for the national currency growth in employment and income are also looked into. The monetary policy affects the real sector through long and variables periods while the financial markets are also impacted through short-term implications. The objective of monetary policy must be regarded as being part of the overall economic objectives to be pursued by the government. Monetary policy should be directed to achieve different objectives, depending on the environment and the time factor. In the Indian context the prime objective of reasonable price stability. Monetary policy, being a part of public policy, is obviously 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. During the course of planning, the monetary policy of India aimed at the following objectives: To promote savings and tap potential savings. To mobilize savings for capital formation and for the growth of investment projects. (i) To provide incentives to investment and, thus, to prepare an investments climate (ii) Conductive to the fulfillment of plan objectives. (iii) To provide extensive credit to cater to the growing needs of agricultural, industry, trade, commerce and other productive activities, thereby promoting on overall economic growth.
  21. 21. (iv) To curb the inflationary spiral. To maintain an appropriate structure of relative prices and general price stability. (v) To permit growth without any financial impediments. In a developing economy like that of India, the monetary policy has to be, therefore, both promotional and regulatory. It should smoothen the process of economic growth and accelerate it through adequate credit expansion, but at the time, the inflationary impact of extensive credit generation should be checked. Monetary policy should intimate the process of monetisation of the economy by creating additional flow of money. In an expanding economy, the additional money supply may prove helpful for activising unutilized resources and unemployed labour into productive activity. Monetary policy can significantly assist in the institutionalization of savings and investment in a developing economy. The Reserve Bank of India, as such, assumes an important role in initiating, promoting and regulating banking and financial intermediaries in the country. Again, it has a vital role to play in checking inflationary forces that are released through the methods of financing involved in the process of development. There are four main 'channels' which the RBI looks at: • Quantum channel: money supply and credit (affects real output and price level through changes in reserves money, money supply and credit aggregates). • Interest rate channel. • Exchange rate channel (linked to the currency). • Asset price.
  22. 22. Role of Monetary Policy in a Developing Economy In modern times, any newly-developing country may be concerned with the problem of how to use the monetary policy successfully to stimulate economic growth. In an under-developed country, the monetary policy has to play a vital role in developing the economy from a stage of primary backwardness to a stage of self-sustained growth. It should be noted, however, that the monetary policies and measures of developed countries are not always readily applicable as solutions to the typical problems facing newly developing countries. Monetary policy which is one thing in an advanced economy may be quite another in an under-developed economy. Thus similar course of action cannot be appropriated to both types of countries. Naturally, the economic ends and means and conditions of developed and developing nations are bound to be different, and hence the role of monetary policy should also vary in both cases. Advanced countries of today can afford the luxury of debating whether full employment should take precedence over price stability or whether the aim should be to achieve internal or external balance at the expenses of growth. However, poor countries cannot at any time think of anything but the policy of promoting rapid economic growth. Under the growth-oriented monetary policy, monetary management by the central bank becomes a strategic factor of development in an under- developed country on the following counts:
  23. 23. 1. When the country aspires for rapid economic development, it adopts economic planning. In the process, financial planning needs the support of credit planning and appropriate monetary management. 2. Under developed countries are most susceptible to inflation. Inflation in an under-developed economy generally occurs when there is an abnormal increases in the effective demand exerted mainly by huge government expenditures under the planning process. However, the maintenance of stability in the domestic price level and a fixed, realistic exchange rate are very essential preconditions for achieving a maximum rate of sustained economic growth. This needs an equilibrium of savings and investments. In an under-developed country, however, since the rater of savings is very low, government is usually tempted to raise the level of investment by means of credit expansion and deficit financing. The monetary policy requires special attention in a country which seeks to bring about rapid economic growth with controlled inflations. 3. Above all, the growth objective of monetary policy in under- developed countries implies the promotional role of monetary authorities. Briefly, the promotional role of the monetary authority in an under-developed country many be to improve the efficiency of the banking system as a whole or extend sound credit where needed and to respond promptly to changing conditions. In short, monetary policy of a developing nation has an important role in the creation, working and expansion of financial institutions. 1. Thus, it is an important task of the monetary authority to improve the conditions of unorganized money and capital markets in poor countries in the interest of rapid economic development and the successful working of monetary management.
