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RBI & its Monetary Policy

07 Cherylann Carvalho
49 Tejas Sura
21 Sneha Kamath
26 Sunil Makhecha
20 Dipti Joshi
19 Abhishek Gohil
18 Bijal Gandhi
13 Pratik Dodhia
Contents
1. The RBI
2. What is Monetary Policy?
3. Instruments of Monetary Policy
4. Limitations of Policy
5. Recent Trends
6. The Way Forward
The Reserve Bank of India
• INDIA’S CENTRAL BANK – History
– Established in April 1935 , nationalized in 1949
– Served as Central Bank of Burma & Pakistan
– Operates under the Reserve Bank of India Act, 1934 (II
of 1934)
• Management :
– Central Govt. from time to time can give directions to
the Bank, otherwise the Governor shall also have
powers of general superintendence.
– The Governor of the RBI is supported by a Central
Board and 4 regional local boards - Mumbai, Calcutta,
Chennai and New Delhi.
Functions of the RBI
• Core functions-Traditional
– Monetary Authority , Regulator and
supervisor of the Financial system, Manager
of Foreign Exchange, Issuer of currency and
other Related Functions
• Developmental Role
– To support national objectives such as
ensuring orderly growth, Extending the
organized financial sector to all parts of the
economy, Service to common man.
What is Monetary Policy
• General objectives of Central banks -> price
stability, currency stability, financial stability,
growth in employment and income.
• The major objectives of monetary policy in India->
price stability , ensuring adequate flow of credit to
the productive sectors of the economy and financial
stability.
• Communicated to the public through an annual
policy statement in April and a mid-term review in
October.
• The Monetary Policy regulates the supply of money
and the cost & availability of credit in the economy.
It also deals with both the lending and borrowing
rates of interest for commercial banks.
Instruments of Monetary
Policy
• Quantitative/ Traditional Measures
– Open Market Operations
– Discount Rate or Bank rate
– Reserve Requirements
– Direct Control Measures
• Qualitative Credit Controls
– Selective Credit
– Moral suasion
Open Market Operations
(OMO)
• Purchases & Sale of Government Securities &
Treasury Bills
• OMO conducted through commercial banks
• Supply of Money with the Public
– Increase – RBI purchases
– Decrease – RBI sells
• Supply of and demand for credit
– RBI purchases – increases deposits and cash reserves
of banks – supply of and demand for credit increases
– RBI sells – reduces deposits and cash reserves of
banks – supply of and demand for credit decreases
Ineffectiveness of OMO
• When commercial banks have high
liquidity, OMO are ineffective
• In Buoyant market, credit demand is
difficult to control through OMO
• In Depressed market, OMO are
ineffective due to lack of credit demand
• Government Debt Instruments are not
popular due to low rate of return. RBI
forces commercial banks to buy
Government Bonds
Cash Reserve Ratio (CRR)
• CRR is the ratio of demand and time liabilities
which the commercial banks are required to
maintain in form of cash with Central Bank
• Demand Liabilities are payable on demand
• Time Liabilities are payable on maturity
• Applicable to Scheduled Commercial Banks,
Regional Rural Banks, Scheduled State Co-
operative Banks.
• Cash Reserves are non – interest bearing in nature
• Currently at 5.75%
Cash Reserve Ratio (CRR)
• Increase in CRR means higher cost of funds and
banks have less funds for investments, money
is sucked out of circulation and vice versa
• Tool for liquidity control thereby curb on
inflation, by restricting the banks from lending
money
• Inflexible system, uniformly applicable to all
banks across all regions irrespective of the size
and reserve position.
Statutory Liquidity
Requirement (SLR)
• SLR refers to the ratio of deposits which
commercial banks are required to maintain with
them in the form of liquid assets
• Liquid Assets - Cash / Gold / Government
Securities
• Limits
– Minimum – 25%
– Maximum – 40%
• Objectives
– To discourage banks to sell liquid assets during
hikes in CRR
– To ensure solvency of bank
Bank Rate / Discount Rate
• Rate at which RBI lends money to the
commercial banks
• By rediscounting bills of exchange or buying of
eligible securities for purchase
• Current Bank Rate : 6%
• Objective
– To support banks facing shortage of cash reserves
– Lender of Last Resort
Direct Market Controls
• Repurchase Agreement - REPO
– RBI buys securities from the commercial
– An agreement between RBI and the selling
bank to repurchase the same on the due date
– Leads to expansion of money supply in the
system
– Current Rate : 4.75%
Direct Market Controls
• Reverse Repurchase Agreements –
REVERSE REPO
– RBI sells securities to the commercial
– An agreement between RBI and the buying
bank to repurchase the same on the due date
– Leads to contraction of money supply (M3) in
the system
– Current Rate : 3.25%
Direct Market Controls
• Liquidity Adjustment Facility (LAF) Scheme
– To help banks manage day – to – day mismatches
– Operated through REPO & Reverse REPO auctions
– Transferable Government Securities & Treasury Bills
– Conducted on Daily Basis
– Minimum Bid Size : Rs. 5 Crores and in multiples thereof
Direct Market Controls
• Market Stabilisation Scheme (MSS)
– To absorb excess liquidity for managing
large and persistent capital inflow
– Auction of Securities / Bonds issued by RBI
– RBI decides the amount, tenure and dated
securities
– Communicated through Press Release
Qualitative Control
Techniques
• Techniques aim at regulating the direction
and distribution of bank credit to particular
sectors/ segments of the economy
according to the needs of time and national
priority

