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RBI Monetary Policy

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RBI Monetary Policy

Reserve Bank of India

shape Introduction

RBI Monetary Policy 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 Act. Reserve Bank of India (RBI) is responsible for conducting monetary policy. The responsibility is explicitly mandated under the Reserve Bank of India Act, 1934.

shape MP

Monetary Policy is how central banks manage the money supply to guide healthy economic growth.

  • The money supply is credit, cash, checks, and money market mutual funds.

  • The most important of these is credit, which includes loans, bonds, mortgages, and other agreements to repay.

  • The 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.

Monetary Policy Committee (MPC):
According to the section 45ZB of the amended RBI Act, 1934 provides for an empowered six-member monetary policy committee (MPC) to be constituted by the Central Government. The Members of the current MPC are as follows:-

  • Governor of RBI – Chairperson, ex officio;

  • Deputy Governor of RBI, in charge of Monetary Policy – Member, ex officio;

  • One officer of RBI to be nominated by the Central Board – Member, ex officio;

The MPC determines the policy interest rate required to achieve the inflation target. RBI’s Monetary Policy Department (MPD) assists the MPC in formulating the monetary policy. Financial Markets Operations Department (FMOD) operationalizes the monetary policy, mainly through day-to-day liquidity management operations.

Instrument of Monetary Policy

Open Market Operations (OMOs):

  • It refers to buying and selling of government securities by RBI in the open market.

  • It controls the money supply in the economy. When RBI sells govt. securities to banks, the lendable resources of the latter are reduced and banks are forced to reduce or contain their lending, thus curbing the money supply.

  • When money supply is reduced, it result increase in the interest rates tends to limit spending and investment. On the other hand, when RBI buys Govt. securities from banks, their lending resources are higher which in turn encourage banks to lend more in the market and lending leads to increase in money supply.

  • When money supply is increased, it result decline in the interest rates tends to promote spending and investment.

Cash Reserve Ratio (CRR):
It is the amount of funds that the banks have to keep with the RBI. Current CRR is 4%. For ex – When a bank’s deposits increase by Rs100, and if the cash reserve ratio is 4%, the banks will have to hold additional Rs 4 with RBI and Bank will be able to use only Rs 96 for investments and lending / credit purpose. Therefore, higher the ratio (i.e. CRR), the lower is the amount that banks will be able to use for lending and investment.

Statutory Liquidity Ratio (SLR):
It indicates the minimum percentage of deposits that the bank has to maintain in form of gold, cash or other approved securities.
Note: If SLR increases, banks need to keep more liabilities (deposits) with them and provides less loans to people. If SLR decreases, banks need to keep fewer liabilities (deposits) with them and provides more loans to people. Changes in SLR often influence the availability of resources in the banking system for lending to the private sector.

Repo Rate:
It is the rate at which RBI lends money to commercial banks in the event of any shortfall of funds. It is the rate of interest which RBI implements on the short term loans, i.e., from a period ranging between 2 days to 3 months (90 Days). It is used by monetary authorities to control inflation. A reduction in the repo rate helps banks get money at a cheaper rate and vice versa.

Reverse Repo Rate:
It is the rate at which the RBI borrows money from commercial banks. Banks are always happy to lend money to the RBI since their money is in safe hands with a good interest. An increase in reverse repo rate can prompt banks to park more funds with the RBI to earn higher returns on idle cash. It is also a tool which can be used by the RBI to drain excess money out of 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 SLR portfolio up to a limit (currently two per cent of their net demand and time liabilities deposits) at a penal rate of interest (currently 100 basis points above the repo rate). This provides a safety valve against unanticipated liquidity shocks to the banking system. MSF rate and reverse repo rate determine the corridor for the daily movement in short term money market interest rates.

Bank Rate:
Bank rate is the rate of interest implemented by RBI when it lends money to a public sector bank on a long term basis, i.e. from a period ranging from 90 days to 1 year. Under this definition, Bank Rate and Repo Rate seem to be similar terms because both are the interest rates at which RBI lends money to banks.

Indicator Current Rate [Updated in 2019]
Repo Rate 6.20%
Reverse Repo Rate 6.00%
CRR(Cash Reserve Ratio) 4.00%
SLR (Statutory Liquidity Ratio) 19.25%
MSF (Marginal Standing Facility) 6.50%
Bank Rate 6.50%