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MONETARY POLICIES
The Monetary and is the policy statement, traditionally
announced twice a year, through which the Reserve Bankof India seeks to ensure price stability for the economy.
The Monetary Policy aims to maintain price stability, fullemployment and economic growth. It can increase or
decrease the supply of currency as well as interest rate,
carry out open market operations, control credit and varythe reserve requirements.
The monetary management of a country is how well the
central bank of a country implements the monetary policiesand how well the government controls the various financial
aspects of the country.
ROLE OF MONETARY POLICIES INDEVELOPING ECONOMY
Developing countries including India suffer from the
problems of low level of real per-capita income, businessfluctuations, price instability, lack of credit facilities, lack
of capital formation, balance of payment disequilibrium.
An effective monetary policy will not only provide adequatefinancial resource for economic development but also help
developing economies to step up and accelerate the rate ofoutput, employment and income. Monetary policy may also
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help these countries in containing inflationary pressures
and achieving balance of payment equilibrium.
SOME IMPORTANT OBJECTIVES OFMONETARY POLICIES
1.) Investment and Savings
The problem of inadequate savings cannot be solved
merely by opening new institutions, but this problem can be
solved only by having profitable investment of savings.Economic growth can not be increased unless the savings
are utilized in productive activities. The investment rate isvery low in developing countries on account of absence of
profitable productive activities, lack of entrepreneurialability and marginal efficiency of capital.
2.) Maintenance of monetary equilibrium
The important object of monetary policy in developing
economy is to direct economy towards achieving equalitybetween economic development, there is need to expand
credit facilities, but once a certain level of growth is
achieved credit restrictions of different types must beimposed by the reserve bank.
3.) Price stability
Internal price stability is an important objective of
monetary policy in every developing country. Violent
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fluctuations in the internal price level not only disrupt the
smooth working of countys economy but theses also leadto insecurity and social injustice. Increasing cost of labour
and materials also increases the various cost of projects,which adversely affects the rate of economic growth. The
effect of price instability is always commutative incharacter. Thus, central banks of developing countries
should pursue such type of monetary policy which mayhelp in maintaining price stability over a long period so
that development activities may go uninterrupted.
4.) Making balance of payment favourable
All most all developing countries have to import capital
goods, machinery, equipments, technical know-how etc. inprimary stages of progress. Consequently, their imports
exceed the exports and balance of payment becomesunfavourable. Monetary policy should be directed towards
maintaining stability in exchange rates and removingdisequilibrium in balance of payments.
5.) Inducement to saving
In present time capital formation depends upon saving.Object of monetary policy in developing country is
promoting savings, their mobilization and their investmentin productive activities. Central bank of the country has to
provide adequate banking facilities to the public so thatthey may deposit their small savings with the banking
institutions, which may later on be utilized for investmentpurpose.
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6.) Proper policy of interest rate
The structure of interest rate is generally not conductive toeconomic growth in developing countries- the rates of
interest do not only differ according to different time,schedules but also differ in various regions and business
activities. High rates of interest discourage public andprivate investments. The central bank is required to
formulae such a policy as regard the rate of interest which
may induce the investors to go in for more loans and
advances from the commercial banks and financialinstitutions.
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RBI AND ITS FUNCTIONS
Reserve bank of India (RBI) is the central bank of India.
According to preamble of the reserve bank of India act, themain function of the bank is to regulate the issue of banknotes and the keeping of reserves with a view to securing
monetary stability in India and generally to operate thecurrency and credit system of the country to its
advantage. The various functions performed by the RBIcan be conveniently classified in three parts which are as
follows:
1.) Traditional central banking functions.
2.) Promotional functions.3.) Supervisory functions.
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Traditional central banking functions.
1. Bank of Issue
The Bank has the sole right to issue bank notes of alldenominations. The distribution of one rupee notes and
coins and small coins all over the country is undertaken bythe Reserve Bank as agent of the Government. The Reserve
Bank has a separate Issue Department which is entrusted
with the issue of currency notes.
2. Banker to Government
The second important function of the Reserve Bank of India
is to act as Government banker, agent and adviser. TheReserve Bank is agent of Central Government and of all
State Governments in India excepting that of Jammu andKashmir. The Reserve Bank has the obligation to transact
Government business, via. to keep the cash balances asdeposits free of interest, to receive and to make payments
on behalf of the Government and to carry out their
exchange remittances and other banking operations.
