There are three broad contours of monetary policy stance. These are:To provide an appropriate interest rate environment to support growth as inflation risks moderateTo contain inflation and anchor inflation expectationsTo continue to manage liquidity to ensure adequate flow of credit to the productive sectors of the economy.
Bank Rateminimum rate at which the central bank provides loans to commercial banksAlso called the discount rate. An increase in bank rate results in commercial banks increasing their lending rates. Changes in bank rate alter the cost of creditCurrent Bank rate 6%Cash Reserve Ratio Certain amount of banks deposits in cash with RBI. This % is cash reserve ratioThe current CRR requirement is 5 per cent. Statutory Liquidity RatioBanks to maintain 24 per cent of their demand and time liabilities in government securities and certain approved securities called SLR securitiesBuying/Selling of securities laid to Harshad Mehta scam(1992)Reposecured short-term (usually 15 days) loan by one bank to another against government securities. The borrower sells the securities to the lending bank for cash, with the stipulation that at the end of the borrowing term, it will buy back the securities at a slightly higher price, the difference in price representing the interest.Current Repo Rate is 5%Reverse Reposame repurchase agreement(as Repo) from the buyer's viewpoint seller executing the transaction would describe it as a 'repo', while the buyer would describe it a 'reverse repo‘Current Reverse Repo rate is 3.5%CAR (Capital adequacy Ratio ):ratio of a bank's capital to its riskNational regulators track a bank's CAR to ensure banks can bear reasonable amount of loss and are complying with statutory Capital requirementscapacity of bank meeting the time liabilities and other risk Risk could be credit risk, operational risk, etcBank's capital is the "cushion" for potential losses, which protect the bank's depositors or other lendersBanking regulators in most countries define and monitor CAR to protect depositors, thereby maintaining confidence in the banking systemCAR is similar to leverageOpen Market Operationsimportant instrument of credit controlRBI purchases/sells securities in open market operations. During inflation, RBI sells securities to remove excess money in the market.During Deflation ,RBI purchases securitiesMoney Supply (M3)total volume of money circulating in the economycurrency with the public and demand deposits (current account + savings account) with the public. four concepts of measuring money supply:M1= currency with the public + demand deposits with the public + other deposits with the public. All coins and notes in circulation, and personal current accounts. M2= M1+ personal deposit accounts + government deposits + deposits in currencies other than rupee. M3= fixed deposits + savings deposits with post office + saving banks + M1Most Popular and known as Broad money conceptInflationInflation refers to a persistent rise in pricesToo much money and too few goodsScarcity of goods and many buyers, push the prices up Deflation is Converse of inflation persistent falling of prices. RBI can take two steps to reduce InflationReduce supply of money Increase interest rates
Monetary policy final...
Monetary Policy Anuradha Kumari (1204) Pankaj Agarwal (1215) Srijita Dutta (1220)National Academy of Agricultural Research Management
RBI It is the Central Bank of country. It was established in 1935 with a capital of Rs.5 crore. It was nationalised on january 1,1949. Functions of Reserve Bank-• Issue of Notes• Banker to the government• Banker’s Bank• Controller of Credit• Custodian of Foreign Reserves• others National Academy of Agricultural Research Management
Monetary Policy Regulation of supply of money and cost and availability of credit in the economyPurpose of Monetary Policy Maintain price stability, Higher rate of employment, ensure adequate flow of credit to the productive sectors of the economy and overall economic growth Variables affected by Monetary Policy in the economy Interest Rates Liquidity Credit Availability Exchange Rates National Academy of Agricultural Research Management
Monetary Policy – RBI’s roleDemand for Money Demand for goods/services Instruments such as Ensuring price CRR, OMO & Bank stability and Rate ensuring savings Control on money supply, velocity of Control on bank circulation of credit when money during prices rise/fall inflation National Academy of Agricultural Research Management
Monetary Policy Instruments Bank rate Cash Reserve Ratio Statutory Liquidity Ratio Repo rate Reverse Repo rate National Academy of Agricultural Research Management
Bank Rate Bank Rate is the rate at which RBI allows finance to commercial banks. Any upward revision in Bank Rate by central bank is an indication that banks should also increase deposit rates as well as Prime Lending Rate. Thus any revision in the Bank rate could mean more or less interest on deposits and also an increase or decrease in EMI. National Academy of Agricultural Research Management
CRR(Cash Reserve Ratio) CRR is the amount of Cash(liquid cash like gold) that the banks have to keep with RBI. This Ratio is basically to secure solvency of the bank and to drain out the excessive money from the banks. RBI uses CRR either to drain excess liquidity or to release funds needed for the economy from time to time. Increase in CRR means that banks have less funds available and money is sucked out of circulation. Thus we can say that this serves dual purposes i.e. it not only ensures that a portion of bank deposits is totally risk-free, but also enables RBI to control liquidity in the system, and thereby, inflation by tying the hands of the banks in lending money. National Academy of Agricultural Research Management