  24. 24. 2. Moreover, an important function of monetary policy in an under- developed economy is to have an also to make use of a most suitable interest rate structure. 3. Public debt management responsibility also lies with the monetary authority of the country. In a growing economy, thus, it is a very important and difficult task. 4. Under-developed countries are characterized with 20-30 percent of non-monetised sector. Hence, it is the prime duly of the monetary authority to extend the process of monetisation in these barter sections of the economy. This will tend to improve the working and effectiveness of the monetary policy.
  25. 25. Scope of Monetary Policy in Under-developed Countries 1. The scope of monetary policy in under-developed countries is extremely limited, compared to that in advanced countries for the following reasons: 2. The money market is unorganized in an under-developed country and therefore, the monetary management of the central bank cannot be perfect. 3. In most of the under-developed nations, money supply primarily consists of currency in circulation while bank deposits from relatively a small proportion of it. Lack of banking habits on the part of the people in poor countries makes it difficult for the monetary authority to influence the economy by controlling the banking system. 4. Changes in bank rate or other monetary instruments are proved to be ineffective in under-developed countries also on account of the existence of a vast non-monetised sector in their economies. The above stated factors impose a limit on the scope of monetary policy in under-developed countries. However, this does not mean that monetary policy has no role to play at all. Despite its various limitation, the monetary policy in an under-developed country can greatly assist economic growth “by influencing the supply and use of credit, combining inflation and maintaining the balance of payment equilibrium.” It has been argued that since the bulk of money supply in an under-developed economy is in the
  26. 26. form of currency rather than bank deposits, the central bank can regulate with greater efficiency the rate of spending by controlling the currency as such. Monetary policy and management have an active role to play in a scheme of planning for economic development in an under-developed country. It would have to take on a direct and active role firstly, in increasing or helping to create the machinery needed for financing development activities all over the country, and secondly, in ensuring that the finance available flows in the direction intended. Briefly, thus, the monetary policy in an under-developed economy has to be used to activise the growth process and to create favourable conditions for fostering economic development with reasonable stability
  27. 27. Efficiency of Monetary Policy It is generally conceived that monetary policy is more effective in checking economic activity than in stimulating it. In other words, monetary policy is more effective in checking boom conditions than in generating recovery from recession or depression. In times of depression or stagnation, the monetary authority can do very little. It cannot enforce investment merely by following an easy money policy or credit expansion as such. It can control the money rate of interest to some extent but not the rate of profit which may be a very low or even in a negative quantity during a depression. Investment generally seems to be interest inelastic. The interest- inelasticity of investment can be explained on two counts. a. Interest represents a minor element of total costs in short-term investments, b. In making long-term investments, business expectations and other economic variables are far more important than the influence of interest rates. Thus, when there is overall pessimism prevailing in the economy and the marginal efficiency of capital is very low, mere monetary expansion by the monetary authority cannot do anything substantial. Moreover, there is no direct relationship between the quantity of monetary and the price level as was traditionally assume. There are many other factors affecting prices and business activity as powerfully as the mone7y supply. Most of them being non-monetary in nature, cannot be controlled by monetary action alone.
  28. 28. Depression needs action to revive effective demand by raising the consumption and marginal efficiency of capital through public investment programmes and such other measures. Hence, fiscal policy was advocated as a powerful weapon for offsetting and checking depression and unemployment. Only in times of prosperity can monetary policy be used effectively, as it can control speculative boom and inflation by regulating undue credit expansion, Thus, it seems that monetary policy is admirably suited to situations requiring the restraint of inflationary pressures of requiring high short-term interest rates to lessen the flow of capital for reducing a deficit in the balance of payments. In formulating an effective monetary policy, the following two points should be born in mind: • The magnitudinal dimension, and • The time dimension. The strength of the monetary policy is measured by its magnitudinal dimension; while the lag involved in its effectiveness is measured by the dimension of the policy. Again, the strength of monetary policy is determined by the elasticity as well as the degree of stability of functional relations – monetary and real – in the economy. It has been observed that the strength of the monetary policy is inversely related to the interest rate elasticity of demand for real assets. Thus, when low elasticity of demand for money is combined with high elasticity of demand for real assets, the monetary policy will have a stronger effect. In such cases, a large percentage change in the demand for real assets; that there will be a larger change effected in output of goods and services in
  29. 29. order to correct the resulting sizable discrepancy between the desired and actual holdings of real assets. The monetary authority, however has to learn from its past experience to judge the size of the magnitudinal effect of its operations. Nowadays, econometric models are also being constructed to estimate the effectiveness of a monetary policy. A correct knowledge of magnitudinal effect is, however, very much helpful on prescribing the correct dosage of monetary policy according to the requirement of the prevailing circumstances. Similarly, the knowledge of time dimension of a monetary policy if of great help in prescribing the appropriate timing of the policy action. The time dimension factor measures the lags involved in the working of monetary policy. There are a number of such lags: • The action:- A lag between the time when a need for a policy change is recognized and the actual change effected; • The credit market lag:- A lag between the time when monetary policy is changed and the time when such change leads to changes in important monetary variables like interest rates, the supply of money and other financial assets; • Recognition lag;- a lag between the time when change in policy is required and the time when this essentiality is recognized; • The output lag:- the lag between the time when the monetary and financial market conditions change and the time when these changes bring about changes in the real income and output. The first two types of lags are described as “ inside lag”, and the last two are called “ the outside lag” of monetary policy.
