Monetary policy final...

Monetary Policy

Anuradha Kumari (1204)

Pankaj Agarwal (1215)

Srijita Dutta (1220)

National Academy of Agricultural Research Management

RBI

It is the Central Bank of country. It was established in 1935 with a capital of Rs.5 crore. It was nationalised on january 1,1949.

Functions of Reserve Bank-• Issue of Notes• Banker to the government• Banker’s Bank• Controller of Credit• Custodian of Foreign Reserves• others


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, Higher rate of employment, ensure adequate flow of credit to the productive sectors of the economy and overall economic growth


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


Monetary Policy Instruments

Bank rate

Cash Reserve Ratio

Statutory Liquidity Ratio

Repo rate

Reverse Repo rate


Bank Rate

Bank Rate is the rate at which RBI allows finance to commercial banks.

Any upward revision in Bank Rate by central bank is an indication that banks should also increase deposit rates as well as Prime Lending Rate.

Thus any revision in the Bank rate could mean more or less interest on

deposits and also an increase or decrease in EMI.


CRR(Cash Reserve Ratio)

CRR is the amount of Cash(liquid cash like gold) that the banks have to keep with RBI.

This Ratio is basically to secure solvency of the bank and to drain out the excessive money from the banks.

RBI uses CRR either to drain excess liquidity or to release funds needed for the economy from time to time.

Increase in CRR means that banks have less funds available and money is sucked out of circulation.

Thus we can say that this serves dual purposes i.e. it not only ensures that a portion of bank deposits is totally risk-free, but also enables RBI to control liquidity in the system, and thereby, inflation by tying the hands of the banks in lending money.


SLR(Statutory Liquidity Ratio)

SLR is the minimum percentage of deposits a commercial bank needs to maintain in the form of cash, or gold or govt. approved securities (Bonds) before providing credit to its customers.

SLR rate is determined and maintained by the RBI (Reserve Bank of India) in order to control the expansion of bank credit.

Generally this mandatory ration is complied by investing in Govt bonds. In deficit Budgeting ,Govt. lending is more so they borrow money

from banks by selling their bonds to banks. So banks have invested more than required percentage and use these excess bonds as collateral security ( over and above SLR )to avail short term Funds from the RBI at Repo rate.


Repo And Reverse Repo Rate

It is the rate at which the RBI lends shot-term money to the banks. When the repo rate increases borrowing from RBI becomes more expensive.

Therefore, we can say that in case, RBI wants to make it more expensive for the banks to borrow money, it increases the repo rate; similarly, if it wants to make it cheaper for banks to borrow money, it reduces the repo rate

It is the rate at which banks park their short-term excess liquidity with the RBI. The RBI uses this tool when it feels there is too much money floating in the banking system.

An increase in the reverse repo rate means that the RBI will borrow money from the banks at a higher rate of interest. As a result, banks would prefer to keep their money with the RBI

Repo Rate Reverse Repo Rate


• 8.5%Bank Rate

• 4.0CRR

• 23.0%SLR

• 7.5%Repo Rate

• 6.5%Reverse Repo Rate

• 54.38Re/$

Cu Current Rates


Monetary Policy- Expansionary/Contractionary Policy

Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest to attain a set of objectives oriented towards the growth and stability of the economy.

Monetary policy is referred to as either being an expansionary policy, or a Contarctionary policy. Expansionary policy increases the total supply of money in the economy

rapidly. Expansionary policy is used to combat unemployment in a recession by

lowering interest rates. Contarctionary policy decreases the total money supply, or increases it

slowly. Contarctionary policy involves raising interest rates to combat inflation.


Expansionary Monetary Policy

When the Open Market Committee wishes to increase the money supply, it can do a combination of three things:

Purchase securities on the open market, known as Open Market Operations

Lower the Discount Rate (Repo & Reverse Repo Rate)

Lower Reserve Requirements (CRR & SLR)


Contd..

Expansionary monetary policy causes an increase in bond prices and a reduction in interest rates.

Lower interest rates lead to higher levels of capital investment. The lower interest rates make domestic bonds less attractive, so the

demand for domestic bonds falls and the demand for foreign bonds rises. The demand for domestic currency falls and the demand for foreign

currency rises, causing a decrease in the exchange rate. (The value of the domestic currency is now lower relative to foreign currencies)

A lower exchange rate causes exports to increase, imports to decrease and the balance of trade to increase.


Effects of Monetary Policy on Economy

Erratic increase or decrease in prices of commodities or other items, if continued unabated for a substantial period, can be a source of imbalance in the economy.

While framing monetary policies, the fundamental objective of central banks all over the world is to maintain price stability.

Price stability is directly related to demand and supply of the products besides the available money supply.

By using monetary policy tools, the central banks ensure that money supply is controlled in a manner such that the aim of sustainable economy is achieved.

(Sustainable Economy=Maximum Employment+ Stable Prices+ Growth).

.


Impact on Inflation

SLR &CRR is maintained for bank solvency and higher ratio of SLR and CRR makes bank relatively safe as higher ratio means they have more of their funds deposited in liquid securities and can fulfill the demand on redemption of deposit from the Bank.

When an economy grows too fast and there is too much growth, it can lead to inflation (more money in the market→ people consuming more→ higher prices→ inflation).

If inflation is an imminent danger, central bank will hike interest rates so that there is decrease in money supply (if interest rates are hiked, people will save more and spend less so that they can get better returns on their investments).


Contd..

When RBI increases these ratios then money supply in market decreases and inflation falls.