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3. Bankers Bank and Lender of the Last Resort
The Reserve Bank of India acts as the bankers' bank.
The scheduled banks can borrow from the Reserve Bank ofIndia on the basis of eligible securities or get financial
accommodation in times of need or stringency byrediscounting bills of exchange. Since commercial banks
can always expect the Reserve Bank of India to come totheir help in times of banking crisis the Reserve Bank
becomes not only the banker's bank but also the lender of
the last resort.
4. Controller of Credit
The Reserve Bank of India is the controller of credit i.e. ithas the power to influence the volume of credit created by
banks in India. It can do so through changing the Bankrate or through open market operations.
The Reserve Bank of India is armed with many more
powers to control the Indian money market. Every bank
has to get a license from the Reserve Bank of India to dobanking business within India, the license can be cancelled
by the Reserve Bank of certain stipulated conditions arenot fulfilled. Every bank will have to get the permission of
the Reserve Bank before it can open a new branch. Eachscheduled bank must send a weekly return to the Reserve
Bank showing, in detail, its assets and liabilities. Thispower of the Bank to call for information is also intended
to give it effective control of the credit system. The Reserve
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Bank has also the power to inspect the accounts of any
commercial bank.
5. Custodian of Foreign Reserves
The Reserve Bank of India has the responsibility to
maintain the official rate of exchange.
The Reserve Bank has the responsibility of maintaining
fixed exchange rates with all other member countries of the
I.M.F.
Besides maintaining the rate of exchange of the rupee, the
Reserve Bank has to act as the custodian of India's reserveof international currencies. The vast sterling balances were
acquired and managed by the Bank. Further, the RBI hasthe responsibility of administering the exchange controls of
the country.
Promotional functions
The scope of the functions performed by the reserve bank
has further widened after the introduction of economicplanning in the country. The bank now performs a variety
of promotional and developmental functions. The RBI hasto provide facilities for agricultural and industrial finance.
1.) RBI and agricultural credit
The banks responsibility in this field has beenoccasioned by the pre-dominantly agricultural basis
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of the Indian economy and the urgent need to expand
and coordinate the credit facilities available to therural sector. The RBI has set up a separate
agricultural department to maintain an expert staff tostudy all questions of agricultural credit and
coordinate the credit facilities available to the ruralsector. After the establishment of the NABARD on
july12, 1982, all the functions of RBI relating to ruralcredit have been transferred to this new agency.
2.) Reserve bank of India and industrial finance
The RBI has also helped in establishment of otherfinancial institution such as the industrialDevelopment bank of India, the Industrial
Reconstruction Bank of India, Unit trust of India, etc.
Supervisory functions
The banking regulation act, 1949, provides wide powers tothe reserve bank to regulate and control the activities of
banks to safeguard the interests of depositors. Thesupervisory functions of RBI can be summarized as
follows:-
1. It grants license to companies wishing to commence
banking business in India.2. It sets out capital, reserves and liquidity limits for the
banks.3. It grants permission to banks to establish new
branches in unbanked and other areas of the country.
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4. It can inspect any banking company to safeguard the
interest of the depositors and to build up and maintaina sound banking system in conformity with the
banking laws and regulation as well as the countryssocio economic objectives.
5. It can prohibit banks from engaging in tradingactivities, exempt in realization of the security given
to be held by it.
6. It takes initiative in the building up of institutional
arrangements to impart training to banking
personnel.
In brief, the reserve bank of India is performing bothtraditional central banking function and developmental
functions for the steady growth of Indian economy.
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VARIOUS OPERATIONS OR INSTRUMENTS
OF MONETARY POLICY USED BY RBI
The reserve bank of India makes use of both quantitative
(general) and qualitative (selective) methods of credit
control.
A.) QUANTITATIVE CONTROLS
These are also known as traditional or monetary methodsof credit control. These controls affect the cost and
availability of bank credit. Quantitative controls include
the following measure of credit control.