  30. 30. The outside lag in the effect of monetary policy is a distributed lag. The effect of monetary policy on prices, income, employment, etc., cannot be perceived at a moment of time; it is, however, distributed over a span of time. Whenever a monetary policy is changed its effect its may be generated immediately but it tends only after a sufficiently long period of time. However, a long lag is not good as it impairs the effectiveness of monetary policy. Under a longer lag, the effect of a change in monetary policy cannot be set according to need, as the effect will not be predictable with certainty. Thus, under a long and variable time lag, discretionary monetary policy’s efficacy is very much doubted. In order to produce desired changes in the economic activity, the central bank pursue a monetary policy to bring about changes in the quantity of monetary and credit there by to case changes in the flow of spending which influences the level and mode of economic activity. The central bank in this regard usually adopts monetary measures of credit control such as bank rate policy, etc., which affect the flow of bank credit on the economy. Modern monetarists, however, feel that this is not enough. The central bank must aim at influencing the total volume of liquidity rather than the quantity of money alone to bring forth effective results. It has been contended that the fundamental object of monetary action of the central bank is to change the level of aggregate demand by influencing the community’s rate and volume of spending. In short, the decision to spend depends on a host of factors like: • Cash balance • Bank balance • withdrawal of time and saving deposit,
  31. 31. • selling of financial assets held. Thus, as the Radcliffe Report put, “the spending is not limited by the amount of money in existence, but it is related to the amount of money people think they can get hold of whether by receipts of income, by disposal of capital assets or by borrowing. In this context, obviously the whole structure of interest rates comes into consideration, as an interest rate change affects the liquidity of the various groups of financial institutions which in turn affects the liquidity of others – thus, “general liquidity”. Thus, it has been advocated that the centerpieces of the monetary mechanism is the structure of interest rates of the “general liquidity” of the whole economy rather than the supply of money. A rise in interest rates will slacken their lending activities by improving capital losses on their asset holding. Thus, a rise in the interest rates depresses aggregate spending indirectly by reducing the lending of finance institution and so liquidity of the public in general. Thus, in the liquidity approach, the aim of monetary policy is shown to not the regulation of the quantity of monetary but the control of the general liquidity position of business, banks and other financial institutions. It is, therefore, widely accepted that the central bank should be concerned with the total credit and liquidity structure of the economy, and not merely with the size and behaviour of money supply.
  32. 32. Limitations of Monetary Policy Monetary policy has its unique role and significance in a developed or a developing country. But, it cannot be the be-all and end-all of the system. In view of its scope and operational aspect, various limitations of the monetary policy may be stated as under:  Broad Front. Monetary policy operates on a board front, giving little consideration to the bottlenecks or shortage it has to counter, in practice, at a micro level. Further, it can affect the volume of investment but cannot cause sharp changes in the pattern of investment through credit controlling measures.  Structure and Growth of the Banking System. Since the working of the monetary policy is basically confined to the banking activity, its success of failure very much depends on the degrees of development of the banking system, its organization, co-ordination, and integrated network in the country as a whole.  Tradition and Statutory Provisions. The use of policy measures by the monetary authorities in realising the broad economic objectives may have institutional restrictions due to tradition and/or statutory-legal rules and regulations governing the banking system of the country.
