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Monetary Policy

Macroeconomic Policies
Physical Policy
Related to overcoming specific problems of the economy

Fiscal Policy
Related to budget, government expenditure, taxation

Monetary Policy Related to money supply, exchange rate control and bank rate control

Fiscal Policy
Use of Government Expenditure, and taxation to manage the economy.

Purpose of Fiscal Policy Stabilise economic growth, avoiding the boom and bust economic cycle

Variables affected by Fiscal Policy in the economy Aggregate demand and the level of economic activity The pattern of resource allocation The distribution of income.

Physical Policy
Meant to affect only strategic points of the economy

Purpose of Physical Policy Overcome specific problems such as pricing of particular commodity, shortages or surpluses developing in the economy etc.

Variables affected by Physical Policy in the economy Price and distribution of specific commodity Investment and production Foreign Trade

Monetary Policy
Regulation of supply of Money and Cost and Availability of Credit in the economy Purpose of Monetary Policy Maintain price stability, ensure adequate flow of credit to the productive sectors of the economy and overall economic growth

Variables affected by Monetary Policy in the economy Interest Rates Liquidity Credit Availability Exchange Rates

Monetary Policy RBIs role

Demand for Money

Demand for goods/services

Instruments such as CRR, OMO & Bank Rate

Ensuring price stability and ensuring savings

Control on money supply, velocity of circulation of money during inflation

Control on bank credit when prices rise/fall

Monetary Policy Terminology

Inflation Money Supply (M3) Bank Rate Cash Reserve Ratio (CRR)
Inflation refers to a persistent rise in prices Total volume of money circulating in the economy Minimum rate at which the central bank provides loans to commercial banks Amount of money that banks must set aside with RBI against their deposits Percentage of bank funds to be maintained in government and approved securities Rate at which RBI lends to other banks against government securities

Statutory Liquidity Ratio (SLR)

Repo Rate Reverse Repo Rate Capital Adequacy Ratio (CAR)

Rate at which RBI borrows from other banks

Capacity of bank meeting the time liabilities and other risk

Open Market Operations (OMO) Purchase and sale of securities in the open market

Current Rates
Inflation Bank Rate CRR 0.27 (New low in 30 years) 6.0% 5.0

Repo Rate


Reverse Repo Rate 3.5% PLR Re/$ 12.75% 13.25% 50.95

Monetary Policy Influence

Target Variables

Policy Variables - Money supply - OMO: Liquidity conditions - policy rates (CRR, repo etc.)

-Inflation -Interest rate -Real GDP -Employment -Consumption


CRR Movement

Before 1991
Government raised funds below market rate No depth in Government Securities Market Regulation of deposit rates Under developed financial markets, Less financial instruments availability

Complex, distorted interest rate structure Adversely affected viability and profitability of banks Transparency and norms could not be followed strictly

CRR Movement
Boost Economy after 2001 Slowdown / dotcom bubble Rise in CRR to control liquidity, due to Heavy Capital Inflow & to curb Re Appreciation

Stable CRR from 2004 to 2006

CRR hikes to curb inflation

CRR Cuts to boost economy after Sub prime loss / Global meltdown

Inflation Movement
CRR hikes proved to Be effective To curb Inflation Uncontrolled Inflation despite Further CRR hikes Inflation Down on account of global credit crunch

SLR Movement

Banks to made available more funds & More Efficiency

Stable SLR from 1998 onwards

Repo and Reverse Repo rates Movement

Repo rate reduction due to make credit available at cheaper rates

Increased rates to control the liquidity

Exchange Rate Movement

Sterilization to Control rupee Appreciation

LAF - To Control Exchange Ratio Outflow of $ from India Market

Forex Reserves Position

The Surge in Foreign Exchange Reserves

Sterilization / Selling bonds & Buying dollars

Sterilization under MSS

Sterilization bonds under (MSS) - April 2004 Cap. Rs.700 Cr. In 2005 & 1500 Cr. In 2007


Current Global Scenario

Global GDP -0.6% Tighter credit Recession Estimated PPP Global Growth 0.5% Demand Slump Job losses

World trade contraction by 2.8%

Production Plunge

Aggressive and unconventional measures taken by Governments and central banks

Impact on India
Money and credit market
Domestic Banks Local Institutions Domestic MFs NBFC


Financial Channel


Challenges for RBI

Growth amid Global economic slowdown


Limitations Monetary Policy

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!!

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