What is all the whole fuss about monetary policy?

What is a Monetary Policy?

It is a policy laid down by central bank of India i.e. RBI to manage the supply of money to match the demand of money to achieve price stability i.e. control inflation and economic growth. It is responsible for everything on macro level like financial markets, interest rates control, regulations on financial institutions etc.

How often does RBI announce monetary policy?

RBI announces Monetary Policy in April of every year. It is followed by three quarterly reviews. However, RBI has its own discretionary powers to announce the required measures in policy interim. The current year monetary policy announcement details are as follows - https://rbi.org.in/Scripts/Annualpolicy.aspx

How does RBI implement monetary policy?

The various instruments used by RBI to implement the monetary policy are as follows:

Open Market Operations – In the case of excess money supply, RBI uses sale of Government-securities to suck out rupee from system. Similarly, when there is a limited money supply in the economy, RBI buys Government securities from the market, thereby releasing liquidity. It is followed as and when needs arises.

Liquidity Adjustment Facility- RBI uses the Repo Rate and Reverse Repo Rate for introducing / pulling out of liquidity in line with the prevailing monetary policy stand. The repo rate (at which liquidity is introduced) and reverse repo rate (at which liquidity is pulled back) under the Liquidity Adjustment Facility (LAF) are the main weapons of the Reserve Bank’s interest rate indicating in the Indian economy. The details of current repo rate can be viewed over here – https://www.rbi.org.in/Home.aspx

Marginal Standing Facility – It can be understood as the temporary arrangement of the commercial and other co-operative banks to meet their fund requirement. They can raise these funds against their G-secs holding at a rate of 100 basis points more than the existing repo rate.

Statutory Liquidity Ratio The banks and other financial establishments in India have to keep a certain percentage of their net time and demand liabilities in the form of liquid assets such as G-secs, precious metals or any other approved securities etc. This is called as Statutory Liquidity Ratio (SLR). The current SLR rate is at 21%. Similarly, there is a CRR rate where every bank is supposed to maintain a portion of money in cash form. The current CRR rate is 4%.

Bank Rate - the rate at which RBI provides loan to other banks which includes commercial / cooperative banks, development banks etc is known as bank rate. This is usually against bills of exchange or commercial papers.

Credit Ceiling Under the credit ceiling, RBI manages the bank eligibility to the extent / limit they can get credit. It ensures that the bank is not over exposed to high risk and depositors’ money is not defaulted. It can even direct the banks to direct certain portion of their loans towards farming or other priority sector.

Who decides the policy rate?

“The Reserve Bank’s Monetary Policy Department (MPD) assists the Governor in formulating the monetary policy. Views of key stakeholders in the economy, advice of the Technical Advisory Committee (TAC), and analytical work of the Reserve Bank contribute to the process for arriving at the decision on policy repo rate. The Financial Markets Operations Department (FMOD) operationalizes the monetary policy, mainly through day-to-day liquidity management operations. The Financial Markets Committee (FMC) meets daily to review the consistency between policy rate, money market rates, and liquidity conditions.

The Governor, one Deputy Governor and one officer of the Bank would be the ex-officio members of the Committee. The other three members shall be appointed by the Central Government as per the procedure laid down in the amended RBI Act. The Committee will determine the policy interest rate required to achieve the inflation target.”- (reproduced from RBI website)

Regards

Saarthi Financial Planners