In this blog, we bring to you a comprehensive overview of the Monetary Policy of India.
Monetary Policy of India is one of the most common topics that Banking Exams and Government Exams aspirant needs to be aware of. There might be questions from the topic in general awareness sections of various exams like IBPS Clerk, IBPS PO, SBI PO, Canara Bank PO, RBI Grade B, SSC CGL etc.
Monetary Policy of India – This is the most powerful tool used by the Reserve Bank of India to influence the economic activity in the country. Monetary policy is concerned with the management of interest rates and the total supply of money in the economy. It refers to the policy of the central bank with regard to the use of monetary instruments under its control to achieve the goals specified in the Reserve Bank of Act 1934. The Reserve Bank of India (RBI) is vested with the responsibility of conducting monetary policy.
Monetary Policy of India – Definition and Objectives
- It is the policy that is used by the central bank i.e. Reserve Bank of India controls the supply and availability of money in the economy with the objective of economic growth.
- Central bank, RBI in case of India controls the cost of short term borrowing often targeting the inflation-rate or interest rate to ensure price stability and maintain general trust in the economy.
- So Monetary policy has twin objectives: Price Stability and Economic Growth
Monetary Policy of India – Types of Monetary Policies
Basically there are two types of Monetary Policies.
- Expansionary Monetary Policy – As part of expansionary monetary policy, RBI lowers the interest rates leading to increased consumer spending on a variety of goods and services thereby increasing the money supply in the economy. With low-interest rates loans, businesses make investments leading to an increase in employment and common man gets higher disposable income that can be used in all kinds of purchases and investments. If the country is facing the problem of unemployment, recession and slowdown, it can opt for expansionary monetary policy.
- Contractionary Monetary Policy – As part of contractionary monetary policy, RBI increases the interest rates to bring down inflation, to reduce money supply in the economy thus making spending unfavourable and thereby promoting savings. To contain inflation and to keep the cost of living in check RBI opts for contractionary monetary policy.
Monetary Policy of India – Monetary Policy Committee
The MPC determines the policy interest rate required to achieve the inflation target.
Section 45ZB of the amended RBI Act 1934 provides for a six-member monetary policy committee (MPC) to be constituted by the Central Government. Accordingly, the Central Government in September 2016 constituted the MPC as under:
- Governor of the Reserve Bank of India – Chairperson;
- Deputy Governor of the Reserve Bank of India, in charge of Monetary Policy – Member;
- One officer of the Reserve Bank of India to be nominated by the Central Board – Member;
- Shri Chetan Ghate, Professor, Indian Statistical Institute (ISI) – Member;
- Professor Pami Dua, Director, Delhi School of Economics – Member; and
- Dr. Ravindra H. Dholakia, Professor, Indian Institute of Management, Ahmedabad – Member.
Monetary Policy of India- Instruments of Monetary Policy
There are several Direct and Indirect instruments that RBI uses for implementing the Monetary Policy.
- Repo Rate: The interest rate at which the Reserve Bank provides overnight liquidity to banks against the collateral of government securities under the liquidity adjustment facility (LAF).
- Reverse Repo Rate: The interest rate at which the Reserve Bank absorbs liquidity on an overnight basis from banks against the collateral of eligible government securities under the LAF.
- Liquidity Adjustment Facility (LAF): The LAF consists of overnight as well as term repo auctions. The Reserve Bank has increased the proportion of liquidity injected under variable rate repo auctions of range of tenors. The aim of term repo is to help develop the inter-bank term money market, which in turn can set market-based benchmarks for pricing of loans and deposits, and hence improve the transmission of monetary policy. The
- Marginal Standing Facility (MSF): A facility under which scheduled commercial banks can borrow additional amount of overnight money from the Reserve Bank by dipping into their Statutory Liquidity Ratio (SLR) portfolio up to a limit at a penal rate of interest. This provides a safety valve against unanticipated liquidity shocks to the banking system.
- Corridor: The MSF rate and reverse repo rate determine the corridor for the daily movement in the weighted average call money rate.
- Bank Rate: It is the rate at which the Reserve Bank is ready to buy or rediscount bills of exchange or other commercial papers. The Bank Rate is published under Section 49 of the Reserve Bank of India Act, 1934. This rate has been aligned to the MSF rate and, therefore, changes automatically as and when the MSF rate changes alongside policy repo rate changes.
- Cash Reserve Ratio (CRR): The average daily balance that a bank is required to maintain with the Reserve Bank as a share of such per cent of its Net demand and time liabilities (NDTL) that the Reserve Bank may notify from time to time in the Gazette of India.
- Statutory Liquidity Ratio (SLR): The share of NDTL that a bank is required to maintain in safe and liquid assets such as unencumbered government securities, cash and gold. Changes in SLR often influence the availability of resources in the banking system for lending to the private sector.
- Open Market Operations (OMOs): These include both, outright purchase and sale of government securities for injection and absorption of durable liquidity.
- Market Stabilisation Scheme (MSS): This instrument for monetary management was introduced in 2004. Surplus liquidity of a more enduring nature arising from large capital inflows is absorbed through sale of short-dated government securities and treasury bills. The cash so mobilized is held in a separate government account with the Reserve Bank.
So this was an overview of the monetary policy of India. Read it completely, be thorough about it and never miss on any marks in the upcoming exams.