  33. 33.  Conflicting Objectives. When two or more objectives are of a conflicting nature, the monetary authorities have to reconcile them and while doing so a particular goal may be pursued, price stability is to be sacrificed to some extent.  Dichotomy of Monetary Market. As in the case of under-developed countries, when there is dichotomy of money market in the composition of money supply also serves as a limiting factor to the scope of monetary policy. In most of the under-developed nations, money supply preliminary consists of currency in circulation while bank deposits form relatively a small proportion of it. Lack of banking habits on the part of the people in poor countries makes it difficult for the monetary authority to influence the economy by controlling the banking system.  Existence of Non-monetised Sector. The existence of a significant non-monetised sector tends to restrict the scope and limits the effectiveness of monetary policy and its measures, as is the case with many under-developed countries.  No Direct Influence on Strategic Growth Variables. Monetary policy deals with the monetary factors like money supply, credit, rate of interest, etc. But, it cannot directly affect the rate of profit,
  34. 34. investment function, savings, capital formation etc. Which are strategic growth variables.  Depression Phase. Monetary policy is not very effective in overcoming depression. It is generally conceived that monetary policy is more effective in checking economic activity than in stimulating it. In other words, monetary policy is more effective in checking boom conditions than in generating recovery from recession or depression. In terms of depression or stagnation, the monetary authority can do very little. It cannot enforce investment merely by following an easy money policy or credit expansion as such. It control the money rate of interest to some extent but not the rate of profit which may be a very low or even in a negative quantity during a depression. Investment generally seems to be interest inelastic. The interest inelasticity of investment can be explained on two counts: (i) interest represents a minor element of total costs in short-term investment, (ii) in making long-term investment, business expectation and other economic variables are far more important than the influence of interest rates. Thus, when there is an overall pessimism prevailing in the economy and the marginal efficiency of capital is very low, mere monetary expansion by the monetary authority cannot do anything substantial. Moreover, there is no
  35. 35. direct relationship between the quantity of money and the price level as was traditionally assumed. There are many other factors affecting prices and business activity as powerfully as the money supply. Most of them being non-monetary nature, cannot be control by monetary action alone. Depression needs action to revise effective demand by raising the consumption and marginal efficiency of capital through public investment programmes and such other measures. Hence, a fiscal policy was advocated as a powerful weapon for offsetting and checking depression and unemployment. Only in times of prosperity can monetary policy be used effectively, as it can control speculative boom and inflation by regulating undue credit expansion.  General Liquidity. Most of the economists, today, however, feel that central bank’s management of stock of money alone is totally inadequate in pursuing goals like curbing of inflation through effective checks on spendings. In a modern economy, the capacity to spend and a propensity to consumer basically determined by the liquidity position rather than just the quantity of money. Thus, what is wanted is influence the general liquidity structure of the economy as a whole. In modern economy, the decision to spend depends on a host of factors like: • Cash balance • Bank balance • withdrawal of time and saving deposit, • selling of financial assets held and • borrowing possibilities
  36. 36. Thus, as the Radcliffe Report put, “the spending is not limited by the amount of money in existence, but it is related to the amount of money people think they can get hold of whether by receipts of income, by disposal of capital assets or by borrowing”. Major Issues of Indian Monetary Policy in Retrospect and Prospect Monetary policy in Indian has to designed and pursued in the context of planning in the mixed economy where the main object is to accelerate the process of economic growth with stability and social justice.  The Policy Stances 1. The monetary policy stances during the course of planning in India (1951- 1987) may be stated as follows. 2. During the First Fiver-Year Plan period (1951-56), the role of monetary policy was confined to the allocation of resources in conformity with the plan objectives. Initially in 1951, to contain inflationary pressures, the RBI raised the bank rate from 3 percent to 3.5 per cent in November 1951. 3. During the Second Plan period (1956-61), the policy was more or less anti- inflationary. The bank rate was raised further to 4 per cent in May 1957 and the selective credit control scheme was introduced in May 1956. 4. During the Period of Third Plan (1961-66) and Annual Plans(1966-69), the RBI adopted a credit policy of restraint. It raised the bank rate further to 4.5 percent in January 1963, to 5.0 per cent in October 1964 and again to 6.0 percent in March 1965. The Credit Authorisation Scheme was introduced. In 1964, a system of differential interest rates (CDIR) was also introduce. The SLR was raised from 20 per cent to 25 per cent.
