RBI works as the monetary authority of India and there by operates the monetary policy. Reserve Bank of India announces Monetary Policy every year in the Month of April. This is followed by three quarterly Reviews in July, October and January. But, RBI at its discretion can announce the measures at any point of time. The Annual Monetary Policy is made up of two parts viz. Part A: macroeconomic and monetary developments; Part B: Actions taken and fresh policy measures. Monetary policy of the RBI deals with almost all other vital topics such as financial stability, financial markets, interest rates, credit delivery, regulatory norms, financial inclusion and institutional developments etc.
Objectives of the monetary policy
Monetary policy refers to an umbrella of operations used for the control of money supply in the economy with broad objective to maintain economic and financial stability; and ensure adequate financial resources for the purpose of development.
These objectives of the monetary policy in India have gone through a process of gradual evolution and can be further expanded to maintaining price stability, adequate flow of credit to productive sectors, promotion of productive investments & trade, promotion of exports and economic growth.
Maintaining price stability
Using the monetary policy tools, RBI increases and reduced the money supply in the system in order to maintain price stability and check too much inflation.
Adequate flow of credit to productive sectors
RBI makes efforts for the controlled expansion of bank credit and helps commercial banks in credit creation. It also makes decisions regarding credit allocation to priority and marginal sector. The overall objective is to allow equitable distribution of credits to all sectors of economy and all segments of people.
Promotion of productive investments & trade
RBI tries to increase the productive investments in the country by retraining non-essential investments and creating an enabling environment for productive investments. These efforts lead to a boost in the efficiency of the financial system of the country.
Monetary Policy Stance
India had entered into the era of economic planning in 1951. At that time, the monetary and Fiscal Policies had to be adjusted to the requirements of the planned development in the country and accordingly, the economic policy of the Reserve Bank was emphasized on the following two major objectives.
- To speed up the economic development of the nation and raise the national income and standard of living of the people.
- Control and reduce the “Inflationary” pressure on the economy.
The requirement was an adequate financing of the economic growth programmes, and at the same time containing the inflationary pressure and maintenance of price stability. Thus this was a period of “Controlled Expansion“.
Since 1972, there is a rapid increase in the money supply with the public and banking system. The expansion of the Bank credit to trade and industry also increased. The early 1970s marked an era of serious inflationary situations. The frequent fluctuations in the agricultural productions, defective government polices and global inflationary pressures arising out of the oil prices etc. led the RBI to abandon the “controlled expansion” and adopt a policy that is most suitable for retraining the credits. This is called “tight monetary” policy and RBI has been successful with varying degree of success.
In summary, monetary policy stance is based upon the assessment of the macroeconomic and financial conditions and monetary measures.
Instruments of Monetary Policy
Various instruments of monetary policy of RBI can be divided into quantitative and qualitative instruments. They have been discussed below.
Quantitative Instruments of Monetary Policy
Various measures of monetary policy can be divided into quantitative measures and qualitative measures. The quantitative measures are Open Market Operations, Liquidity Adjustment Facility (Repo and Reverse Repo), Marginal Standing Facility, SLR, Bank Rate, Credit Ceiling etc.
Open Market Operations
In the case of excess liquidity, RBI resorts to sale of G-secs to suck out rupee from system. Similarly, when there is a liquidity crunch in the economy, RBI buys securities from the market, thereby releasing liquidity. read more.
Liquidity Adjustment Facility
RBI uses the weapons of Repo Rate and Reverse Repo Rate for injection or absorption of liquidity that is consistent with the prevailing monetary policy stance. The repo rate (at which liquidity is injected) and reverse repo rate (at which liquidity is absorbed) under the Liquidity Adjustment Facility (LAF) have emerged as the main instruments for the Reserve Bank’s interest rate signalling in the Indian economy. read more.
Marginal Standing Facility
To curb the problem of volatility in inter-bank interest rates in the overnight rate, banks are allowed to borrow more funds against G-secs as collateral from the RBI at a rate 100 basis points above the Repo Rate. This is known as Marginal Standing Facility. read more.
Statutory Liquidity Ratio
The banks and other financial institutions in India have to keep a fraction of their total net time and demand liabilities in the form of liquid assets such as G-secs, precious metals, approved securities etc. This fraction is called Statutory Liquidity Ratio (SLR). read more.
Bank Rate refers to the official interest rate at which RBI will provide loans to the banking system which includes commercial / cooperative banks, development banks etc. read more
Under the credit ceiling, RBI informs the banks to what extent / limit they would be getting credit. When RBI imposes a credit limit, the banks will get tight in advancing loans to public. Further, RBI may also direct the banks to provide certain fractions of their loans to certain sectors such as farm sector or priority sector.
Qualitative Measures of Monetary Policy
There are some qualitative measures also such as margin requirements, consumer credit regulation, guidelines, Moral suasion and direct action.
This refers to difference between the securities offered and and amount borrowed by the banks.
Consumer Credit Regulation
This refers to issuing rules regarding down payments and maximum maturities of instalment credit for purchase of goods.
RBI issues oral, written statements, appeals, guidelines, warnings etc. to the banks.
Rationing of credit
The RBI controls the Credit granted / allocated by commercial banks.
Moral Suasion refers to a request by the RBI to the commercial banks to take certain measures as per the trend of the economy. For example, RBI may ask banks to not to give out certain loans. It includes psychological means and informal means of selective credit control.
This step is taken by the RBI against banks that don’t fulfil conditions and requirements. RBI may refuse to rediscount their papers or may give excess credits or charge a penal rate of interest over and above the Bank rate, for credit demanded beyond a limit.