Macroeconomics & Policy

Assignment
Khyati Dhabalia
PGDM RM
Roll no. 19

I. Effectiveness of Monetary Policy

Monetary policy is regulatory policy by which the central bank or the monetary authority of a country
controls the:
a) Supply of money
b) availability of bank credit
c) rate of interest
the main objective of monetary policy is growth with stability.
Current Rates (as on Dec 2, 2014):
Repo rate under Liquidity Adjustment Facility: unchanged at 8.0%
CRR: 4.0% of NDTL
Liquidity under overnight repos at 0.25 % of NDTL at the LAF repo rate and under 7 day and 14 day term
repos of up to 0.75 % of NDTL
Reverse repo rate under LAF unchanged at 7%
MSF at 9%
Bank Rate at 9%0
Source: Fifth Bi-Monthly Monetary Policy Statement, 2014-15 By Dr. Raghuram G Rajan, Governor
(http://rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=32649)
Effectiveness of Monetary Policy:
Achievements:
a) Financial stability:
RBI has been successful in maintaining financial stability during the global financial crisis because of its
controls, regulations and supervision mechanism. it has also been able to maintain macroeconomic
stability to a large extent during the global crisis period.
b) Short Term liquidity management:
The RBI has succeeded in managing short term liquidity in order to maintain stability in interest rate and
exchange rate. it has developed various method to do this through LAF, OMO and MSS. in spite of large
inflow, of foreign capital the RBI has managed its sterilization operations very well.
c) Adaptability:
The RBI has adopted its monetary policy approach with changing times. it has developed new methods of
credit control and shifted from monetary targeting to multiple indicator approach. this has made the
monetary system in India flexible helping it to move with times.

d)Financial Inclusion:
RBI, along with he NABARD,, has made a great impact in the growth of microfinance. it has supported the
Self Help Group model and promoted other microfinance institutions. however, there is a lot more that
needs to be done in this area.
e) Promotion of Growth:
RBI has used its instruments effectively to maintain the growth of the economy even during the current
phase of global slowdown, India at present has the second highest rate of GDP growth after China.
Monetary policy has played a major role in this.
Limitations of the Monetary Policy:
a) Existence of unorganized money market:
Despite all that has been achieved by the banking sector through branch expansion, a large unorganised
sector continues to exist, especially in the rural areas. RBI's monetary policy does not affect the
functioning of this sector. it is comprised of indigenous bankers, money lenders, agents etc. who continue
to provide credit to a large number of people at high rate of interest.
b) Weak channels of monetary transmissions:
Recently, RBI has admitted that the traditional channels of monetary transmission, interest rate, credit
availability, asset prices and exchange rates are weak. This is because of underdeveloped securities
market, unorganised money market and speculative assets market.
c) Existence of black money:
Due to high rate of taxation in the past, India has had high incidence of tax evasion. this has generate
huge amount of black money. black economy gives rise to inflation and speculative activates. the impact
of such money cannot be controlled by RBI's monetary policy.
d) Preference for Cash Transactions:
A large part of the country is still non-monetized and transactions are preferred to be done with cash
rather than through the banking sector.
e) Phasing out of selective methods:
It is being argued that the RBI should revise the use of selective measures of credit control to directly
attack the sector specific inflation, since the general methods are ineffective in case of such inflation.
Methods like credit rationing and discriminatory interest rates can be used in his case.

II. Features of FRBM Act:

The Fiscal Responsibility and Budget Management Act, 2003 (FRBMA) was enacted by the Parliament of
India to institutionalize financial discipline, reduce Indias fiscal deficit, improve macroeconomic
management and the overall management of the public funds by moving towards a balanced budget.
The main purpose was to eliminate revenue deficit of the country (building revenue surplus thereafter)
and bring down the fiscal deficit to a manageable 3% of the GDP by March 2008. However, due to the
2007 international financial crisis, the deadlines for the implementation of the targets in the act was
initially postponed and subsequently suspended in 2009. In 2011, Economic Advisory Council publicly
advised the Government of India to reconsider reinstating the provisions of the FRBMA.

Main Features
a) The Act mandates the central government to take appropriate measures to reduce fiscal deficit and

revenue deficits so as to eliminate the revenue deficit by March 31, 2009 and thereafter build up
adequate revenue surplus.
b) It requires the reduction in fiscal deficit by 0.3 per cent of GDP each year and the revenue deficit by
0.5 per cent. If this is not achieved through tax revenues, the necessary adjustment has to come from a
reduction in expenditure.
c) The actual deficits may exceed the targets specified only on grounds of national security or natural
calamity or such other exceptional grounds as the central government may specify.
d) The central government shall not borrow from the Reserve Bank of India except by way of advances to
meet temporary excess of cash disbursements over cash receipts.
e) The Reserve Bank of India must not subscribe to the primary issues of central government securities
from the year 2006-07.
f) Measures to be taken to ensure greater transparency in fiscal operations.
g) The central government to lay before both Houses of Parliament three statements Medium-term
Fiscal Policy Statement, The Fiscal Policy Strategy Statement, The Macroeconomic Framework Statement
along with the Annual Financial Statement.
h) Quarterly review of the trends in receipts and expenditure in relation to the budget be placed before
both Houses of Parliament.
The Act applies only to the central government. Though few states like Karnataka, Kerala, Punjab, Tamil
Nadu and Uttar Pradesh have enacted fiscal responsibility legislations, the objective of fiscal
consolidation, growth and macroeconomic stability will not be achieved if all the states do not
participate. However, though there has been an effort by the government to widen the tax net and
ensure better compliance, there have been fears that welfare expenditure may get reduced to meet the
targets mandated by the Act.

Objectives or Importance of the FRBM Act:

The first objective of the Act is to make the Government responsible to "ensure inter generational
equity in fiscal management" implying that borrowings are nothing but deferred taxation and the
governments living beyond their means leave a burden of debt on future generations.
The second objective is to make the Government responsible for ensuring long term Macro Economic
stability because reckless borrowings by government crowds out private investment or fuels inflation or
leads to balance of payment crises eventually leading to macro-economic instability.
The third objective is to make the Government responsible for removing fiscal impediments to the
effective conduct of monetary policy because unsustainable increase in deficit makes the task of the RBI
to control money supply difficult as the RBI also happens to be the debt manager of the government.