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TERM PAPER

BUSSINESS ENVIRONMENT

TOPIC

IMPACT OF MONETORY POLICY ON INDIAN INDUSTRY

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CONTENTS

➢ ACKNOWLEDGEMENT
➢ INTRODUCTION
• MONETARY POLICY
➢ HOW IT DOES WORK
➢ OBJECTIVE OF STUDY
➢ REVIEW OF LITRATURE
➢ METHODOLOGY
➢ ANALYSIS
➢ CONCLUSION
➢ BIBLIOGRAPHY

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ACKNOWLEDGEMENT

INTRODUCTION

➢ The RBI makes use of instruments to regulate money supply and bank credit so as to
influence the level of aggregate demand for goods and services. The availability and
cost of credit are regulated to influence the level and nature of economic activities.

➢ The monetary policy has to reconcile the objectives of economic growth and price
stability.

➢ Economic growth requires expansion in the supply of money so that no legitimate


productive activity suffers due to finance shortage. Price stability requires restraint on
the expansion of credit so that money supply does not become excessive to cause
inflation.

➢ Changes in the monetary policy can be made anytime during the year. The Central
Bank may adopt an expansionary or contractionary policy depending on the general
economic policy of the Government and conditions in the economy.

➢ Monetary policy may also be used to influence the exchange rate of the country’s
currency

HOW IT DOES WORK

Consider that an economy is growing too fast. This is also referred to as overheating
of the economy: a situation that typically happens in the boom phase when GDP
(gross domestic product) growth exceeds the long-term growth potential of the
economy. The producers of goods are not able to make enough goods to meet the

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rising demand. The resultant demand-supply mismatch creates inflationary pressures
in the economy. This situation is regarded as unsustainable, as the high growth
translates into higher inflation. In this situation, the RBI raises interest rates to
depress
spending and reduce the pressure on inflation.

OBJECTIVE OF STUDY

Full Employment:- One of the objectives of monetary policy is attain full


employment. It is not only because unemployment leads to wastage of potential
output. But also because of the loss of social standing and self- respect.It also breeds
poverty

Price stability :- Another objective of monetary policy is to stabilize the price


level. Both , rising and falling prices a r e bad as the bring unnecessary loss to some
and undue advantage to others. They are associated with business cycles. So a policy
of price stability keeps the v alue of money stable,eliminates cyclical
fluctuations.Brings economic stability, helps in reducing inequalities of income and
wealth, secures social justice and promotes economic welfare .

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Economic growth :-Monetary policy can be imposed to influence the rapid
economic growth. Economic growth is defined as the process whereby the real per
capita income of a country increases over a long period of time it is
measured by the increase in the amount of goods and services produced in a country.
A growing economy produces more goods and services in
each successive time period. Thus, growth occurs when an economy thus, economic
growth implies raising the standard of living of the people, and reducing inequalities
of inequalities of income distribution.

REVIEW OF LITERATURE

Industry Effects of Monetary Policy:


Evidence from India

Saibal Ghosh

Abstract

The study exploits 2‐digit level industry data for the period 1981‐2004 to ascertain the

interlinkage between a monetary policy shock and industry value added. Accordingly, we first

estimate a Vector Auto Regression (VAR) model to ascertain the magnitude of a monetary policy

shock on industrial output. Subsequently, we try to explain the observed heterogeneity in terms

of industry characteristics. The findings indicate that (a) industries exhibit differential response to

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a monetary tightening and (b) both interest rate and financial accelerator variables tend to be

important in explaining the differential response.

Monetary Policy:Its Impact On The Profitability Of Banks In India


Punita Rao, (Email: puni12@hotmail.com), K. J. Somaiya College Of Arts & Commerce, Mumbai, India

ABSTRACT

This purpose of this study is to investigate the impact of monetary policy on the profitability of

banks in the context of financial sector reforms in India. We discuss the financial sector reforms

and the implication of the banks, the various instruments of monetary policy in India, and the

impact of monetary policy on the profitability of banks.

MONETARY POLICY, CAPITAL ADEQUACY REGULATION AND


BANKING SYSTEM SOUNDNESS IN INDIA

Journal of Financial Management & Analysis, January 2008 by


Adolphus J. Toby
Summary:
The purpose of this research is two-fold. First, the study was intended to determine
the effects of bank liquidity management practices (monetary policy outcomes) on
industry asset quality, measured with the proportion non-performing loans (npls) in
the loans portfolio. Second, we also investigated the effects of capital adequacy
regulation on selected bank asset quality and efficiency measures. Relevant data
were generated from the Central Bank of Nigeria (C.B.N.) and Nigeria Deposit
Insurance Corporation (N.D.l.C.) official sources, including the balance sheets of
selected Nigerian quoted banks. With the estimation of eight multiple regression
equations, we found that the use of the minimum liquidity ratio (MLR) is irrelevant
in controlling industry npls. The objective of controlling banking sector liquidity in

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the Nigerian industry with the MLR may rather increase industry npls and culminate
in high risk concentrations. The cash reserve ratio (CRR) is a more effective tool in
controlling the level of npls in the industry as a whole and the distressed banks in
particular. As the ratio of equity to loans advances increases, we should expect the
classified loans ratio to decrease and asset quality to rise, and vice versa. Under
regimes of rising equity-to-total-assets (ETA) ratio, we should expect the loan loss
reserves ratio to fall, and vice versa

Global financial crisis and monetary policy response in India


by Mr Deepak Mohanty, Executive Director of the Reserve Bank of India,12 November 2009.

