MONETARY POLICY

Contents
 Introduction
 Objectives
 Scope
 Instruments of Monetary Policy
 Quantitative Measures
Qualitative Measures
 Controlling
Inflation
 Monetary Policy of India
 INTRODUCTION
•Monetary Policy is essentially a
programme of action undertaken by the
Monetary Authorities, generally the
Central Bank, to control and regulate the
supply of money with the public and the
flow of credit with a view to achieving
pre-determined macro-economics goals.

•At the time of inflation monetary policy

seeks to contract aggregate spending by
tightening the money supply or raising
the rate of return.
 Contents
 Introduction
 Objectives
 Scope
 Instruments of Monetary Policy
Quantitative Measures
Qualitative Measures
 Controlling
Inflation
 Monetary Policy of India
 OBJECTIVES

 To achieve price stability by controlling

inflation and deflation.

 To promote and encourage economic

growth in the economy.

 To ensure the economic stability at full

employment or potential level of output.
 Contents
 Introduction
 Objectives
 Scope
 Instruments of Monetary Policy
Quantitative Measures
Qualitative Measures
 Controlling
Inflation
 Monetary Policy of India
 SCOPE OF MONETARY POLICY
The scope of Monetary policy depends on
two factors

1. Level of Monetization of the Economy -

In this all economic transactions are carried out
with money as a medium of exchange . This is
done by changing the supply of and demand for
money and the general price level. It is capable
of affecting all economics activities such as
Production, Consumption, Savings, Investment
etc.

2. Level of Development of the Capital

Market
Some instrument of Monetary Policy are work
through capital market such as Cash Reserve
Ratio (CRR) etc. When capital market is fairly
developed then the Monetary Policy effects the
 Contents
 Introduction
 Objectives
 Scope
 Instruments of Monetary Policy
Quantitative Measures
Qualitative Measures
 Controlling
Inflation
 Monetary Policy of India
• The open market operations is sale and purchase of
government securities and Treasury Bills by the
central bank of the country.

• When the central bank decides to pump money into

circulation, it buys back the government securities,
bills and bonds.

• When it decides to reduce money in circulation it sells

the government bonds and securities.

• The central bank carries out its open market

operations through the commercial banks.
 Discount rate or bank rate is the rate at which
central bank rediscounts the bills of exchange
presented by the commercial bank.

 The central bank can change this rate increase

or decrease depending on whether it wants to
expand or reduce the flow of credit from the
commercial bank.
• A rise in the discount rate reduces the net worth
of the government bonds against which
commercial banks borrow funds from the central
bank. This reduces commercial banks capacity
to borrow from the central bank.

• When the central bank raises its discount rate,

commercial banks raise their discount rate too.
Rise in the discount rate raises the cost of bank
credit which discourages business firms to get
their bill of exchange discounted.
• The cash reserve ratio is the percentage of total
deposits which commercial banks are required to
maintain in the form of cash reserve with the central
bank.

• The objective of cash reserve is to prevent shortage of

cash for meeting the cash demand by the depositors.

• By changing the CRR, the central bank can change the

money supply overnight.

• When economic conditions demand a contractionary

monetary policy, the central bank raises the CRR. And
when economic conditions demand monetary
expansion ,the central bank cuts down the CRR.
• In India ,the RBI has imposed another reserve
requirement in addition to CRR. It is called
statutory liquidity requirement.

• The SLR is the proportion of the total deposits

which commercial banks are statutorily required
to maintain in the form of liquid assets in
addition to cash reserve ratio.
 Contents
 Introduction
 Objectives
 Scope
 Instruments of Monetary Policy
Quantitative Measures
Qualitative Measures
 Controlling
Inflation
 Monetary Policy of India
 When there is a shortage of institutional credit
available for the business sector, the large and
financially strong sectors or industries tend to capture
the lion’s share in the total institutional credit.
 As a result the priority sectors and essential industries
are of necessary funds.

Below two measures are generally adopted:

 Imposition of upper limits on the credit available to

large industries and firms

 Charging a higher or progressive interest rate on the

bank loans beyond a certain limit.

• The banks provide loans only up to a certain
percentage of the value of the mortgaged
property.

• The gap between the value of the mortgaged

property and amount advanced is called Lending
Margin.

• The central bank is empowered to increase the

lending margin with a view to decrease the bank
credit.
 The moral suasion is a method of persuading
and convincing the commercial banks to
advance credit in accordance with the directives
of the central bank in overall economic interest
of the country.

 Under this method the central bank writes letter

to hold meetings with the banks on money and
credit matters.
 Contents
 Introduction
 Objectives
 Scope
 Instruments of Monetary Policy
Quantitative Measures
Qualitative Measures
 Controlling
Inflation
 Monetary Policy in India
 An Expansionary Policy increases the total supply
of money in the economy while a Contractionary
Policy decreases the total money Supply into the
market.

 Expansionary policy is traditionally used to

combat a recession by lowering interests rates.

