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IFIN’s Basic Education – Series 15
20-Jun-12
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Overfilling of stocks and products becoming outdated due to excess of stock often results is sickness of the unit.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.
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IFIN’s Basic Education – Series 15
20-Jun-12
Equitable 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 Operations:
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.
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IFIN’s Basic Education – Series 15
20-Jun-12
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. As of 17 April, 2012 the bank rate was 9.0%.
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 effect 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. The current rate is 4.75%. ( As on Date- 9 March, 2012).
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:
1. Minimum margins for lending against specific securities.
2. Ceiling on the amounts of credit for certain purposes.
3. Discriminatory rate of interest charged on certain types of advances.
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IFIN’s Basic Education – Series 15
20-Jun-12
Direct credit controls in India are of three types:
1. Part of the interest rate structure i.e. on small savings and provident funds, are administratively set.
2. Banks are mandatory required to keep 24% of their deposits in the form of government securities.
3. 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 18 June, 2012
Bank Rate
Repo Rate
Reverse Repo Rate
Cash Reserve Ratio (CRR
Statutory Liquidity Ratio (SLR)
Base Rate
Reserve Bank Rate
Deposit Rate
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9.00%
8.00%
7.00%
4.75%
24.0%
10.00%–10.50%
4%
8.00%–9.25%
IFIN’s Basic Education – Series 15
20-Jun-12
RESEARCH TEAM
Devarajan. S
Technical & Derivative Strategist
044 - 28306686
[email protected]
Arun . V
Research Analyst
044 - 28306623
[email protected]
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