Monetary policy
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The document discusses monetary and fiscal policy, highlighting their purposes, objectives, and key instruments, such as interest rates, liquidity, and credit availability. It distinguishes between monetary policy, which regulates money supply and credit costs, and fiscal policy, which uses government expenditure and taxation to influence economic activity. Additionally, it examines specific tools like cash reserve ratio (CRR), repo rate, and open market operations, along with challenges faced by the Reserve Bank of India in implementing effective monetary policy.
Monetary policy
- 1. • Presented By: • Rashmi Vaishya 14 • Sunil Shinde 15
- 2. MONETARY POLICY Regulation of supply of Money and Cost and Availability of Credit in the economy Purpose of Monetary Policy Maintain price stability, ensure adequate flow of credit to the productive sectors of the economy and overall economic growth Variables affected by Monetary Policy in the economy Interest Rates Liquidity Credit Availability Exchange Rates
- 3. FISCAL POLICY Use of “Government Expenditure”, and “taxation” to manage the economy. Purpose of Fiscal Policy Stabilise economic growth, avoiding the boom and bust economic cycle Variables affected by Fiscal Policy in the economy Aggregate demand and the level of economic activity The pattern of resource allocation The distribution of income.
- 4. IMPORTANCE OF MONETARY POLICY Gross National Product (GNP) = C + I + G + X Where: C = Private Consumption expenditure I = Private Investment Expenditure G = Government Expenditure X = Net Exports C, I, X can be influenced by the monetary policy which can also influence the private consumption and investment spending and exports and imports.
- 5. What are the objectives of the Monetary Policy? • Maximum feasible output. • High rate of growth. • Fuller employment. • Price stability. • Greater equality in the distribution of income and wealth. • Healthy balance in balance of payments(BOP) • ensure adequate flow of credit to the productive sectors of the economy.
- 6. How is the Monetary Policy different from the Fiscal Policy? MONETARY POLICY FISCAL POLICY •regulates the supply of money •regulates the cost and availability of credit in the economy •deals with both the lending and borrowing rates of interest for commercial banks •aims to maintain price stability, full employment and economic growth. •defined as a deliberate change in government revenue and expenditure to influence the level of national output and prices •broader tool with the government •used to overcome recession and control inflation
- 7. MONETARY POLICY – RBI’s ROLE Demand for Money Demand for goods/services Ensuring price stability and ensuring savings Control on bank credit when prices rise/fall Instruments such as CRR, OMO & Bank Rate Control on money supply, velocity of circulation of money during inflation
- 8. TYPES OF MONETARY POLICY Quantitative measures Qualitative Measures • Bank rate • Open market operations • Cash reserve ratio (CRR) • Statutory liquidity ratio (SLR) • Rationing of credit • Moral Suasion • Direct Action • Regulation in consumer credit • Marginal standing facility(MSF)
- 9. How does monetary policy affect inflation and other problems???
- 10. Inflation Movement Uncontrolled Inflation despite Further CRR hikes CRR hikes proved to Be effective To curb Inflation Inflation Down on account of global credit crunch http://www.rgemonitor.com/emergingmarkets-monitor/archive/200806/
- 11. BANK RATE POLICY • Bank rate is the minimum rate at which the central bank provides loans to the commercial banks. It is also called the discount rate. • The bank rate has been increased from 12.00% in 1991 8.75% in 2013 9.00% in 2014 Dear money policy Bank rate interest rate borrowing will be less profitable results contraction of credit Near money policy Bank rate interest rate borrowing will be more profitable results expansion of credit
- 12. OPEN MARKET OPERATIONS • An open market operation is an instrument of monetary policy which involves buying or selling of government securities from or to the public and banks. • This mechanism influences the reserve position of the banks, yield on government securities and cost of bank credit • When RBI offers securities for sale, it intends to contract money supply and credit. • When the RBI is pursuing the expansionary monetary policy will buy securities in the market, so that supply and credit capacity will be increased.