 Lowered interest rates means lower cost of credit

which induces people to borrow and spend
thereby providing steam to various industries
and kick start a slowing economy.
 A Contractionary Policy results in increasing
interest rates to combat inflation.
 An Economy growing in an uninhibited manner
leads to inflation
 Hence increasing interest rates increase the cost
of credit thereby making people borrow less.
 Due to lesser borrowing the amount of money in
the system reduces which in turn brings down
inflation.
 A Contractionary Policy is also known as TIGHT
POLICY as it tightens the flow of money in order
to contain Inflationary forces.
 The RBI makes an adjustment in its lending
rate(Repo Rates) in order to influence the cost
of credit. Thereby discouraging borrowing and
hence reduces brings reduction in the system.
 Whenever the liquid in the system increases, the
RBI intervenes to stabilize the system.
 The Central Bank does this by issuing fresh
bonds and treasury bills in open market. This
tool was extensively used at the time when
dollar inflows into our economy were very high,
resulting in rupee appreciatin. Inorder to
stabilize the exchange rates, RBI first bought
additional dollars thereby stabilizing the rate of
exchange.
 CRR-
 By increasing the CRR, the RBI decreases the
lending capacity of the bank to the extent of the
increase in the ratio.
 E.g of the CRR is increased from 7.5% to 8.5%
the banks were deprived of lending to the
extent of 75 basis points of their deposit value.
 CENTRAL BANK

CASH
SECURITIES AND BANK RATE CASH RESERVE STATUTORY
TRESURY BILLS
RATIO LIQUID RATIO

CRR
LE
INC ING
ND

SO

E IN
RE RA

LD
A S TE

%
S
REA
E

INC
COMMERCIAL BANKS

CORPORATES INDIVIDUALS
REDUCED BORROWING OF
LOANS REDUCE LIQUIDITY
IN MARKET
 Contents
 Introduction
 Objectives
 Scope
 Instruments of Monetary Policy
Quantitative Measures
Qualitative Measures
 Controlling
Inflation
 Monetary Policy of India
 Historically, the Monetary Policy is announced
twice a year April-September and (October-March).

 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.

 The Monetary policy determines the supply of

money in the economy and the rate of interest
charged by banks. The policy also contains an
economic overview and provides future forecasts.

 The Reserve Bank of India is responsible for

formulating and implementing Monetary Policy..
 The Monetary Policy aims to maintain price
stability, full employment and economic growth.

 Emphasis on these objectives have been changing

time to time depending on prevailing
circumstances.

 For explanation of monetary policy, the whole

period has been divided into 4 sub periods:
a) Monetary policy of controlled expansion (1951 to
1972)
b) Monetary Policy during Pre Reform period (1972
to 1991)
c) Monetary Policy in the Post-Reforms (1991 to
1996)
d) Easing of Monetary policy since Nov 1996
 Monetary policy of controlled expansion (1951 to 1972)
 To regulate the expansion of money supply and bank credit to
promote growth.
 To restrict the excessive supply of credit to the private sector
so as to control inflationary pressures.
Following steps were taken:
1) Changes in Bank Rate from 3% in 1951 to 6% in 1965 and it
remained the same till 1971.
2) Changes in SLR from 20% in 1956 to 28% in 1971

3) Select Credit Control: In order to reduce the credit or bank

loans against essential commodities, margin was increased.
As a result of the above changes, the supply of money increased
from 3.4% (1951 to 1956) to 9.1 (1961 to 1965).
 Monetary Policy during Pre Reform period (1972 to
1991):
Also known as the Tight Monetary policy: Price situation
worsened during 1972 to 1974.

Following Monetary Policy was adopted in 70’s and 80’s

which were mainly concerned with the task neutralizing
the impact of fiscal deficit and inflationary pressure.

1)Changes in CRR to the legally maximum limit of 25%

2)Changes in SLR also to the maximum limit to 38.5%
Monetary Policy in the Post-Reforms – 1991 to 1996:
The year 1991-1992 saw a fundamental change in the
institutional framework in setting the objective of
monetary policy. It had twin objectives which were Price
stability and economic growth. Following instruments
were used:
1) Continuing the same maximum CRR and SLR of 25%
and 38.5%, mopped up bank deposits to the extent of
63.5%.
2) In order to ensure profitability of banks, Monetary
Reforms Committee headed by late Prof. S Chakravarty,
recommended raising of interest rate on Government
Securities which activated Open Market Operations
(OMO).
3) Bank rate was raised from 10% in Apr 1991 to 12% in
Oct 1991 to control the inflationary pressures.
 Easing of Monetary policy since Nov 1996:
In 1996-97, the rate of inflation sharply declined. In
the later half 1996-97, industrial recession gripped
the Indian economy. To encourage the economic
growth and to tackle the recessionary trend, the RBI
eased its monetary policy.
1.Introduction of Repo rate. Repo rate increased from
3% in 1998 to 6.5% in 2005. This instrument was
consistently used in the monitory policy as a result of
rapid industrial growth during 2005-06. In the
current monetary policy, the Repo rate was cut from
5.00% to 4.75%.
2.Reverse Repo rate –Through RRR, the RBI mops up
liquidity from the banking system. In the current
monetary policy, the Repo rate was cut from 3.50%
to 3.25%.
 Easing of Monetary policy since Nov 1996: (Contd)

3. Flow of credit to Agriculture – The flow of credit to

agriculture has increased from 34,013 (9.2% of overall
credit) in 2008 to 52,742 (13% in overall credit) in 2009 –
(Rs. in crore).

4. Reduction in Cash Reserve Ratio – The CRR which was at

15% until 1995 gradually reduced to 5% in 2005. The CRR
remained unchanged in the current monetary policy.

5. Lowering Bank rate – The Bank rate was gradually reduced

from 12% in 1997 to 6% in 2003. Since then the Bank Rate
has remained unchanged to 6%.
 Review of 2009/10 Monetary policy
 The Policy Review projects GDP growth at 6% this FY due
to slackening private consumption and investment
demand.
 The RBI set its inflation projection for March 10 at 4%
(currently at -1.21%). The RBI also projects the CPI to
come down into the single digit zone.
 Assurance of a non-disruptive borrowing in 2009-10.
Recently, the Government increased the borrowing plan
from Rs. 2.41 lakh crore to 2.99 Lakh crore because of
ample liquidity in the market due to slow credit growth.
 The fiscal stimulus packages of the Government and
monetary easing and regulatory action of the Reserve
Bank have helped to arrest the moderation in growth
and keep our financial markets functioning normally.
THANK YOU