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RBI – Monetary Policy

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RBI – Monetary Policy

shape Introduction

Monetary policy defines the actions taken by the central bank(RBI) for managing economic growth and inflation. Monetary policy refers to the policy of the RBI with regard to theuse of monetary instruments under its control to achieve the goals specified in the RBI Act,1934.

shape RBI

  • Primary objective is to maintain price stability while keeping in mind the objective of growth.


  • In May 2016, RBI Act, 1934 was amended to provide a statutory basis for the implementation of the flexible inflation targeting framework.


  • The Act also provides for the inflation target to be set by the Government of India, in consultation with the Reserve Bank, once in every five years.

  • Monetary Policy framework aims at setting the policy (repo) rate based on an assessment of the current and evolving macroeconomic situation; and modulation of liquidity conditions to anchor money market rates at or around the repo rate.


  • Repo rate changes transmit through the money market to the entire the financial system, which, in turn, influences aggregate demand –a key determinant of inflation and growth.

  • Section 45ZB of the amended RBI Act, 1934 also provides for an empowered six-member monetary policy committee (MPC) to be constituted by the Central Government by notification in the Official Gazette.


Accordingly, the Central Government in September 2016 constituted the MPC as under:

  • 1. Governor of the Reserve Bank of India – Chairperson, ex officio;


    • 2. Deputy Governor of the Reserve Bank of India, in charge ofMonetary Policy –Member, ex officio;


    3. One officer of the Reserve Bank of India to be nominated by the Central Board – Member, ex officio;


    4. Shri Chetan Ghate, Professor, Indian Statistical Institute (ISI) – Member;


    5. Professor Pami Dua, Director, Delhi School of Economics – Member; and


    6. Dr. Ravindra H. Dholakia, Professor, Indian Institute of Management, Ahmedabad – Member.


Under the amended RBI Act, the monetary policy making is as under:

  • The MPC is required to meet at least four times in a year.


  • The quorum for the meeting of the MPC is four members.


  • Each member of the MPC has one vote, and in the event of an equality of votes, the Governor has a second or casting vote.



shape Instruments

There are several direct and indirect instruments that are used for implementing monetary policy.

Repo Rate:

The (fixed) interest rate at which the Reserve Bank provides overnight liquidity to banks against thecollateral of government & other approved securities under the liquidity adjustment facility (LAF).

Reverse Repo Rate:

The (fixed) interest rate at which the Reserve Bank absorbsliquidity, on an overnight basis, from banks against the collateral of eligible government securities under the LAF.

Liquidity Adjustment Facility (LAF):

  • RBI’s liquidity adjustment facility/LAF helps banks to adjust their daily liquidity mismatches.


  • It has two components which are repo (repurchase agreement)and reverse repo.


  • When banks need liquidity to meet its daily requirement, theyborrow from RBI through repo.


  • The rate at which they borrow fund is called the repo rate. When banks are flush with the fund, they park with RBI through the reverse repo mechanism at reverse repo rate.


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.


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 for long terms. 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 changesalongside policy repo rate changes.


Cash Reserve Ratio (CRR):

The average daily balance that a bank is required to maintainwith 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)(CRR):

  • The share of NDTL that a bank is required to maintain in safeand liquid assets, such as, unencumbered governmentsecurities, cash and gold.


    • Changes in SLR often influence the availability of resources inthe 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,respectively.

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 mobilised is held in a separate government account

  • with the Reserve Bank.


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