• 2 Types of Qualitative Control Techniques:


– Selective credit control methods
– Moral Suasion
Selective Credit Control
Methods
• Availability of bank credit to priority or weaker
sectors
• Arises when there is shortage of available credit
to priority or weaker sectors
• Checks the misuse of borrowing facilities
• Helps achieving socially desirable objectives like
controlling and checking speculative trading and
hoarding of sensitive commodities
Moral Suasion
• Directions given by the central bank
to commercial banks in respect of
their lending and other operations

• Due to the unique position of the


central bank no banks can ignore any
advice given by the central bank
Limitations of Monetary
Policy
• The time lag
– Inside Lag
– Outside Lag
• Problem in forecasting
• Non-banking financial intermediaries
• Underdevelopment of money and
capital markets
The Year that was .. FY 08-
09
Date Bank Reverse Repo Repo Rate Cash Reserve Statutory
Rate Rate Ratio Requirement Ratio
April 26, 2008 6.00 6.00 7.75 7.75 (+0.25) 25

May 10, 2008 6.00 6.00 7.75 8.00 (+0.25) 25

May 24, 2008 6.00 6.00 7.75 8.25 (+0.25) 25

June 11, 2008 6.00 6.00 8.00 (+0.25) 8.25 25

June 25, 2008 6.00 6.00 8.50 (+0.50) 8.25 25

July 5, 2008 6.00 6.00 8.50 8.50 (+0.25) 25

July 19, 2008 6.00 6.00 8.50 8.75 (+0.25) 25

October 11, 2008 6.00 6.00 8.00 (-0.50) 6.50 (-2.25) 25

October 20, 2008 6.00 6.00 8.00 6.50 25

October 25, 2008 6.00 6.00 8.00 6.00 (-0.50) 25

November 03, 2008 6.00 6.00 7.50 (-0.50) 6.00 25

November 08, 2008 6.00 6.00 7.50 5.50 (-0.50) 24 (-1.00)

December 08, 2008 6.00 5.00 (-1.00) 6.50 (-1.00) 5.50 24

January 05,2009 6.00 4.00 (-1.00) 5.50 (-1.00) 5.50 24

January 17,2009 6.00 4.00 5.50 5.00 (-0.50) 24

March 05,2009 6.00 3.50 (-0.50 5.00 (-0.50) 5.00 24


The Year that was .. FY 08-
09
• The cash reserve ratio (CRR) was reduced from 9
per cent (September 2008) to 5 per cent by early
January 2009 injecting nearly Rs.1,60,000 crore of
primary liquidity in the system.
• Fresh issuances under MSS were stopped and
buyback of existing MSS securities was also
resorted to to inject liquidity into the system.
• Other measures taken by the Reserve Bank in
response to the global financial crisis include cut
in the statutory liquidity ratio (SLR).
The Year that was .. FY 08-
09
• The policy rates were also cut - the repo rate by 400
basis points from 9.00 per cent to 5.00 per cent and
the reverse repo rate by 250 basis points from 6.00 per
cent to 3.50 per cent.
• Opening of new refinancing windows, refinance to
SIDBI and EXIM Banks, and clawing back of prudential
norms in regard to provisioning and risk weights.
• The measures to improve forex liquidity included
increase in interest rate ceilings on non-resident
deposits, and easing of restrictions on external
commercial borrowings and on short-term trade
credits.
Year of Consolidation .. FY
09-10
Date Bank Reverse Repo Repo Rate Cash Reserve Statutory
Rate Rate Ratio Liquidity
Requirement
April 21,2009 6.00 3.25 (-0.25) 4.75 (-0.25) 5.00 24

October 27,2009 6.00 3.25 4.75 5 25

January 29,2010 6.00 3.25 4.75    5.75  (+0.75) 25


Year of Consolidation .. FY
09-10
• The following measures constitute the first phase of ‘exit’:
• The statutory liquidity ratio (SLR), which was reduced from 25
per cent of demand and time liabilities to 24 per cent, is
being restored to 25 per cent.
• The limit for export credit refinance facility, which was raised
to 50 per cent of eligible outstanding export credit, is being
returned to the pre-crisis level of 15 per cent.
• The two unconventional refinance facilities:
1. special refinance facility for scheduled commercial banks; and
2. special term repo facility for scheduled commercial banks [for
funding to mutual funds (MFs), non-banking financial companies
(NBFCs), and housing finance companies (HFCs)] are being
discontinued with immediate effect.
Year of Consolidation .. FY
09-10
• The cash reserve ratio (CRR) of
scheduled banks has been increased by
75 basis points in two stages from 5.0 per
cent to 5.75 per cent of their net demand
and time liabilities (NDTL). As a result of
the CRR increase, about Rs.36,000 crore
of excess liquidity will be absorbed from
the system.
• The policy rates, both the repo rate and
the reverse repo rate have been retained
at their current levels.
The Way Forward…
The Way Forward…
• The stance of monetary policy for the
remaining period of 2009-10 will be as follows:
– Anchor inflation expectations and keep a vigil on
the trends in inflation and be prepared to respond
swiftly and effectively through policy adjustments
as warranted.
– Actively manage liquidity to ensure that credit
demands of productive sectors are adequately met
consistent with price stability.
– To maintain an interest rate environment consistent
with price stability and financial stability, and in
support of the growth process.