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Monetary policy

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  • 1. MONETARY POLICY
  • 2. About Monetary Policy ∫Monetary policy is the process by which monetary authority of a country, generally a central bank controls the supply of money in the economy by exercising its control over interest rates in order to maintain price stability and achieve high economic growth. ∫In India, the central monetary authority is the Reserve Bank of India (RBI). is so designed as to maintain the price stability in the economy.
  • 3. About Monetary Policy ∫The part of the economic policy which regulates the level of money in the economy in order to achieve certain objectives. ∫In INDIA,RBI controls the monetary policy. It is announced twice a year, through which RBI, regulate the price stability for the economy. 1. Slack Season policy April-September 2.Busy Season Policy October- March
  • 4. Importance of Monetary Policy ∫Gross National Product (GNP) = C + I + G + X Where: C = Private Consumption expenditure I = Private Investment Expenditure G = Government Expenditure X = Net Exports ∫C, I, X can be influenced by the monetary policy which can also influence the private consumption and investment spending and exports and imports.
  • 5. Objectives of Monetary Policy ∫Price Stability ∫Controlled Expansion Of Bank Credit ∫Promotion of Fixed Investment ∫Restriction of Inventories ∫Promotion of Exports and Food Procurement Operations ∫Desired Distribution of Credit ∫Equitable Distribution of Credit ∫To Promote Efficiency ∫Reducing the Rigidity
  • 6. Objectives of Monetary Policy ∫Price Stability: • Price Stability Price Stability implies promoting economic development with considerable emphasis on price stability. • The Centre of focus is to facilitate the environment which is favorable to the architecture that enables the developmental projects to run swiftly while also maintaining reasonable price stability.
  • 7. Objectives of Monetary Policy ∫Controlled Expansion Of Bank Credit: • One of the important functions of RBI is the controlled expansion of bank credit and money supply with special attention to seasonal requirement for credit without affecting the output. ∫Promotion of Fixed Investment: • The aim here is to increase the productivity of investment by restraining non essential fixed investment.
  • 8. Objectives of Monetary Policy ∫Restriction of Inventories: • Overfilling of stocks and products becoming outdated due to excess of stock often results is sickness of the unit. • To avoid this problem the central monetary authority carries out this essential function of restricting the inventories. • The main objective of this policy is to avoid over- stocking and idle money in the organization
  • 9. Objectives of Monetary Policy ∫Promotion of Exports and Food Procurement Operations: • Monetary policy pays special attention in order to boost exports and facilitate the trade. • It is an independent objective of monetary policy.
  • 10. Objectives of Monetary Policy ∫Desired Distribution of Credit : • Monetary authority has control over the decisions regarding the allocation of credit to priority sector and small borrowers. This policy decides over the specified percentage of credit that is to be allocated to priority sector and small borrowers. ∫Equitable Distribution of Credit: The policy of Reserve Bank aims equitable distribution to all sectors of the economy and all social and economic class of people.
  • 11. Objectives of Monetary Policy ∫To Promote Efficiency : • It is another essential aspect where the central banks pay a lot of attention. • It tries to increase the efficiency in the financial system and tries to incorporate structural changes such as deregulating interest rates, ease operational constraints in the credit delivery system, to introduce new money market instruments etc.
  • 12. Objectives of Monetary Policy ∫Reducing the Rigidity: • RBI tries to bring about the flexibilities in the operations which provide a considerable autonomy. • It encourages more competitive environment and diversification. • It maintains its control over financial system whenever and wherever necessary to maintain the discipline and prudence in operations of the financial system.
  • 13. Tools of Monetary Policy Quantitative Measures Select Credit Control Elements of Monetary Policy
  • 14. Tools of Monetary Policy/ Monetary Operations • Monetary operations involve monetary techniques which operate on monetary magnitudes such as money supply, interest rates and availability of credit aimed to maintain Price Stability, Stable exchange rate, Healthy Balance of Payment, Financial stability, Economic growth. • RBI, the apex institute of India which monitors and regulates the monetary policy of the country stabilizes the price by controlling Inflation. • RBI takes into account the following monetary policies.
  • 15. Tools of Monetary Policy Quantitative Measures Open Market Operation Cash Reserve Ratio Bank Rate Policy Statutory Liquidity Ratio
  • 16. Tools of Monetary Policy ƒ Open Market Operations:  An open market operation is an instrument of monetary policy which involves buying or selling of government securities from or to the public and banks.  This mechanism influences the reserve position of the banks, yield on government securities and cost of bank credit.  The RBI sells government securities to contract the flow of credit and buys government securities to increase credit flow.  Open market operation makes bank rate policy effective and maintains stability in government securities market.
  • 17. Tools of Monetary Policy ƒBank Rate Policy:  The bank rate, also known as the discount rate, is the rate of interest charged by the RBI for providing funds or loans to the banking system.  This banking system involves commercial and co- operative banks, Industrial Development Bank of India, IFC, EXIM Bank, and other approved financial institutes.  Funds are provided either through lending directly or rediscounting or buying money market instruments like commercial bills and treasury bills.
