monetary policy

PRESENTATION BY MR. CHANDAN GUPTA MR. GIRISH BHATT MR. J. SHARMA MR. NEERAJ K. JHA MR. R. VIKAS NEGI MR. S. PRAKASH

ACKNOWLEDGEMENT We are very much thankful to those people from whom we have got help during the preparation of this presentation. W e wish to express our gratitude to Ms. Shagun Arora of NIS Academy under whose advice and guidance we have completed this presentation. This presentation is prepared by the full cooperation of our team members with team spirit

WHAT IS MONETARY POLICY The part of the economic policy which regulates the level of money in the economy in order to regulate inflation, improve balance of payments, increase gross national product etc. RBI, in case of India controls the monetary policy. The policy statement traditionally announced twice a year through which RBI insures Price stability for the economy. April-September - Slack Season Policy October-March - Busy Season Policy RBI reserves its right to alter monetary policy to time to time depending upon state of economy

AIM OF MONETARY POLICY Maintain price stability Flow of credit to the productive sector of economy Stability of national currency Growth in employment & income Achieving foreign exchange stability Managing suitable level of investment and savings Regulating rate of interest & induce higher level of investment Achieving monetary equilibrium to ensure equality between demand & supply of money.

QUANTITATIVE - Tools Bank Rate-The rate at which RBI extends credit to comm. Banks . CRR-The percentage of bank’s deposits which they must keep as cash with RBI. SLR-A comm. Bank has to keep a portion of total deposits with itself in liquid assets. Open Market Operations LAF – Repo & reverse Repo MSS – Market stabilization scheme

Qualitative Monetary Control Selective quality control Rationing of credit. Margin requirement Variable interest rate Regulation of consumer credit Licensing to ensure proper regional coverage They can be negative in character intended to discourage activities which are regarded as inessential or undesirable.

Recommendation of Narshimham committee Nov.1991 SLR should not be used for directed investment in PSUs. It should be lower down to minimum limit of 25% CRR should be lower than the present rate. As an instrument it should be used less & Govt. should depend upon OMOs. Selective credit control should be slowly phased out Prime lending rate of commercial bank should be independent of RBI control

BANK RATE Banks use this rate to price their Long term loans to individual and companies Increase in Bank rate Increase in lending rate of Commercial Banks Decline in aggregate money expenditure lowering inflation and vice versa. This tool now not much in use and remains same since years .

Bank Rate TRENDS OF BANK RATE In 1940’s BR was at low 3% and remained unchanged till 1953.In 1953 RBI adopted policy controlled expansion BR raised to 3.5%.It reached at max. level in 1991 12%. Presently it is 6%

CASH RESERVE RATIO RBI has the power to vary this ratio and there by use it as an instrument of Credit Control. Permissible limit is 3 to 15%(1962) It is essential for a bank to maintain the ratio or otherwise it may not be able to meet the withdrawal demand of all its depositors, and failure to do so may eventually result in failure of the bank. Increase in CRR reduce the excess reserves available to a bank for lending contracting Credit Increase in CRR absorbs Foreign Capital Inflows checking rupees appreciation.

TRENDS OF CRR In beginning it was 5% of demand deposit & 2% of time deposits Reached max. in 1991,92 after 1993 it followed Narsimham report & decreased. But from dec.06 it raised 7 times, 250bp to cool credit growth & supply .

STATUTORY LIQUIDITY RATIO Statutory Liquidity Ratio Narsimham committee recommended to reduced it at minimum level. According to that it is 25%and remains unchanged. Khan committee suggested abolishment of SLR. The buying & selling of these securities laid the foundation of the 1992 Harshad Mehta scam.

TRENDS OF SLR It was 25% in 1949 after that it increased continuously 32%(1972)--- 35% (1981)---36%(1984)--- 38%(1988). From 1997 it is constant at 25%

OMOs-Meanings & Objectives Open Market Operations-these refer to the sale and purchase of Govt. securities by the RBI The main objective of these operations has been to stabilizes the prices of Govt. securities. The control of inflationary pressures has, however been the secondary objectives. It is used several times after 1991 for controlling inflows.

OMO - TOOLS Repo Rate This is the rate at which the central bank adds funds to the monetary market. Present rate 7.75% Reverse Repo Rate The rate at which the central bank borrows funds from the market. It impacts Govt. bond yields and short term bank deposits. Present rate 6%

Factors Effecting Monetary Policies Govt. agenda and development plans Recommendation of Narshimham committee,Tarapore committee and Khan committee report. Inflation and price situation. Credit and liquidity condition. Foreign money inflow (specially USD) IMF and World bank.