As the crisis intensified, the Reserve Bank, like most central banks, took a number
of conventional and unconventional measures to augment domestic and foreign exchange
liquidity, and sharply reduced the policy rates. In a span of seven months between October
2008 and April 2009, there was unprecedented policy activism. For example: (i) the repo rate
was reduced by 425 basis points to 4.75 per cent, (ii) the reverse repo rate was reduced by
275 basis points to 3.25, (iii) the cash reserve ratio (CRR) was reduced by a cumulative
400 basis points to 5.0 per cent, and (iv) the actual/potential provision of primary liquidity was
of the order of Rs. 5.6 trillion (10.5 per cent of GDP).

RBI may halt policy tightening on slowing growth: Moody's


Accord Fintech. Mumbai: Oct 13, 2010.

Abstract (Summary)
Industry players interpret this as the impact of continuous monetary tightening
by the RBI and therefore want the central bank to take a pose in next policy review.
'...the RBI should not raise policy rates any further as it could have a negative impact
on consumer demand as well as corporate investment and thereby slowdown
economic growth,' said the confederation of Indian Industries (CII) said in a
statement.

Indian Banks - The Effects of Confused Monetary Policy


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August 7, 2006
The Reserve Bank of India has, like most Central Banks
in the world, been following a dear money policy for the last few
months and had recently increased its lending and refinance rates.

The normal effect of this would be for banks to revise their lending and deposit
rates. The Government of India has however stepped into the
picture and asked banks to think again before passing on the hike.

This analysis takes a look at this confusion in Indian monetary policy and how
it will impact:
a. Banks Profitability
b. Availability of funds to trade and industry
c. Other factors

Money and Monetary Policy in Less Developed Countries: Survey of Issues and
Evidence
Warren L. Coats, Jr. and Deena R. Khatkhate
In less developed countries money's role need neither be denigrated nor exaggerated.
Money's traditional functions as medium of exchange and store of value remain
important in these countries, but its function as a conduit of resources from savers to
investors is more central to an understanding of its contribution to development. This
view of money and monetary policy in the less developed countries has been
strengthened in recent years by a growing body of theoretical and empirical work in
this area. This paper attempts to survey many of the issues which have been dealt
with both by academic economists and policy-makers, to throw light on some of the
important issues still remaining to be explored and to show the extent to which some
of the core ideas are supported by the empirical evidence gathered from several less
developed countries.

FM opposes tight monetary policy to check rising prices


Express news service Tags : Pranab Mukherjee, RBI, D Subbarao, inflation
Posted: Sun Sep 20 2009, 01:58 hrs Bangalore:

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Finance minister Pranab Mukherjee today said he does not favour a
hike in lending rates at this stage to tame inflationary pressures as
doing so would hurt economic growth. “At this point of time, I
cannot accept a dear money policy or credit curbs as it will have an
adverse impact on growth,” Mukherjee told reporters. His remarks
echoed RBI governor D Subbarao’s comments a few days back that
the RBI would not exit from stimulus measures unless sure of a
sustained economic recovery.

METHODOLOGY
We have identified four economic variables in the above model, which links
the transmission process. Recent developments in the economic literature
mostly depend upon two types of methodologies in order to analyze
the transmission process. The first category uses simulation methods based
upon general equilibrium models and second one depends upon vector
auto- regression methods. Present study employs vector auto regression method
in order to analyze the transmission mechanism.
In Indian context data are available on nine specified sectors by economic
activity viz.
1.agriculture
2.mining and quarrying
3.manufacturing,
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4.electricity, gas and water supply
5.construction
6.trade hotels
7.transport & communication
8.financing, insurance, real estate & business services
9.community, social & personal services.
So we have nine sector specific models in order to identify the differential
impacts of the monetary policy.

ANALYSIS OF IMPACT OF MONETARY POLICY

While considering the impact of monetary policy on the structure of the economy
through its impact on spending in various sectors, wealth adjustment process is the
appropriate framework for the analysis. Brunner and Meltzer1 have developed a compatible
framework for analyzing the monetary policy (wealth adjustment process in a stock-flow
dimension) in a series of papers. Monetary policy actions (for example increase in base
money) disrupt the prevailing allocation pattern of financial assets. Agents will try to adjust
the portfolio in their desired position. Operation of prices (interest rates), which is closely
associated with the asset allocation process, modifies the response of money sock and total
volume of financial assets. The conversion of financial and physical assets depends upon
1

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the rate of return and risk. The conversion process is determined by the prices and income.
The asset allocation process will accelerate (or decelerate) the pace of real economic
activities. Monetary policy influences the asset allocation and conversion process through
the changes it makes in the relative prices.

CONCLUSION

The overall monetary and macroeconomic conditions are, at present quite


satisfactory and in line with the policy expectations. India needs to further improve upon
the financial sector reforms. Nevertheless the Reserve Bank would continue to keep a
constant watch on the domestic and external situation. Monetary policy is guided by the
objective of provision of adequate liquidity to meet credit growth and support investment
demand in the economy while monitoring carefully the movements in the price level. The
policy stance continues to be one of preference for a soft and flexible interest rate
environment within the framework of macroeconomic stability.

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BIBLOGRAPHY

• Analysis by: Nitish Grover


• Analysis of: Banks Listen to their Master's Voice

• www.business-standard.com

• Journal of Financial Management & Analysis, January 2008 by


• Adolphus J. Toby

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