  • 18. Tools of Monetary Policy Increase in Bank Rate increases the cost of borrowing by commercial banks which results into the reduction in credit volume to the banks and hence declines the supply of money.  Increase in the bank rate is the symbol of tightening of RBI monetary policy. As of 1 January 2013, the bank rate was 8.75% and as on 29 October 2013 bank rate is 8.75%
  • 19. Tools of Monetary Policy
  • 20. Tools of Monetary Policy ƒCash Reserve Ratio:  Cash Reserve Ratio is a certain percentage of bank deposits which banks are required to keep with RBI in the form of reserves or balances .  Higher the CRR with the RBI lower will be the liquidity in the system and vice-versa.  RBI is empowered to vary CRR between 15 percent and 3 percent.
  • 21. Tools of Monetary Policy  But as per the suggestion by the Narshimam committee Report the CRR was reduced from 15% in the 1990 to 5 percent in 2002.  As of October 2013, the CRR is 4.00 percent.
  • 22. Tools of Monetary Policy
  • 23. Tools of Monetary Policy ƒStatutory Liquidity Ratio:  Every financial institution has to maintain a certain quantity of liquid assets with themselves at any point of time of their total time and demand liabilities.  These assets can be cash, precious metals, approved securities like bonds etc.  The ratio of the liquid assets to time and demand liabilities is termed as the Statutory liquidity ratio.  There was a reduction of SLR from 38.5% to 25% because of the suggestion by Narshimam Committee.  The current SLR is 23%.
  • 24. Tools of Monetary Policy
  • 25. Tools of Monetary Policy Selective Credit Control Credit Rationing Moral Suasion Direct Control Leading Margins
  • 26. Tools of Monetary Policy ƒCredit Rationing:  Under this method there is a maximum limit to loans and advances that can be made, which the commercial banks cannot exceed.  RBI fixes ceiling for specific categories. Such rationing is used for situations when credit flow is to be checked, particularly for speculative activities.  Minimum of”Capital:Total Assets" (ratio between capital and total asset) can also be prescribed by Reserve Bank of India
  • 27. Tools of Monetary Policy ƒLeading Margins/ Marginal Requirement:  Marginal Requirement of loan = current value of security offered for loan-value of loans granted.  The marginal requirement is increased for those business activities, the flow of whose credit is to be restricted in the economy.  e.g.- a person mortgages his property worth Rs. 1,00,000 against loan.
  • 28. Tools of Monetary Policy The bank will give loan of Rs. 80,000 only. The marginal requirement here is 20%. In case the flow of credit has to be increased, the marginal requirement will be lowered. RBI has been using this method since 1956.
  • 29. Tools of Monetary Policy ƒMoral Suasion:  This method is also known as “Moral Persuasion” as the method that the Reserve Bank of India, being the apex bank uses here, is that of persuading the commercial banks to follow its directions/orders on the flow of credit.  RBI puts a pressure on the commercial banks to put a ceiling on credit flow during inflation and be liberal in lending during deflation.
  • 30. Tools of Monetary Policy ƒDirect Action:  Under the banking regulation Act, the central bank has the authority to take strict action against any of the commercial banks that refuses to obey the directions given by Reserve Bank of India.  There can be a restriction on advancing of loans imposed by Reserve Bank of India on such banks. e.g. - RBI had put up certain restrictions on the working of the Metropolitan Co-operative Banks.  Also the ‘Bank of Karad’ had to come to an end in 1992.
  • 31. Limitation of Monetary Policy Time Gap Difficulty in Forecasting Non-Banking Financial Intermediaries Less Development of Money & Credit Market
  • 32. Limitation of Monetary Policy ƒTime Gap:  Refers to one of the major limitations of monetary policy.  It involves time taken in formulating & implementing monetary policy in an economy.  Time Lag increases, it would not only result in new types of economic problems, but make the whole monetary policy ineffective.
  • 33. Limitation of Monetary Policy ƒDifficulty in Forecasting:  Implies that monetary policy can be effective if there is proper analysis of economic problems for which the policy to be implemented should be assessed properly.  Forecasting economic conditions has always been a controversial issue.
  • 34. Limitation of Monetary Policy ƒNon-Banking Financial Intermediaries:  Refers to that the growth of financial market has decreased the scope of monetary policy.  With the emergence of non-banking financial intermediaries such as industrial development bank, insurance companies & mutual funds etc.  This new segment of the economy is responsible in grabbing the share of commercial banks.
  • 35. Limitation of Monetary Policy ƒLess Development of Money & Credit Market:  Acts as one of the important factors for ineffectiveness of monetary policy.  The effectiveness of monetary policy depends upon the efficiency of money & credit market  Therefore monetary policy in these countries has proved ineffective.