SLR(Statutory Liquidity Ratio) SLR is the minimum percentage of deposits a commercial bank needs to maintain in the form of cash, or gold or govt. approved securities (Bonds) before providing credit to its customers. SLR rate is determined and maintained by the RBI (Reserve Bank of India) in order to control the expansion of bank credit. Generally this mandatory ration is complied by investing in Govt bonds. In deficit Budgeting ,Govt. lending is more so they borrow money from banks by selling their bonds to banks. So banks have invested more than required percentage and use these excess bonds as collateral security ( over and above SLR )to avail short term Funds from the RBI at Repo rate. National Academy of Agricultural Research Management
Repo And Reverse Repo RateRepo Rate Reverse Repo Rate It is the rate at which the RBI It is the rate at which banks park lends shot-term money to the their short-term excess liquidity banks. When the repo rate with the RBI. The RBI uses this increases borrowing from RBI tool when it feels there is too becomes more expensive. much money floating in the Therefore, we can say that in banking system. case, RBI wants to make it more An increase in the reverse repo expensive for the banks to rate means that the RBI will borrow money, it increases the borrow money from the banks at repo rate; similarly, if it wants to a higher rate of interest. As a make it cheaper for banks to result, banks would prefer to borrow money, it reduces the keep their money with the RBI repo rate National Academy of Agricultural Research Management
Cu Current Rates Bank Rate • 8.5% CRR • 4.0 SLR • 23.0% Repo Rate • 7.5% Reverse Repo Rate • 6.5% Re/$ • 54.38 National Academy of Agricultural Research Management
Monetary Policy-Expansionary/Contractionary PolicyMonetary policy is the process by which the monetary authority of a countrycontrols the supply of money, often targeting a rate of interest to attain a set ofobjectives oriented towards the growth and stability of the economy.Monetary policy is referred to as either being an expansionary policy, ora Contarctionary policy. Expansionary policy increases the total supply of money in the economy rapidly. Expansionary policy is used to combat unemployment in a recession by lowering interest rates. Contarctionary policy decreases the total money supply, or increases it slowly. Contarctionary policy involves raising interest rates to combat inflation. National Academy of Agricultural Research Management
Expansionary Monetary Policy When the Open Market Committee wishes to increase the money supply, it can do a combination of three things: Purchase securities on the open market, known as Open Market Operations Lower the Discount Rate (Repo & Reverse Repo Rate) Lower Reserve Requirements (CRR & SLR) National Academy of Agricultural Research Management
Contd.. Expansionary monetary policy causes an increase in bond prices and a reduction in interest rates. Lower interest rates lead to higher levels of capital investment. The lower interest rates make domestic bonds less attractive, so the demand for domestic bonds falls and the demand for foreign bonds rises. The demand for domestic currency falls and the demand for foreign currency rises, causing a decrease in the exchange rate. (The value of the domestic currency is now lower relative to foreign currencies) A lower exchange rate causes exports to increase, imports to decrease and the balance of trade to increase. National Academy of Agricultural Research Management
Effects of Monetary Policy on Economy Erratic increase or decrease in prices of commodities or other items, if continued unabated for a substantial period, can be a source of imbalance in the economy. While framing monetary policies, the fundamental objective of central banks all over the world is to maintain price stability. Price stability is directly related to demand and supply of the products besides the available money supply. By using monetary policy tools, the central banks ensure that money supply is controlled in a manner such that the aim of sustainable economy is achieved.(Sustainable Economy=Maximum Employment+ Stable Prices+ Growth). . National Academy of Agricultural Research Management
Impact on Inflation SLR &CRR is maintained for bank solvency and higher ratio of SLR and CRR makes bank relatively safe as higher ratio means they have more of their funds deposited in liquid securities and can fulfill the demand on redemption of deposit from the Bank. When an economy grows too fast and there is too much growth, it can lead to inflation (more money in the market→ people consuming more→ higher prices→ inflation). If inflation is an imminent danger, central bank will hike interest rates so that there is decrease in money supply (if interest rates are hiked, people will save more and spend less so that they can get better returns on their investments). National Academy of Agricultural Research Management
Contd.. When RBI increases these ratios then money supply in market decreases and inflation falls. The Increase in CRR will squeeze money from market so less money will chase few things means less demand so it will reduce Inflation. National Academy of Agricultural Research Management
How rate hike affects inflation rate?17 Source:The RisksBank National Academy of Agricultural Research Management
Change in Repo rate impacts on Inflation Rate 9 9 8 77.5 6 Borrowing rate(repo 5 6 rate%) are nearly 3% 4 higher than two years 34.5 ago. 2 1 3 0 Reverse repo rate Provisional annual inflation rate based on all India general CPI (Combined) for February 2013 on point to point basis (February 2013 over February 2012) is 10.91% as compared to 10.79% (final) for the previous month of January 2013. National Academy of Agricultural Research Management
