Monetary Policy

• Presented By:• Rashmi Vaishya 14• Sunil Shinde 15

MONETARY POLICY

Regulation of supply of Money and Cost and Availability of Credit in the economy

Variables affected by Monetary Policy in the economy

Interest RatesLiquidityCredit AvailabilityExchange Rates

Purpose of Monetary Policy

Maintain price stability, ensure adequate flow of credit to the productive sectors of the economy and overall economic growth

FISCAL POLICY

Use of “Government Expenditure”, and “taxation” to manage the economy.

Variables affected by Fiscal Policy in the economy

Aggregate demand and the level of economic activity The pattern of resource allocationThe distribution of income.

Purpose of Fiscal Policy Stabilise economic growth, avoiding the boom and bust economic cycle

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.

What are the objectives of the Monetary Policy?

• Maximum feasible output.• High rate of growth.• Fuller employment.• Price stability.• Greater equality in the distribution of

income and wealth.• Healthy balance in balance of

payments(BOP)• ensure adequate flow of credit to the

productive sectors of the economy.

How is the Monetary Policy different from the Fiscal Policy?

MONETARY POLICY FISCAL POLICY

•regulates the supply of money•regulates the cost and availability of credit in the economy•deals with both the lending and borrowing rates of interest for commercial banks•aims to maintain price stability, full employment and economic growth.

•defined as a deliberate change in government revenue and expenditure to influence the level of national output and prices•broader tool with the government •used to overcome recession and control inflation

MONETARY POLICY – RBI’s ROLE

Demand for Money

Demand for goods/services

Control on bank credit when prices rise/fall

Ensuring price stability and ensuring savings

Control on money supply, velocity of circulation of money during inflation

Instruments such as CRR, OMO & Bank Rate

TYPES OF MONETARY POLICY

Quantitative measures

Qualitative Measures

• Bank rate• Open market

operations• Cash reserve ratio

(CRR)• Statutory liquidity

ratio (SLR)

• Rationing of credit• Moral Suasion• Direct Action• Regulation in

consumer credit• Marginal standing

facility(MSF)

How does monetary policy affect inflation and other problems???

http://www.rgemonitor.com/emergingmarkets-monitor/archive/200806/

Uncontrolled Inflation despite Further CRR hikes

CRR hikes proved to Be effective

To curb Inflation

Inflation Down on account of global credit crunch

Inflation Movement

BANK RATE POLICY

• Bank rate is the minimum rate at which the central bank provides loans to the commercial banks. It is also called the discount rate.

• The bank rate has been increased from

12.00% in 1991 8.75% in 2013 9.00% in

2014

Dear money policy

Bank rate

interest rate

borrowing will be less profitable

results contraction of credit

Near money policy

Bank rate

interest rate

borrowing will be more profitable

results expansion of credit

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

• When RBI offers securities for sale, it intends to contract money supply and credit.

• When the RBI is pursuing the expansionary monetary policy will buy securities in the market, so that supply and credit capacity will be increased.

OMO’s TOOLREPO RATE REVERSE REPO

RATE

Repo rate is the rate at which RBI

lends to commercial banks generally against

government securities

Reverse Repo rate is the rate at which

RBI borrows money from the

commercial banks

tightening of the policy

The repo rate is 8.00 %

The reverse repo rate is 7.00%.

20002002

20042006

20080

2

4

6

8

10

12

Reverse Repo rate

Repo rate reduction due to make credit available at cheaper rates

Repo and Reverse Repo rates Movement

Increased rates to control the liquidity

CASH RESERVE RATIO

• CRR, or cash reserve ratio, refers to a portion of deposits (as cash) which banks have to keep/maintain with the RBI.

• During Inflation RBI increases the CRR due to which commercial banks have to keep a greater portion of their deposits with the RBI .

• Higher the CRR with the RBI lower will be the liquidity in the system and vice-versa.

• This serves two purposes. – ensures that a portion of bank deposits is

totally risk-free and– enables that RBI control liquidity in the system,

and thereby, inflation• As of today, the CRR is 4%

Change in CRR… why?

It has been decided to reduce the minimum daily maintenance of

CRR from 99 % 95 % effective

from the fortnight beginning September

21, 2013, while keeping the CRR

unchanged at 4.0 %

This reduction (in CRR from 5.5 per cent to

4.75 per cent) injected around Rs 48,000crore

of primary liquidity into the banking

system. (Rs 16000crores for every 25 basis points

cut in CRR)

In the third quarter review of January 2012 CRR was reduced, to mitigate tight liquidity conditions, by 50 basis points leading to

increase in liquidity by Rs.480 billion into the banking system.