- 13. OMO’s TOOL REPO RATE REVERSE REPO RATE Repo rate is the rate at which RBI lends to commercial banks generally against government securities Reverse Repo rate is the rate at which RBI borrows money from the commercial banks tightening of the policy The repo rate is 8.00 % The reverse repo rate is 7.00%. 12 10 8 6 4 2 0 Reverse Repo rate
- 14. Repo and Reverse Repo rates Movement Repo rate reduction due to make credit available at cheaper rates Increased rates to control the liquidity
- 15. CASH RESERVE RATIO • CRR, or cash reserve ratio, refers to a portion of deposits (as cash) which banks have to keep/maintain with the RBI. • During Inflation RBI increases the CRR due to which commercial banks have to keep a greater portion of their deposits with the RBI . • Higher the CRR with the RBI lower will be the liquidity in the system and vice-versa. • This serves two purposes. – ensures that a portion of bank deposits is totally risk-free and – enables that RBI control liquidity in the system, and thereby, inflation • As of today, the CRR is 4%
- 16. Change in CRR… why? In the third quarter review of January 2012 CRR was reduced, to mitigate tight liquidity conditions, by 50 basis points leading to increase in liquidity by Rs.480 billion into the banking system. It has been decided to reduce the minimum daily maintenance of CRR from 99 % 95 % effective from the fortnight beginning September 21, 2013, while keeping the CRR unchanged at 4.0 % This reduction (in CRR from 5.5 per cent to 4.75 per cent) injected around Rs 48,000crore of primary liquidity into the banking system. (Rs 16000crores for every 25 basis points cut in CRR)
- 17. CRR Movement Before 1991 •Government raised funds below market rate •No depth in Government Securities Market •Regulation of deposit rates •Under developed financial markets, Less financial instruments availability Result •Complex, distorted interest rate structure •Adversely affected viability and profitability of banks •Transparency and norms could not be followed strictly
- 18. Boost Economy after 2001 Slowdown / dotcom bubble Stable CRR from 2004 to 2006 Rise in CRR to control liquidity, due to Heavy Capital Inflow & to curb Re Appreciation CRR hikes to curb inflation CRR Cuts to boost economy after Sub prime loss / Global meltdown CRR Movement
- 19. STATUTORY LIQUID RATIO • Every financial institution has to maintain/invest a certain quantity of liquid assets with themselves at any point of time of their total time and demand liabilities before providing credits to its customer. • These assets can be cash, precious metals, approved securities like bonds etc. The current SLR is 23%.
- 20. Stable SLR from 1998 onwards SLR Movement Banks to made available more funds & More Efficiency
- 21. MARGIN STANDING FACILITY • MSF scheme is that in MSF banks can use the securities under SLR to get loans from RBI • During Inflation RBI fixes a high rate of margin on the securities kept by the public for loans • If the margin increases the commercial banks will give less amount of credit on the securities kept by the public thereby controlling inflation • MSF rate is 1% more than repo rate.
- 22. DEFICIT FINANCING • It means printing of new currency notes by RBI • If more new notes are printed it will increase the supply of money thereby increasing demand and prices • Thus during Inflation, RBI will – stop printing new currency notes thereby controlling inflation. – issue new currency notes replacing many old notes • This will reduce the supply of money in the economy
- 23. LIQUIDITY ADJUSTMENT FACILITY • LAF consists of daily infusion or absorption of liquidity on a repurchase basis, through repo (liquidity injection) and reverse repo (liquidity absorption)auction operations, using government securities as collateral • The increase in the policy repo rate under the liquidity adjustment facility (LAF) by 25 basis points from 7.25 % 7.5 %
- 24. EXCHANGE RATE MOVEMENT LAF - To Control Exchange Ratio – Outflow of $ from India Market Sterilization to Control rupee Appreciation
- 25. FOREX RESERVES POSITION The Surge in Foreign Exchange Reserves Sterilization / Selling bonds & Buying dollars
- 26. MONETARY POLICY – TERMINOLOGY • Inflation refers Inflation to a persistent rise in prices Money Supply • Total volume of money circulating in the economy • Minimum rate at which the central bank provides loans to commercial banks Bank Rate •Amount of money that banks must set aside with RBI against their deposits Cash Reserve Ratio (CRR) • Percentage of bank funds to be maintained in government and approved securities Statutory Liquidity Ratio (SLR) Repo Rate • Rate at which RBI lends to other banks against government securities Reverse Repo Rate • Rate at which RBI borrows from other banks Capital Adequacy Ratio (CAR) • Capacity of bank meeting the time liabilities and other risk Open Market Operations (OMO) • Purchase and sale of securities in the open market
- 28. Monetary Policy – Influence Target Variables -Inflation -Interest rate -Real GDP -Employment -Consumption -Savings -Investment Policy Variables - Money supply - OMO: Liquidity conditions - policy rates (CRR, repo etc.)
- 29. FACTORS AFFECTING MONETARY POLICY There exist a non-monetized sector Excess of non-banking financial institutions (NBFI) Existence of unorganized financial market Money not appearing in an economy Time lag affects success of monetary policy Monetary policy and fiscal policy lacks coordination
- 30. IMPACT ON INDIA Money and credit market Local Institutions Domestic Banks Domestic MFs NBFC Re $ Financial Channel
- 31. 31 CHALLENGES FOR RBI Growth amid Global economic slowdown
- 32. LIMITATIONS – MONETARY POLICY Cannot simultaneously stimulate economic demand to reduce unemployment and restrain demand to combat inflation Monetary policy is restricted by the impact of other government actions, especially Fiscal policy, i.e. decisions about government expenditures and taxation Problems of an inflexible labour market, inadequate infrastructure and, most important, fiscal policy whose discipline is open to question limits the effectiveness of the Monetary policy 32 Monetary Policy cannot work in isolation!!