GDP growth and industrial production has fallen in last two years.National Academy of Agricultural Research Management
Impact on Interest rates of these ratios Interest rate are fixed on the demand supply situation of the amount available with person who want to lend and person who want to borrow. If demand is more and supply is less then interest rate rises up and if demand is less and supply is excessive then interest rate comes down. RBI increase these ratio(CRR & SLR) then available funds with the banks will go down and as demand remain the same then people will have to pay more as interest and interest rate will go up. & vice versa. So these rates have double impact :1. Direct effect is bank increase rate of lending so less money is available with people & vice-versa.2. Interest on deposit will be increased so less money will be available with the people & vice-versa. Some time region wise and seasonal or other factor also effect the decision of Interest rate. National Academy of Agricultural Research Management
Limitations – Monetary PolicyCannot simultaneously stimulate economic demand to reduce unemploymentand restrain demand to combat inflationMonetary policy is restricted by the impact of other governmentactions, especially Fiscal policy, i.e. decisions about government expendituresand taxationProblems of an inflexible labour market, inadequate infrastructure and, mostimportant, fiscal policy whose discipline is open to question limits theeffectiveness of the Monetary policy Monetary Policy cannot work in isolation!! National Academy of Agricultural Research Management
Mid-Quarter Monetary Policy Review:19th March 2013 Growth has decelerated significantly below trend through 2011-12 and 2012-13 so far and overall economic activity remains subdued. On the demand side, investment activity has been way below desired levels and consumption demand has started to decelerate. On the supply side, constraints in the availability of key raw materials and intermediates are becoming binding. In turn, this is being reflected in a widening of the CAD with adverse implications for external sustainability. While the monetary policy stance has sought to balance the growth- inflation dynamic through calibrated easing, it is critical now to arrest the loss of growth momentum without endangering external stability. The moderation in inflation conditions provides the opportunity for monetary policy to act in conjunction with fiscal and other measures to stem the growth risks. National Academy of Agricultural Research Management
Monetary Measures Taken Reduced the policy repo rate under the liquidity adjustment facility (LAF) by 25 basis points from 7.75 per cent to 7.5 per cent with immediate effect. Consequently, the reverse repo rate under the LAF stands adjusted to 6.5 per cent Bank Rate reduced to 8.5 per cent. CRR which was reduced by 25 basis point in Jan. to 4 per cent remains the same. Since the Reserve Bank’s Third Quarter Review (TQR) of January 2013, global financial market conditions have improved.
Monetary and Liquidity Conditions Money supply (M3) and bank credit growth have broadly moved in alignment with the revised indicative trajectories. With government cash balances with the Reserve Bank persisting at a higher than normal level, the liquidity deficit, as reflected by the net drawls by banks under the liquidity adjustment facility (LAF), has remained above the indicative comfort zone. The reduction in the cash reserve ratio (CRR) of banks by 25 basis points, effective from February 9 and open market purchases of `200 billion since February have enabled money market rates to remain anchored to the policy repo rate. The Reserve Bank will continue to actively manage liquidity through various instruments, including open market operations (OMO), so as to ensure adequate flow of credit to productive sectors of the economy. National Academy of Agricultural Research Management
Expected Outcomes It is expected that RBI policy actions and the guidance given, will result in the following three outcomes:1. Investment will be encouraged, thereby supporting growth2. Medium-term inflation expectations will remain anchored on the basis of a credible commitment to low and stable inflation3. There will be an improvement in liquidity conditions to support credit flow.Bankers indicated that they would cut lending and deposit rates over nextcouple of days to the benefit of borrowers, though depositors may get lesserreturns. The industry too appeared satisfied with the rate cut hoping that itwould boost demand and promote growth.* CRR cut to infuse Rs 18,000 crore in system which is effective from Feb9,2013. National Academy of Agricultural Research Management
Comments... Commenting on the policy action, Commerce and Industry Minister Anand Sharma said: "It is a positive step which will infuse liquidity and help in catalysing growth.“ Planning Commission Deputy Chairman Montek Singh Ahluwalia said the CRR cut will have impact on long term interest rates."I think this is the right thing to do at this point of time given that (the decline) in economy is beginning to bottom out," he said.
Outlook The foremost challenge for returning the economy to a high growth trajectory is to revive investment. A competitive interest rate is necessary for this, but not sufficient. Sufficiency conditions include bridging the supply constraints, staying the course on fiscal consolidation, both in terms of quantity and quality, and improving governance. National Academy of Agricultural Research Management
Source www.rbi.org.in http://www.simpletaxindia.net/2008/11/what-is-crrrepo-rateslr-how-it- effects.html#ixzz2P22kCYuK http://www.buzzle.com/articles/how-does-monetary-policy-affect- the-economic-growth.htm National Academy of Agricultural Research Management
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