  37. 37. In 1969, the Government of India nationalized the major commercial banks, thereby bringing nearly 85 percent of the banking activity in the hands of the public sector. 1. During the Fourth Plan (1969-74) period, the restrictive credit control measures were adopted very sharply. The Net Liquidity Ratio (NLR) was stipulated from 31 per cent to 34 per cent between April 1970 and January 1971. The SLR was enhanced to 30 per cent and NLR further to 37 per cent by March 1973. The Bank rate was raised to 7 per cent and CRR to 5 percent in May 1973. In September 1973, CRR was raised to 7 percent. 2. During the Fifth Plan (1974-79) period, the policy had remained basically anti-inflationary. 3. During the Sixth Plan period (1980-85), efforts have been continuously directed towards containing the inflationary pressures. In 1981-82, the SLR was raised from 34 per cent. It was further raised to 36 percent in September 1984 and again to 37 percent in July 1985. The selective credit controls were rationalized and simplified.  Important Observations Reviewing the course of monetary policy in India, we may make a few observations as under: (a) The Reserve Bank of India tried to use a number of traditional as well as non-traditional monetary measures in the course of its monetary management.
  38. 38. (b) However, all the instruments of credit have not been boldly and adequately used for achieving the goal of price and economic stability. (c) By and large, the monetary policy in India has remained anti-inflationary, but without much success in achieving its goal. As an anti-inflationary device, however, the monetary policy in India has not only acted through the availability of credit but has also adjusted the cost of credit upwards, from time to time. (d) As Dr. Rangarajan, the Deputy Governor of the RBI, observes, during the last 35 years, monetary policy measures in India have generally been a response to fiscal policy and action. The monetary policy has been essentially direct towards facilitating Government finance and public debt management. (e) In the seventies and eighties, the RBI’s monetary policy concentrated more on the distributional aspect rather than on the level of total credit in the banking system. The scope of monetary policy has, therefore, been extended from a mere regulation of money supply to the distribution of credit in favour of priority sectors. (f) Recently, the Chakravarty Committee has recommended a scheme of flexible monetary targeting as a device for the regulation of money supply in the economy. (g) Monetary policy alone cannot deliver the goods in a planned economy like that of India. There is an urgent for a healthy and pragmatic co-ordination between monetary and fiscal policies in the context of economic planning of the country.
  39. 39. Instruments of Monetary Policy  Bank Rate Bank rate is the rate which the Reserve Bank of India rediscounts certain defined bills. The Bank Rate Policy has been defined as ‘the varying of the terms and of the conditions, in the broadest sense, under which the market may have temporary accesses to the central bank through discounts of selected short term assets or through secured advances. At the very outset it may be pointed out that the Bank Rate Policy has not been very successful in the past, as from its very inception the Bank had to maintain a cheep monetary policy under which the Bank Rate was maintained constantly at 3 per cent. The announcement of the Bank in1951 increasing the Bank Rate to 3 and half percent marks an important turning point in the bank rate policy hitherto followed by the Bank. The Bank announced that it would refrain from purchasing Government securities to meet the seasonal requirements of scheduled banks but would, as a normal practice, advance money at the prevailing Bank Rate on Government and other securities specified in the Reserve Bank of India Act. This was definitely a new step in the monetary policy pursued by the Bank till 1951. these measures had the immediate effect of making credit dearer. There was a general increase in the market rates also. The Bank Rate was further increased to 4 percent with effect from May 1957. As in the previous change, the market rates responded to this
  40. 40. change. Thus, after a long period of cheap monetary policy, the Bank assumed a ‘flexible interest rate’ policy in the realm of monetary policy, acquiring thereby a greater measure of control over the banking system than it had ever before.  Open Market Operations (i) Open market operations have a direct effect on the availability and cost of credit. The open market operations policy has two dimensions: (ii) it directly increases or decreases the loanable funds or the credit- creating capacity of banks; and (iii) It leads to changes in the prices of government securities and the term structure of interest rates. The Trend of the OMO of the Reserve Bank of India However, in view of the underdeveloped security market in India, the Reserve Bank of India has rarely used OMO as a sharp weapon of credit control. In Year Net Purchased ( ) Or Sales(- ) (Rs, in Crores) Year Net Purchased ( ) Or Sales( - ) (Rs. In Crores) 1951-52 11.82 1960-61 - 6.52 1952-53 - 1.20 1961-62 0.81 1953-54 -22.14 1962-63 -11.00 1954-55 -28.00 1963-64 -44.70 1955-56 -15.95 1964-65 -98.60 1956-57 19.17 1965-66 -18.80 1957-58 -65.22 1966-67 -44.40 1958-59 -88.95 1967-68 -38.20 1959-60 -60.33 1968-69 -53.40 1988-89 -136.50
