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Monetary Policy of RBI | RBI Repo Rate | Current CRR | Reverse Repo Rate News & Updates


monetary-policy-of-rbi

The monetary policy can be defined as a regulatory policy whereby the central bank upholds its control over money supply for the comprehension of general economic goals.

What is Monetary Policy of RBI?

Definition: Monetary policy is the macroeconomic policy laid down by the central bank. It involves management of money supply and interest rate and is the demand side economic policy used by the government of a country to achieve macroeconomic objectives like inflation, consumption, growth and liquidity.

The monetary policy can be defined as a regulatory policy whereby the central bank upholds its control over money supply for the comprehension of general economic goals. This notion of monetary policy may be right in the context of developed economies, however in less developed countries like India, monetary policy cannot remain restricted only to controlling money supply.

Looking at the Reserve Bank's monetary policy in this scaffold we find that it has been intended to meet the particular requirements of developing economy of India. Appropriately summarizing the monetary policy of RBI, S.L.N. Simha has stated, "The Reserve Bank's responsibility is not merely one of credit restriction. In a growing economy there has to be a continuous expansion of money supply and bank credit and the central bank has the duty to see that lawful credit requirements are met. The Bank's responsibility in the circumstances is mainly to moderate the expansion of credit and money supply, in such a way as to ensure the legitimate requirements of industry and trade and curb the use of credit for unproductive and speculative purposes. That is why the Bank has rightly called its credit policy in recent years as one of controlled expansion.”

In India, at present both cheques and currency notes are used for payment purposes. Coins represent a very small part of money supply in the nation & they are now used for making small payments.

When is Monetary Policy announced?

Traditionally, Monetary Policy is announced two times in a year - a slack season policy (April - September) & a busy season policy (October - March) in line with agricultural cycles. These cycles also overlap with the halves of financial year.

Initially, RBI announced all its monetary measures two times in a year in the Monetary Policy & Credit Policy. The Monetary Policy has become dynamic in nature as the Reserve Bank of India reserves its right to amend it from time to time, depending on the state of economy.

On the other hand, with the share of credit to agriculture coming down & credit towards the industry being granted whole year around, the Reserve Bank of India since 1998 - 99 has moved in for just one policy in April end. Though an evaluation of the policy does take place later in the year.

Some terms related to Monetary Policy of RBI

Bank Rate

Bank rate is the minimum rate at which the central bank offers loans to the commercial banks. It is also known as the discount rate.

Inflation

Inflation refers to a constant rise in prices. It is a state of too much money & too few goods. Thus, due to shortage of goods & presence of numerous buyers, the prices are pushed up.

The opposite of inflation is deflation. It is the relentless falling of prices. Reserve Bank of India can decrease the supply of money or augment interest rates to reduce inflation.

Money Supply

Money supply refers to the total volume of money flowing in the economy, and typically encompasses currency with the public & demand deposits (savings account + current account) with the public.

Instruments of Monetary Policy in India

Gross Domestic Product (GDP):

National output or GDP is the most important concept of macroeconomics. When GDP increases, it is a sign that the economy is getting stronger. While a reduction in the GDP indicates a state of weakening economy. How is GDP really calculated?

One of the most reliable methods to measure the GDP is the expenditure approach which totals up the following elements to calculate the GDP:

GDP = C + G + I + NX

“C” = total private consumption in the country

“G” = total government spending

“I” = total investment made by the country’s businesses

“NX” = net exports (calculated as total exports minus total imports)

In short, the GDP is the state of the economy in a snapshot. The year on year GDP growth rate is closely monitored by investors and white it only indicates what has already happened in a previous time period, every time the GDP data gets published, analysts alter their stance on the future prospects of Indian economy.

Instruments of Monetary Policy used by the RBI

Direct regulation:

Cash Reserve Ratio (CRR):  Commercial Banks are required to hold a certain proportion of their deposits in the form of cash with RBI. CRR is the minimum amount of cash that commercial banks have to keep with the RBI at any given point in time. RBI uses CRR either to drain excess liquidity from the economy or to release additional funds needed for the growth of the economy.

Statutory Liquidity Ratio (SLR): SLR is the amount that commercial banks are required to maintain in the form of gold or government approved securities before providing credit to the customers. SLR is stated in terms of a percentage of total deposits available with a commercial bank and is determined and maintained by the RBI in order to control the expansion of bank credit. For example, currently, commercial banks have to keep gold or government approved securities of a value equal to 23% of their total deposits.

Indirect regulation:

Repo Rate: The rate at which the RBI is willing to lend to commercial banks is called Repo Rate. Whenever commercial banks have any shortage of funds they can borrow from the RBI, against securities. If the RBI increases the Repo Rate, it makes borrowing expensive for commercial banks and vice versa. As a tool to control inflation, RBI increases the Repo Rate, making it more expensive for the banks to borrow from the RBI with a view to restrict the availability of money. The RBI will do the exact opposite in a deflationary environment when it wants to encourage growth.

Reverse Repo Rate: The rate at which the RBI is willing to borrow from the commercial banks is called reverse repo rate. If the RBI increases the reverse repo rate, it means that the RBI is willing to offer lucrative interest rate to commercial banks to park their money with the RBI. This results in a reduction in the amount of money available for the bank’s customers as banks prefer to park their money with the RBI as it involves higher safety.  This naturally leads to a higher rate of interest which the banks will demand from their customers for lending money to them.

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