The Increase in CRR will squeeze money from market so less money will chase few things means less demand so it will reduce Inflation.


How rate hike affects inflation rate?

17

Source:The RisksBankNational Academy of Agricultural Research Management

25/0

1/20

11

17/0

3/20

11

3/5/

2011

16/0

6/20

11

26/0

7/20

11

16/0

9/20

11

25/1

0/20

11

17/0

4/20

12

29/0

1/20

13

19/0

3/20

133

4.5

6

7.5

9

0

1

2

3

4

5

6

7

8

9

Repo rateReverse repo rate

Change in Repo rate impacts on Inflation Rate

Borrowing rate(repo rate%) are nearly 3% higher than two years ago.

Provisional annual inflation rate based on all India general CPI(Combined) for February 2013 on point to point basis (February 2013 over February 2012) is 10.91% as compared to 10.79% (final) for the previous monthof January 2013.National Academy of Agricultural Research Management

GDP growth and industrial production has fallen in last two years.


Impact on Interest rates of these ratios

Interest rate are fixed on the demand supply situation of the amount available with person who want to lend and person who want to borrow.

If demand is more and supply is less then interest rate rises up and if demand is less and supply is excessive then interest rate comes down.

RBI increase these ratio(CRR & SLR) then available funds with the banks will go down and as demand remain the same then people will have to pay more as interest and interest rate will go up. & vice versa.

So these rates have double impact :

1. Direct effect is bank increase rate of lending so less money is available with people & vice-versa.

2. Interest on deposit will be increased so less money will be available with the people & vice-versa.

Some time region wise and seasonal or other factor also effect the decision of Interest rate.


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

Monetary Policy cannot work in isolation!!

Limitations – Monetary Policy


Mid-Quarter Monetary Policy Review: 19th March 2013

Growth has decelerated significantly below trend through 2011-12 and 2012-13 so far and overall economic activity remains subdued.

On the demand side, investment activity has been way below desired levels and consumption demand has started to decelerate.

On the supply side, constraints in the availability of key raw materials and intermediates are becoming binding. In turn, this is being reflected in a widening of the CAD with adverse implications for external sustainability.

While the monetary policy stance has sought to balance the growth-inflation dynamic through calibrated easing, it is critical now to arrest the loss of growth momentum without endangering external stability.

The moderation in inflation conditions provides the opportunity for monetary policy to act in conjunction with fiscal and other measures to stem the growth risks.


Monetary Measures Taken

Reduced the policy repo rate under the liquidity adjustment facility (LAF) by 25 basis points from 7.75 per cent to 7.5 per cent with immediate effect.

Consequently, the reverse repo rate under the LAF stands adjusted to 6.5 per cent

Bank Rate reduced to 8.5 per cent. CRR which was reduced by 25 basis point in Jan. to 4 per cent remains the

same. Since the Reserve Bank’s Third Quarter Review (TQR) of January 2013,

global financial market conditions have improved.

Monetary and Liquidity Conditions

Money supply (M3) and bank credit growth have broadly moved in alignment with the revised indicative trajectories.

With government cash balances with the Reserve Bank persisting at a higher than normal level, the liquidity deficit, as reflected by the net drawls by banks under the liquidity adjustment facility (LAF), has remained above the indicative comfort zone.

The reduction in the cash reserve ratio (CRR) of banks by 25 basis points, effective from February 9 and open market purchases of `200 billion since February have enabled money market rates to remain anchored to the policy repo rate.

The Reserve Bank will continue to actively manage liquidity through various instruments, including open market operations (OMO), so as to ensure adequate flow of credit to productive sectors of the economy.


Expected Outcomes

It is expected that RBI policy actions and the guidance given, will result in the following three outcomes:

1. Investment will be encouraged, thereby supporting growth

2. Medium-term inflation expectations will remain anchored on the basis of a credible commitment to low and stable inflation

3. There will be an improvement in liquidity conditions to support credit flow.

Bankers indicated that they would cut lending and deposit rates over next couple of days to the benefit of borrowers, though depositors may get lesser returns. The industry too appeared satisfied with the rate cut hoping that it would boost demand and promote growth.

* CRR cut to infuse Rs 18,000 crore in system which is effective from Feb 9,2013.


Comments...

Commenting on the policy action, Commerce and Industry Minister Anand Sharma said: "It is a positive step which will infuse liquidity and help in catalysing growth.“

Planning Commission Deputy Chairman Montek Singh Ahluwalia said the CRR cut will have impact on long term interest rates."I think this is the right thing to do at this point of time given that (the decline) in economy is beginning to bottom out," he said.

Outlook

The foremost challenge for returning the economy to a high growth trajectory is to revive investment. A competitive interest rate is necessary for this, but not sufficient.

Sufficiency conditions include bridging the supply constraints, staying the course on fiscal consolidation, both in terms of quantity and quality, and improving governance.


Source

www.rbi.org.in http://

www.simpletaxindia.net/2008/11/what-is-crrrepo-rateslr-how-it-effects.html#ixzz2P22kCYuK

http://www.buzzle.com/articles/how-does-monetary-policy-affect-the-economic-growth.htm


http://www.rbi.org.in/

http://www.simpletaxindia.net/2008/11/what-is-crrrepo-rateslr-how-it-effects.html




http://www.buzzle.com/articles/how-does-monetary-policy-affect-the-economic-growth.html

http://www.buzzle.com/articles/how-does-monetary-policy-affect-the-economic-growth.html

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