  41. 41. 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 if credit. An account of the open market operations of the Reserve Bank of India has been presented above table. It can be seen that, except for the year 1951-52 and 1961-62, in the other years, the Reserve bank operated with the selling expect of the OMO policy with a view to checking the lendable resources of commercial banks.  Cash Reserve Ratios According to the RBI Act of 1934, scheduled commercial banks were required to keep with the Reserve Bank of India a minimum cash reserve of 5 percent of time liabilities. The Amendment Act of 9556 empowered the Reserve Bank of India to use these reserve requirement ratios as a weapon of credit control, by warring them between 5 and 20 percent on the demand liabilities and between 2 and 8 percent on the time liabilities. This variability in Cash Reserve Ratios (CRR) directly affects the availability and cost of credit. An increase in CRR leads to an immediate curb on the excess funds of the banks. When banks credit volume decreases, their profit quantum also decreases. To maintain the same total profits, a decrease in profitability is to be compensated by raising threatening rate. Eventually, when the bank’s lending rates are raised, the cost of credit increases. Since September 1964, the reserve requirement ratio has been kept at 3 percent by the RBI for all scheduled and non-scheduled commercial banks against their demand and time liabilities. Since August 1966, scheduled cooperative banks also have to maintain the same CRR, while non-scheduled state cooperative banks
  42. 42. have to keep 2.5 percent of their demand liabilities and 1 percent of the time liabilities.  Money Supply (M3) This refers to the total volume of money circulating in the economy, and conventionally comprises currency with the public and demand deposits (current account + savings account) with the public. The RBI has adopted four concepts of measuring money supply. The first one is M1, which equals the sum of currency with the public, demand deposits with the public and other deposits with the public. Simply put M1 includes all coins and notes in circulation, and personal current accounts. The second, M2, is a measure of money, supply, including M1, plus personal deposit accounts - plus government deposits and deposits in currencies other than rupee. The third concept M3 or the broad money concept, as it is also known, is quite popular. M3 includes net time deposits (fixed deposits), savings deposits with post office saving banks and all the components of M1. o Debt instruments Debt instruments are basically obligations undertaken by the issuer of the instrument as regards certain future cash flows representing interest and principal, which the issuer would pay to the legal owner of the instrument. Different kinds of debt instruments are discussed below: Money market instruments: By convention, the term “money market” refers to the market for short-term requirement and deployment of funds. Money market instruments are those instruments, which have maturity
  43. 43. period of less than one year. Money market instruments is their high liquidity and tradability. Treasury Bills (T-Bills): These are issued by the Reserve Bank of India on behalf of the Government of India are thus actually a class of Government Securities. At present T-Bills are issued in maturity of 14 days, 91 days and 364 days. The RBI has announced its intention to start issuing 182 days T- Bills shortly. Government of India Securities: Government of India Securities is issued by the reserve Bank of India on behalf of the Government of India. These form a part of the borrowing program approve by Parliament in the Finance Bill each year (Union Budget). Most of the securities issued have been in the 5-10 year maturity bucket. Very recently, securities of 15 and 20 years maturity have been issued.
  44. 44. A Capsule of Monetary policy and Credit Control Measures 1994-95 • Cash Reserve Ratio(CRR) raised in three phases from 14 to 15 percent between June and August 1994. • Cash Reserve Ratio of 15 percent introduced in two phases on Foreign currency Non-residents Accounts scheme (Banks) and CRR of 7.5% imposed on Non-Resident Non-Repatriable Rupee Deposit (NRNR) scheme. • The base for determining the export credit (Rupee) refinance limit shifted by a year and eligibility percentage reduced from 90 to 80% for post-shipment credit denominated in US dollar. • Minimum margin on bank advances against pulses, all seeds, vegetable oil, cotton and kapas raised by 15% points and level of credit ceiling reduced by 15 percentage points. • The maximum term deposit rate on Non- Resident (external ) rupee accounts reduced by one percentage point and minimum maturity for new deposit raised to six months. • Banks allowed to hold shares (including PSU equity) or debentures within overall ceiling of 5 percent incremental deposit of the previous year. • General Line of Credit from RBI to NABARD for seasonal agricultural operations raised to Rs.4,100 corer from Rs.3,700 corer.