EFFECTS OF GLOBAL ECONOMY ON RBI MONETARY POLICY The RBI is likely to keep its Monetary policy tight in view of the uncertainties in global financial markets and high prices of crude oil and food items. The US Fed Reserves rate cuts put pressure on RBI to lower rates. The immediate pressure would come from the FOREX market with bankers expecting the rupees to firm up against the USD.

Devaluation of Rupees RBI in extraordinary condition devaluated Rupees 3 times in past . In Sep.1949-30.5%.(Due to Shadow of Colonial system and aim of overall growth). In June 1966-36.5%(Due to crop failure and Indo-pak.war). In 1991-20% in 3 phase (Due to economic stagnation and failure of PSUs). After 1992-93 Rupees headed towards full convertibility. Now value of Rupees almost depends upon free market forces of demand &supply.

EFFECTS OF POLICY ON INDIAN ECONOMY (A) Interest Rate 1990 1994 1995-97 2003 All sector-specific The minimum rate The ceiling on Bank were Interest rate prescriptions prescription withdrawn. rate on deposits advised to Were abolished Bank free to charge were removed announce a PLR benchmark PLR 2008 Bank are advised to be Proactive in credit scenario 1.Economy opens in 1990 and reforms start. 2.Narsimham committee for autonomy in banking sector. 3.Second generation reforms from 2001. 4.Banks have to compete with multinational banks in 21 st century.

EFFECTS OF MONETARY POLICY ON ECONOMY (B) Inflation & price control It is characterized by increase in quantity of money in proportion to buying power. According to Castle and Keynes domestic price stability should be main objective of central bank’s monetary policy. RBI declared its policy endeavour would be to keep inflation close to 5%. For controlling inflation RBI adopted cheap or dear credit policy and selective credit control .

EFFECTS OF MONETARY POLICY ON ECONOMY (C) On Foreign Exchange RBI has to maintain equilibrium rate of exchange because any change in rate will have repercussion on BOP of India. RBI generally uses CRR and Repo rates for checking inflow or outflow foreign currency From 2000 control of RBI on foreign exchange become less under FEMA act. 2001 onwards exchange rate is decided by market forces and RBI only monitor the process.

Catch 22 situation First situation:- USD inflow > appreciation of INR > increase in trade deficit > any further increase completely ruin the Export economy. RBI has no option but to check this trend. Second situation:- OMOs by RBI or increase in reserve rates > Credit crunch >costly loan + soaring oil prices>manufacturing slow down >economic slow down +price rise>inflation. Due to political compulsion, it is clear mandate before RBI that inflation should remain lower than 5%.

Catch 22 situation(cond.) Currently RBI is in dilemma regarding credit policy because its exchange rate goals and inflation targeting at loggerheads with each other. This leaves RBI in a precarious position. The RBI has to chose between Rs. appreciation and inflation with each of them worse than the other .

Dr. Reddy’s Policy Prescriptions

MONETARY POLICY REVIEW – Jan 29/08 No change in key policy rate owing to continuing inflation concerns overweighting emphasis on growth . Inflation tolerance band reduced to 4 to4.5%. Reddy hinted at further policy measures to curb capital inflows and reduce the impact of already intensified risk to inflation

EXPERT’S VIEWS “ Monetary policy must accommodate primary supply shocks and then curbs secondary effects. The prime aim of Monetary policy should be targeting stability.” Raghuram C Rajam, economist “ We maintain the view that policy rates have peaked but for several reasons do not expect the RBI to cut policy rate at least until the July08,quaterly policy meetings.” India report , JP Morgan Chase

LIST OF BOOKS Books: Economics, ICAI Fundamental of Economics- A.S.Raj Managerial Economics- Varshney & Maheshwari Macro Economics- TMH Dictionary of Economics- Jain and saakshi. Indian Economy since Independence- edited by Uma Kapila Indian Economy- Dutt and Sundaram

LIST OF PERIODICALS Dailies/Periodicals- Economic Times Hindustan Times-Business Business Line Dalal Street (Oct 1-14,07) Business World (Sept 17,07) Financial Express Business Standards Business and Economy(Oct 5-18) The Hindu

List of Websites ` www.rbi.gov.in www.livemint.com www.bloomberg.com www.timesofindia.com www.thehindu.com

monetary policy

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monetary policy