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Context: The Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) decided to keep the interest rates unchanged in the wake of a rise in inflation.


What are the Monetary Policies of RBI?

In India, the monetary policy is a policy formulated by the central bank of India i.e., RBI (Reserve Bank of India) and relates to the monetary matters of the country. The policy involves various measures taken to regulate the supply of money, availability, and cost of credit in the economy.

The Monetary Policy also oversees distribution of credit among users as well as the borrowing and lending rates of interest. In a developing country like India, the monetary policy plays a significant role in the promotion of economic growth.

What are the Instruments of Monetary Policy of RBI?

There are a number of instruments involved in the Monetary Policy of RBI. Some of these includes variations in bank rates, other interest rates, selective credit controls, supply of currency, variations in reserve requirements and open market operations. Some of the major instruments includes:

1. Open Market Operations

It involves buying or selling of government securities like government bond 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 control 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.

2. Cash Reserve Ratio (CRR)

It is a certain percentage of bank deposits which the banks are required to keep with RBI in the form of reserves or balances. 

The higher the CRR with the RBI, the lower will be the liquidity in the system, and vice versa. 

RBI is empowered to vary the CRR between 15% and 3%. As per the suggestion by the Narasimham Committee report, the CRR was reduced from 15% in 1990 to 5 percent in 2002

As of 31 December 2019, the CRR is 4.00 percent.

3. Statutory Liquidity Ratio (SLR)

Each and every financial institution (FI) has to maintain a certain amount of liquid assets with themselves at any point of time of their total time and demand liabilities. These assets have to be kept in non-cash form such as G-secs precious metals, approved securities like bonds etc

The ratio of the liquid assets to time and demand liabilities is termed as the Statutory liquidity ratio

There was a reduction of SLR from 38.5% to 25% because of the suggestion by Narsimham Committee. 

As on 31-December -2019, the SLR stands at 18.25%. 

4. Bank Rate Policy[6]

The bank rate, or otherwise known as the discount rate, is the rate of interest which is charged by the RBI for providing funds or loans to the banking system which involves commercial and co-operative banksIndustrial Development Bank of IndiaIFCEXIM Bank, and other approved financial institutions. 

The funds are provided either through lending directly or discounting or buying money market instruments like commercial bills and treasury bills

It is to be noted that an increase in bank rate increases the cost of borrowing by commercial banks which results in the reduction in credit volume to the banks and hence the supply of money declines. An increase in the bank rate is the symbol of tightening of RBI monetary policy. 

As of 31 December 2019, the bank rate is 5.40%.

5. Credit Ceiling

In this kind of operation, RBI issues prior information or direction that loans to the commercial banks will be given up to a certain limit. In this case, commercial bank will be tight in advancing loans to the public. They will allocate loans to limited sectors. A few examples of credit ceiling are agriculture sector advances and priority sector lending.

6. Credit Authorisation Scheme

This Scheme was introduced in November, 1965 when P C Bhattacharya was the chairman of RBI. Under this instrument of credit regulation, RBI, as per the guideline, authorise the banks to advance loans to desired sectors.

7. Moral Suasion

Moral Suasion is basically just as a request by the RBI to the commercial banks to take certain actions and measures in certain trends of the economy. RBI may request commercial banks not to give loans for unproductive purposes which do not add to economic growth but increase inflation.

8. Repo Rate and Reverse Repo Rate

Repo rate is the rate at which RBI lends to its clients generally against government securities

Any reduction in repo rate helps the commercial banks to get money at a cheaper rate and increase in repo rate discourages the commercial banks to get money as the rate increases and becomes expensive. 

Reverse repo rate is the rate at which RBI borrows money from the commercial banks. 

An increase in the repo rate will increase the cost of borrowing and lending of the banks which will discourage the public to borrow money and will encourage them to deposit. 

As the rates are high the availability of credit and demand decreases resulting to decrease in inflation. This increase in repo rate and reverse repo rate is a symbol of tightening of the policy

As of 31 December, 2019 Repo rate is 5.15% and Reverse Repo rate is 4.90%.

As of 2 January 2020, the key indicators are: 

  • Inflation: 2.86%
  • MSF(Marginal Standing Facility) Rate: 5.40%
  • CRR: 4.0%
  • SLR: 18.50%
  • Bank rate: 5.40%
  • Reverse Repo Rate: 4.90%
  • Repo Rate: 5.15%
  • GDP growth rate: 6.1%

What are the objectives of MPC of RBI?

To ensure Price Stability: It implies promotion of economic development with considerable emphasis on price stability. The centre of focus is to facilitate the environment which is highly favourable to the architecture that enables the developmental projects to run swiftly while also maintaining reasonable price stability.

To ensure Controlled Expansion Of Bank Credit: Controlled expansion of bank credit and money supply with special attention to seasonal requirement for credit without affecting the output is one of the important functions of RBI.

To Promote Fixed Investment: In this case the aim is to increase the productivity of investment by restraining non-essential fixed investment.

To restrict Inventories and stocks: To avoid the sickness of the unit due to excess of stocks, 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 organisation.

Promotion of Efficiency: These policies tries to increase the efficiency in the financial system and tries to incorporate structural changes such as deregulating interest rates, easing operational constraints in the credit delivery system, introducing new money market instruments, etc.

To reduce the Rigidity: RBI tries to bring about flexibilities in 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.

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