  45. 45. • Scope of priority advances extended to include (a) net funds provided by sponsor banks to RRBs (b) advances up to Rs.5 lakh for distribution of inputs for agricultural and allied activities and (c) advance granted to a qualified medical practitioner for purchase of one motor vehicle. • Domestic savings deposit interest rate reduced from 5.0 percent annum to 4.5 percent annum. • Saving deposit rate reduced from 5.0 percent to 4.5 percent per annum for Non- Resident( External) Rupee Accounts. The maximum term deposit rates for NRE accounts for maturity of 6 months to 3 years and above reduced from 10.0 percent to 8.0 percent from October 1994. • Bank advances against paddy/rice to all borrowers exempted from all the provisions of selective credit controls. • Banks directed to maintain on first 13 days a minimum level of 85 percent of the required fortnightly average CRR balances. On the 14th of the reporting fortnight banks will be allowed to maintain less than 85 percent so as to adjust the average of daily balances to the required level. • The facility of stand-by arrangement against commercial paper(CP) was abolished. After issuance of CP, if the issuer wish to revive the earlier level of credit limit, it would have to approach the bank for enhancement afresh.
  46. 46. • Bank advised to extend cash credit facility to farmers with irrigation facilities and also to other farmers undertakings off farm/allied activities. • The ceilings of Rs. 50 crore for each bank abolished and the limit of Rs. 200 crore for finance the banking system as of whole raise to Rs. 500 crore, for any project. • Banks allowed to provider lines of credit/term loans to State Industrial Development/ Financial Corporation as part of priority sector lending. • The ceiling on direct individual housing loans raised to Rs.3 lakh to Rs.10 lakh, and the proportion of investment by way of purchase of bonds of recognized housing finance institutions raised from 40 per cent to 50 per cent. • Banks given the freedom to determine their own policy on margins for loans granted against deposits. • Sub-suppliers of export orders to be provided credit within the overall permissible pre-shipment export credit.
  47. 47. Highlights of Monetary and Credit Policy The message in the Reserved Bank of India’s annual monetary policy statement is “focus on continuity”. The major highlights of the Monetary and Credit policy are as under: Monetary Policy: • The reverse repo rate has increased by 25 basis points to 5% and spread between reverse repo rates and repo rates has reduced to 100 basis points from 125 basis points earlier. This is effective from 29th April, 2005. • Bank rate unchanged at 6%. • Cash reserve ratio remain unchanged at 5%. • GDP growth projection for 2005-06 at 7% Real GDP growth projected at 7% on the back of 3% growth in agriculture under assumption of normal monsoons. Industry and services sector expected to maintain their current growth momentum while absorbing the impact of oil prices. • RBI proposed to shift to quarterly guidance (in January, April, July and October) from biannual guidance (in April and October, next review in July 2005). This will ensure that there is better and structured communication to the market on RBI’s perception of the changing domestic and global environment and the likely impact of these in the near term.
  48. 48. Credit Policy : • Per borrower limit of post harvest / produce pledge loan for agriculture increased to Rs.10 Lakh from Rs.5 Lakh under priority sector. • Emphasis on credit flow to small scale and medium scale industries. • Overseas investment by corporates in their joint venture s and subsidiaries increased to 200% of their net worth. • Reduction in the minimum maturity period for certificate of deposits (CDs) from 15 days to 7 days. • Standardization of settlement in gilt trading to T +1 system. • Banks and primary dealers (PDs) permitted to sell stock on the same day of auction. • Introduction of electronic trading platform for repo operations in government securities. • With effect from 6th August, non bank participants except PDs, go out of the call/notice money market. • Inflation rate for 2005-06 projected at 5 to 5.5% on account of upward pressure in international oil and primary commodity prices, credit growth and non pass through of international oil prices to domestic prices. Positive cushion expected from an increase in sectoral productivity, level of food stocks and forex reserves. • M3 growth projected at 14.5.% in 2005-06.
