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Knowledge Corner

Important Economic Indicators - 1

Monetary Policy in India
Monetary policy is the process by which monetary authority of a country, generally a central bank controls the supply of money in the economy by exercising its control over interest rates in order to maintain price stability and achieve high economic growth. In India, the central monetary authority is the Reserve Bank of India (RBI) is so designed as to maintain the price stability in the economy. Other objectives of the monetary policy of India, as stated by RBI, are:
Price Stability
Price Stability implies promoting economic development with considerable emphasis on price stability. The centre of focus is to facilitate the environment which is favourable to the architecture that enables the developmental projects to run swiftly while also maintaining reasonable price stability.
Controlled Expansion Of Bank Credit
One of the important functions of RBI is the controlled expansion of bank credit and money supply with special attention to seasonal requirement for credit without affecting the output.
Promotion of Fixed Investment
The aim here is to increase the productivity of investment by restraining non essential fixed investment.
Restriction of Inventories
Overfilling of stocks and products becoming outdated due to excess of stock often results is sickness of the unit. To avoid this problem the central monetary authority carries out this essential function of restricting the inventories. The main objective of this policy is to avoid over-stocking and idle money in the organization
Promotion of Exports and Food Procurement Operations
Monetary policy pays special attention in order to boost exports and facilitate the trade. It is an independent objective of monetary policy.
Desired Distribution of Credit
Monetary authority has control over the decisions regarding the allocation of credit to priority sector and small borrowers. This policy decides over the specified percentage of credit that is to be allocated to priority sector and small borrowers.
Distribution of Credit
The policy of Reserve Bank aims equitable distribution to all sectors of the economy and all social and economic class of people
To Promote Efficiency
It is another essential aspect where the central banks pay a lot of attention. It tries to increase the efficiency in the financial system and tries to incorporate structural changes such as deregulating interest rates, ease operational constraints in the credit delivery system, to introduce new money market instruments etc.
Reducing the Rigidity
RBI tries to bring about the flexibilities in the operations which provide a considerable autonomy. It encourages more competitive environment and diversification. It maintains its control over financial system whenever and wherever necessary to maintain the discipline and prudence in operations of the financial system.
Monetary operations
Monetary operations involve monetary techniques which operate on monetary magnitudes such as money supply, interest rates and availability of credit aimed to maintain Price Stability, Stable exchange rate, Healthy Balance of Payment, Financial stability, Economic growth. RBI, the apex institute of India which monitors and regulates the monetary policy of the country stabilizes the price by controlling Inflation. RBI takes into account the following monetary policies:
Major Indicators in the Money Market
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. The RBI sells government securities to contract the flow of credit and buys government securities to increase credit flow. Open market operation makes bank rate policy effective and maintains stability in government securities market.
Bank Rate
RBI lends to the commercial banks through its discount window to help the banks meet depositor’s demands and reserve requirements. The interest rate the RBI charges the banks for this purpose is called bank rate. If the RBI wants to increase the liquidity and money supply in the market, it will decrease the bank rate and if it wants to reduce the liquidity and money supply in the system, it will increase the bank rate.
Cash Reserve Ratio (CRR)
Every commercial bank has to keep certain minimum cash reserves with RBI. Consequent upon amendment to sub-Section 42(1), the Reserve Bank, having regard to the needs of securing the monetary stability in the country, RBI can prescribe Cash Reserve Ratio (CRR) for scheduled banks without any floor rate or ceiling rate (Before the enactment of this amendment, in terms of Section 42(1) of the RBI Act, the Reserve Bank could prescribe CRR for scheduled banks between 3% and 20% of total of their demand and time liabilities]. RBI uses this tool to increase or decrease the reserve requirement depending on whether it wants to affect a decrease or an increase in the money supply. An increase in Cash Reserve Ratio (CRR) will make it mandatory on the part of the banks to hold a large proportion of their deposits in the form of deposits with the RBI. This will reduce the size of their deposits and they will lend less. This will in turn decrease the money supply.
Statutory Liquidity Ratio (SLR)
Apart from the CRR, banks are required to maintain liquid assets in the form of gold, cash and approved securities. Higher liquidity ratio forces commercial banks to maintain a larger proportion of their resources in liquid form and thus reduces their capacity to grant loans and advances, thus it is an anti-inflationary impact. A higher liquidity ratio diverts the bank funds from loans and advances to investment in government and approved securities.
In well-developed economies, central banks use open market operations—buying and selling of eligible securities by central bank in the money market—to influence the volume of cash reserves with commercial banks and thus influence the volume of loans and advances they can make to the commercial and industrial sectors. In the open money market, government securities are traded at market related rates of interest. The RBI is resorting more to open market operations in the more recent years.
Generally RBI uses three kinds of selective credit controls:
  • Minimum margins for lending against specific securities.
  • Ceiling on the amounts of credit for certain purposes.
  • Discriminatory rate of interest charged on certain types of advances.
Direct credit controls in India are of three types:
  • Part of the interest rate structure i.e. on small savings and provident funds, are administratively set.
  • Banks are mandatory required to keep 18% of their deposits in the form of government securities.
  • Banks are required to lend to the priority sectors to the extent of 40% of their advances

Policy rates, Reserve ratios, lending, and deposit rates as of 08 December, 2020

Factors Components
Policy Repo Rate 4.00%
Reverse Repo Rate 3.35%
Marginal Standing Facility Rate 4.25%
Bank Rate 4.25%
CRR 3%
SLR 18.00%
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