CRR Movement

Before 1991•Government raised funds below market rate

•No depth in Government Securities Market

•Regulation of deposit rates

•Under developed financial markets, Less financial instruments availability

Result•Complex, distorted interest rate structure

•Adversely affected viability and profitability of banks

•Transparency and norms could not be followed strictly

Boost Economy after 2001 Slowdown /

dotcom bubble

Stable CRR from 2004 to 2006

Rise in CRR to control liquidity, due to Heavy Capital Inflow &

to curb Re Appreciation

CRR hikes to curb inflation

CRR Cuts to boost economy after

Sub prime loss / Global meltdown

CRR Movement

STATUTORY LIQUID RATIO

• Every financial institution has to maintain/invest a certain quantity of liquid assets with themselves at any point of time of their total time and demand liabilities before providing credits to its customer.

• These assets can be cash, precious metals, approved securities like bonds etc. The current SLR is 23%.

Stable SLR from 1998 onwards

SLR Movement

Banks to made available more funds& More Efficiency

MARGIN STANDING FACILITY

• MSF scheme is that in MSF banks can use the securities under SLR to get loans from RBI

• During Inflation RBI fixes a high rate of margin on the securities kept by the public for loans

• If the margin increases the commercial banks will give less amount of credit on the securities kept by the public thereby controlling inflation

• MSF rate is 1% more than repo rate.

DEFICIT FINANCING

• It means printing of new currency notes by RBI• If more new notes are printed it will increase

the supply of money thereby increasing demand and prices

• Thus during Inflation, RBI will – stop printing new currency notes thereby controlling

inflation.– issue new currency notes replacing many old notes

• This will reduce the supply of money in the economy

LIQUIDITY ADJUSTMENT FACILITY

• LAF consists of daily infusion or absorption of liquidity on a repurchase basis, through repo (liquidity injection) and reverse repo (liquidity absorption)auction operations, using government securities as collateral

• The increase in the policy repo rate under the liquidity adjustment facility (LAF) by 25 basis points from 7.25 % 7.5 %

LAF - To Control Exchange Ratio – Outflow of $ from India Market

Sterilization to Control rupeeAppreciation

EXCHANGE RATE MOVEMENT

The Surge in Foreign Exchange Reserves

Sterilization / Selling bonds & Buying dollars

FOREX RESERVES POSITION

•Inflation refers to a persistent rise in pricesInflation•Total volume of money circulating in the economyMoney Supply•Minimum rate at which the central bank provides loans to commercial banksBank Rate•Amount of money that banks must set aside with RBI against their depositsCash Reserve Ratio (CRR)

•Percentage of bank funds to be maintained in government and approved securitiesStatutory Liquidity Ratio (SLR)

•Rate at which RBI lends to other banks against government securitiesRepo Rate•Rate at which RBI borrows from other banksReverse Repo Rate

•Capacity of bank meeting the time liabilities and other riskCapital Adequacy Ratio (CAR)

•Purchase and sale of securities in the open marketOpen Market Operations (OMO)

MONETARY POLICY – TERMINOLOGY

Target Variables

-Inflation

-Interest rate

-Real GDP

-Employment

-Consumption

-Savings

-Investment

Policy Variables

- Money supply

- OMO: Liquidity conditions

- policy rates (CRR, repo etc.)

Monetary Policy – Influence

FACTORS AFFECTING MONETARY POLICY

There exist a non-monetized sectorExcess of non-banking financial institutions (NBFI)Existence of unorganized financial

marketMoney not appearing in an economyTime lag affects success of monetary

policyMonetary policy and fiscal policy lacks

coordination

Money and credit market

Local Institutions

Domestic Banks

Domestic MFs

NBFC

$ReRe.

Financial Channel

IMPACT ON INDIA

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Monetary Policy

Fiscal Policy Growth amidGlobal economic slowdown

DeflationRe.

CHALLENGES FOR RBI

Cannot simultaneously stimulate economic demand to reduce unemployment and restrain demand to combat inflation

Monetary policy is restricted by the impact of other government actions, especially Fiscal policy, i.e. decisions about government expenditures and taxation

Problems of an inflexible labour market, inadequate infrastructure and, most important, fiscal policy whose discipline is open to question limits the effectiveness of the Monetary policy

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Monetary Policy cannot work in isolation!!

LIMITATIONS – MONETARY POLICY

Bank

Rate

Infl

atio

nO

WO

CRR/SLR

Monetary

policyM

SF

THANKYOU..!