  49. 49. Current scenario Macroeconomic Background: The Reserve Bank of India (RBI) announced the first Quarterly Review of the Monetary Policy for 2007-08 on 31stJuly, 2007. The policy was prepared under the backdrop of an economic scenario which has the elements of high growth combined with higher inflationary pressure. The Review of the Macroeconomic and Monetary Developments for the First Quarter (April-June) of 2007-08 indicates that overall the Indian economy is in a healthy position. The highlights of the Review are as follows. • The Revised estimates of CSO put the real GDP growth of the economy at 9.4% in 2006-07 as against 9% in 2005-06. Service sector which accounts for over 60% of the total growth has been posting a sustained double-digit growth in the past three years. Similarly, the industry which accounts for nearly 1/5 of the economic growth has posted 11% growth in 2006-07 as against 8.0% in 2005-06. Agriculture and allied activities which contributed 18.5% of the total growth in 2006-07 increased by 2.7% as compared to 6% in 2005-06. • The current year has witnessed above normal rain fall (up to July 25) implying a better performance of the agriculture/rural sector. The first two months of the current fiscal have seen industry growing at 11.7% and particularly the manufacturing segment registering a growth of 12.7%. Similarly, infrastructure (electricity, coal, finished steel, crude petroleum, petroleum refinery products, cement) sector recorded a growth of
  50. 50. 8.1% during the same period as against 7.2% in the corresponding period of the last year. • On the fiscal front, all the key deficit indicators of the Central Government finances were lower than a year ago mainly due to higher tax revenue collection, higher non-debt capital receipts and lower plan expenditure. • Monetary sector indicates that as on 6th July 2007, the year-on-year growth in broad-money (M3) continues to be higher at 21.6% as compared to 19% in the previous year. Liquidity conditions in the economy continued to be influenced by the movements in capital flows and cash balances of the Government. • On the price front the Wholesale Price Index (WPI) initially rose to above 6 % in April 2007 but eased to 4.4 % by July 14,2007.Consumer price inflation also eased to 6.1-7.5 % by June 2007,though it remained high reflecting the impact of higher food prices. • The external economy portrays a robust scenario with the country attracting FDI inflows worth $1.6bn in April 2007 as against $0.7bn. last year. Up to July 13 of the current year the FIIs have brought in $8bn. against an outflow of $2bn in the corresponding period of 2006-07. As on 20th July 2007 total forex.
  51. 51. Reserve Bank of India
  52. 52. VISIT IN CENTRAL BANK I had visited in Central Bank and got some information on debt instruments in monetary policy from Manager B.J. BHAVSAR. Debt instruments are basically obligations undertaken by the issuer of the instrument as regards certain future cash flows representing interest and principal, which the issuer would pay to the legal owner of the instrument. Different kinds of debt instruments are discussed below: • Money market instruments: By convention, the term “money market” refers to the market for short-term requirement and deployment of funds. Money market instruments are those instruments, which have maturity period of less than one year. Money market instruments is their high liquidity and tradability. • Treasury Bills (T-Bills): These are issued by the Reserve Bank of India on behalf of the Government of India are thus actually a class of Government Securities. At present T-Bills are issued in maturity of 14 days, 91 days and 364 days. The RBI has announced its intention to start issuing 182 days T-Bills shortly. • Government of India Securities: Government of India Securities is issued by the reserve Bank of India on behalf of the Government of India. These form a part of the borrowing program approve by Parliament in the Finance Bill each year (Union Budget). Most of the securities issued have been in the 5-10 year maturity bucket. Very recently, securities of 15 and 20 years maturity have been issued.
  53. 53. CONCLUSION The Monetary Policy is to maintain price stability and ensure adequate flow of credit to the productive sectors of the economy. The monetary policy affects the real sector through long and variable periods while the financial markets are also impacted through short-term implications. Monetary and policy as part of financial sector reforms, a number of steps have been taken to enhance the effectiveness of monetary policy, and these include, improvement in the payments and settlement systems, development of secondary market in government securities with a diversification of investor base, reduction in non-performing assets, introduction of ALM guidelines, and reduction in the overall transactions costs. In particular, the recent initiatives of RBI to develop money market and debt markets should contribute to improving the transmission mechanisms of monetary policy. Monetary policy can also help in correcting the economic ills of the economy such as inflation or deflation.

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