CS Foundation Business Economics Monetary Policy in India
Monetary policy is a regulatory policy by which the central bank or monetary authority of a country controls the supply of money, availability of bank credit and cost of money, that is, the rate of interest.
RBI, the central bank of India or monetary authority of India, controls the supply of money and bank credit.
The central bank has the duty to see that legitimate credit requirements are met and credit is not used for the unproductive and speculative purpose.
Following are the main objectives of monetary policy in India:
- To regulate monetary growth, price stability.
- Focusing on the regulation, supervision, and development of the financial
- Promote the priority sector
- Employment generation
- Controls external stability
- Encourages savings and investments
- Redistribute income to weaker sections
- Affect the policies and functions of NBFIs (Non-Banking Financial Institutions).
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- Monetary Policy of RBI:
Monetary policy is implemented by the RBI through the instruments of credit control. Generally, two types of instruments are used to control credit.
- Quantitative or General measures
- Qualitative or Selective measures
- Quantitative or General Measures:
Quantitative weapons have a general effect on credit regulation. They are used for changing the total volume of credit in the economy. Quantitative measures consist of:
- Bank Rate Policy:
- Bank rate is the rate at which the Central Bank discounts the bill of commercial banks.
- If the RBI increases the bank rate, it reduces the volume of commercial banks borrowing from the RBI. It discourages banks from further credit expansion as it becomes a more costly affair.
- If the RBI reduces the bank rate, borrowing for commercial banks will be easy and cheaper. This will boost the credit creation.
- Open Market Operation:
- The Open Market Operation refers to the purchase and/or sale of short-term and long-term securities by the RBI in the open market.
- Very effective and popular instrument.
- Used to wipe out the shortage of money, to influence the term and structure of the interest rate and to stabilize the market for government securities etc.
- If RBI sells securities, the commercial banks and private individuals buy it. This reduces the money supply, money gets transferred from commercial banks to RBI. Normally in inflation RBI sells Security.
- RBI buys the security, commercial banks and individual sells it and get back the money they have invested in them. Money in the economy increases. During the depression RBI buys security.
- Variation in the Reserve Ratios(VRR):
- The Central Bank also uses the method of variable reserve requirements to control credit.
- Two types of reserves: Cash Reserve Ratio (CRR), Statutory Liquidity Ratio (SLR).
- RBI increases VRR during inflation to reduce purchasing power and credit creation and decrease during the depression for more cash reserves available for credit expansion.
- Repo Rate and Reserve Repo Rate:
- Repo rate is the rate at which commercial banks money from the central bank in case of any shortage of money they face. It increases amounts with the banks to lend out. Reduction will increase the supply of credit.
- Reserve Repo Rate at which RBI borrows money from commercial banks. Increase in this reduces lending capacity.
- Qualitative Or Selective Measures:
- It is not directed towards the quantity of credit or the use of credit
- Used for discriminating between different uses of credit.
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The Selective measure of credit control comprises the following instruments:
- Fixing Margin Requirements:
- The margin refers to the part of the loan which a borrower has to raise in order to get finance for his purpose.
- A change in a margin implies a change in the loan size.
- Encourage credit supply for the needy sector by increasing the margin for the necessary sectors.
- Discourage credit supply for non-necessary sectors by reducing it for needy sectors.
- Consumer Credit Regulation:
- Consumer credit supply is regulated through hire-purchase and installment sale of consumer goods.
- Publishes various reports stating what is good and what is bad in the system.
- Information can help commercial banks to direct credit supply in the desired sectors.
- Public and bank use information for attaining goals of monetary policy.
- Credit Rationing:
- Credit Rationing by limiting the amount available for each commercial bank.
- It controls even bill rediscounting
- Moral Suasion:
- It helps in restraining credit during inflationary periods.
- In this Central Bank can issue directives, guidelines, and suggestions for commercial banks regarding reducing credit supply for speculative purpose.
- Control through Directives:
- Central bank issue frequent directives.
- Directives guide commercial banks in framing their lending policy.
- It influences credit structures, the supply of credit.
- Directives also issue for not lending loans to the speculative
- Direct Action:
- RBI can impose an action against the bank.
- If banks are not adhering to RBI’s directives, the RBI may refuse to re-discount their bills and securities
- RBI may refuse credit supply to the banks whose borrowings are in excess to capital.
- It can even put a ban on a bank if it does not follow these directives and work against the objectives.
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