A minor study on

Critically analyzing role of

R.B.I. as a federal reserve
Synopsis
This minor study evaluates and discusses on various
events that happened in the Indian Economic scenario
under the worldwide global economic distress and the
role of R.B.I.in formulating and developing effective
plans to combat this economic turmoil and to stabilize the
economy.

This study focuses on various macroeconomic issues

under the influence of R.B.I.’s policies and various
industrial sectors and overall effect on them due to this
turmoil and regulatory policies of R.B.I.

Introduction
The global financial environment entered a crisis phase
in mid-September 2008, following the growing distress
among large international financial institutions and the
declaration of bankruptcy of Lehman Brothers. As credit
markets froze, central banks across the world, along with
the respective governments, responded with both
conventional and unconventional measures. The knock-on
effect of these unprecedented adverse global
developments became evident in the macroeconomic
performance of the Indian economy, particularly in the
second half of 2008-09.

The Indian economy which was on a robust economic

growth in 2007-08 averaging at 8.9% during the period
2003-04 to 2007-08 witnessed a downfall during 2008-
09.
The major cause was the global slowdown but another
cause that could be stated is because of cyclical factors.
• The deceleration in Indian Economy during 2008-09
has been associated with decline in investment
demand, which had been an important driver of
growth in recent years.
• The adverse conditions for access to external capital,
and the depressing effects of the global crisis and the
 depressing effects of global crisis on domestic
business contributed to the slowdown.
• Private consumption expenditure was partly offset by
government consumption expenditure; due to this the
key deficit indicators during the 2008-09 were
significantly higher than the budgeted level as those
of the preceding year.
• This also resulted in deferring the attainment of the
stipulated deficit charges under the Fiscal
responsibility and budget management (F.R.B.M.)
act, 2003.
• Corporate performance subdued and external
demand weakened. Savings and investment rates that
peaked in 2007-08 were likely to be affected
adversely during 2008-09.
• There was a large expansion in trade deficit due to
increase in imports due to higher prices of oil and
decreasing imports. It also showed shocking figures
in the Balance of Payables (BOP) too.
• The large trade deficit led to an expansion in current
account deficit to us$ 36.5 million in April-December
2008 as compared to us$ 17.7 million in April-
December 2007.
• Large net outflows under portfolio investment and
large repayments under short term credit along with
a wider current account deficit led to a decline I
reserves.
• The consequent resulting outflows led to a
contraction in reserves.
Performance of various sectors:
Agriculture sector:
• The target for food grain production for 2008-09 was
set at 227.9 million tones as compared to 230.8
million tones of 2007-08.
• The reduction of food grains in 2008-09 is attributed
to the decline in the kharif production owing to the
flood affected states like Bihar, Assam, Eastern U.P.,
and Orissa.
• The marginally lower estimates of wheat production
for 2008-09 mainly reflected the unusually warm
weather in January and early February 2009.

Industrial sector:
• The loss of momentum in the industrial sector was
evident as IIP index of industrial production which
witnessed a growth of around 5.6% slipped to a low
of 1.7% during august 2008.
• Later it recovered to 6.0% in September.
• However again in December 2008 it registered a
negative growth.

• The manufacturing sector also recorded a slowdown

as the 15 industry groups accounting for the 74.4
percent of the total weight in the IIP recorded a
negative growth during April-February 2008-09.

• Only two groups’ viz. beverages and tobacco were

able to record a positive growth in this sector.
 The Aggregate Demand:

The role of aggregate demand becomes most crucial when

it plays such a vital role in determining a country’s future
economic scenario and is also responsible for the growth
and the future trends of the economy.

• As already discussed the trade deficit of the country

increased due to reduced net export and falling
external demand.
• This deficit was further widening because of falling
of domestic demand too.
• So the only way to sustain the economy the
government expenditure had to increase.

To improve onto the existing prevalent conditions

government increased the aggregate expenditure for the
year 2008-09 which was significantly higher than the
budget estimates mainly on account of fiscal stimulus.
Theses measures were aimed at supporting the aggregate
demand in the economy.

Now if we see above table we can easily infer that

government has clearly tried to increase the aggregate
demand by increasing the government expenditure that
has resulted in widening of fiscal deficit.
In the above table we can see that maximum variation lies
in the sector of subsidies where it is nearly 81%.
Next the maximum variation is in the field of revenue
expenditure. It lies at 22.1 % as compared to the budgeted
estimates.
This also shows that government has taken various
unconventional and conventional measures to sustain and
stabilize the Indian economy.
Various measures taken:
• The three major ad-valorem rates of central excise
duty, via, 14 percent, 12 percent and 8 percent
applicable to non-petroleum products were reduced
by 4 percentage points each.

• An additional allocation of Rs. 350 crore was

announced for export incentive scheme.

• To provide a counter-cyclical stimulus via planned

expenditure, an additional plan expenditure of up to
Rs... 20,000 crore in the current fiscal year was
announced.

• In textile sector, an additional allocation of rs 1400

crores was made to clear the entire backlog of
technology up-gradation fund scheme (TUF).
• In order to support the infrastructure schemes under
Public Private Partnership mode, India Infrastructure
Finance Company Limited (IIFCL) was authorized to
raise Rs.10,000 crore through tax-free bonds by
March 31, 2009.
From above table we can clearly infer that those
economies which are more regulated were less affected as
compared to those that were relatively free and were
totally deregulated.
So, it is really important to know that how RBI is
governing and regulating Indian economy being the
central bank of India.

Role of R.B.I.:

As global liquidity crisis started affecting Indian domestic

market, the reserve bank ensured adequate provisions of
both domestic and foreign exchange liquidity through
banks, with the aim if restoring the normal functioning of
the market and thereby facilitating adequate flow of credit
to the productive sectors of the economy.

• The impact of decline in net foreign exchange assets

on reserve money and domestic market was dealt by
open market operations and market stabilization
schemes and other measures to augment rupee.
• Reserve bank took various conventional and
unconventional measures towards monetary easing.
• The aim of these measures was to ensure provision
ample liquidity to the banking system to make credit
available for productive purposes for reviving the
growth.
• I view of the prevailing economic scenario RBI also
reduced the cash reserve ratio (CRR) by a cumulative
4.0 percentage point from 9.0 percent to 5.0 percent.
• This reduction in C.R.R. released a primary liquidity
of the order of Rs. 1, 60,000 crore in the system.
• The repo rate was also reduced by 2.5 percentage
points to 3.5 percentage points.
• The changes in the CRR also impacted the money
multiplier, i.e. the ratio between the broad money and
the reserve money.
• The money multiplier which had declined from 4.7
March 2007 to 4.3 March 2008, increased to 4.8 at
end march 2009 reflecting the subsequent lowering of
C.R.R.
Movements in the net reserve bank’s credit to the central
government during 2008-09 largely reflected the liquidity
management operations by the reserve bank and changes
in central government deposits with the reserve bank.
In particular, the net reserve bank’s credit to the central
bank increased on account of the reserve bank’s purchases
under open market operations and market stabilization
scheme.
Decline in short term interest rates:
• A decline in the short term interest rates was also
made to increase the investment base and thus an
increase in the aggregate demand could be made.
• Policy rates were continued to be cut down as the
initial inflation concerns were disappearing and the
recession conditions were deep rooted in most of the
advanced economies.
These were the various measures that RBI and other
central banks were taking globally to fight this economic
distress and stabilize their economy.