1.) Bank rate policy
The bank rate is defined as a standard rate at which the
reserve bank rediscounts or buys the first class bills and
securities of the commercial banks. During the period ofbusiness prosperity and inflation the Reserve bank
increases the bank rate. This signified high cost of creditand restricted availability of credit, and thus, adversely
affects business borrowings. Conversely, during the phaseof business depression the reserve bank decreases the bank
rate making credit cheaper and easier. A fall in the bank
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rate is generally followed by a fall in the interest rate
which encourages investments.
2.) Open market operations
Open market operations refer, broadly, to the purchaseand sale by the central bank of a variety of assets such as
foreign exchange, gold, government securities and evencompany shares. The reserve bank of India is authorized
under the RBI Act, 1934, to purchase or sell the
Government securities. After 1951, the reserve bank
decided not to purchase the Govt. securities; instead, thebank provides temporary accommodation againstcollateral of Govt. securities.
3.) Variable Reserve Requirement
The commercial banks in India are required to maintain
statutory cash reserves wit the reserve bank of India andare required to maintain statutory liquidity requirements.
Statutory cash reserves refer to thatportion of total deposits of a commercial bank which it has
to keep with the reserve bank in the form of cash reserves.Originally, scheduled commercial banks were required to
maintain with the reserve bank statutory cash reserve of anamount equal to not less than 3 per cent of their demand
and time liabilities. At present, banks are required tomaintain a cash reserve of 15.0 % of their total demand
and time liabilities.
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Statutory Liquidity Ratio (SLR) refers to that portion of
daily total demand and time liabilities of a commercialbank which it has to keep with itself in the form of liquid
assets. These liquid assets consist of the following:
a.) Excess reserves of the banks
b.) Unencumbered Govt. and other approved
securities andc.) Current account balances with other banks.
B.) QUALITATIVE CONTROLS
Qualitative or selective controls comprise such measures
of credit control which aim at the regulation of credit forspecific purposes or to discourage it from being used for
undesirable purposes. Selective credit control operate o thedistribution of total credit.
The reserve bank of India has used the following
qualitative measures of credit control:
1.) Margin Requirements
The RBI has prescribed higher margins against the loans
based on the security of good grains, cotton and kapas,sugar, textiles etc. higher margins have restricted the
borrowing capacity of the stockholders of thesecommodities.
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2.) Credit Rationing
Through this method the RBI fixes the party wise ceiling of
loans and advances on the basis of crop prospects, supplyposition and price trends.
3.) Fixation of Minimum Lending Rates
The RBI also prescribes minimum lending rate in case of
advances against all commodities with certain
expectations.
4.) Direct Action
The reserve Bank takes the following direct actions againstthe commercial banks:
(i) To refuse rediscounting facilities to the banks whodo not co-operate with the policies of the RBI;
(ii) To refuse loans;(iii) To impose monetary penalties; and
(iv) To alter the conditions of rediscounting.
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FINANCIAL MARKET CONDITIONS
BEFORE THE REFORM PERIOD
In the pre-reform era, the financial market
in India was highly segmented and regulated. The moneymarket lacked depth, with only the overnight
interbank market in place. The interest rates in thegovernment Securities market and the credit market
were tightly regulated.
The dispensation of credit to the
Government took place through a statutory liquidity ratio
(SLR) process whereby the commercial banks were madeto set aside substantial portions of their liabilities for
investment in government securities at below marketinterest rates. Furthermore, credit to the commercial
sector was regulated, with prescriptions of multiple lendingrates and a prevalence of directed credit at highly
subsidized interest rates.
The Reserve Bank had to subscribe to thegovernment dated securities which were not taken up by
the market. As a result, net Reserve Bank credit to the
Central government, which constituted about three-quarters of the monetary base (reserve money) during the
1970s, rose to over 920/0 during the 1980s.
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In such an environment, monetary policy had
to address itself to the task of neutralizing the inflationaryimpact of the growing deficit. The Reserve Bank had to
resort to direct instruments of monetary control, inparticular the cash reserve ratio. This ratio was used to
neutralize the financial impact of the Governmentsbudgetary operations rather than as an independent
monetary instrument.
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FINANCIAL MARKET CONDITIONS AFTER
THE REFORM PERIOD
The reform period took place in the early 1990s. The
financial sector reforms initiated following therecommendations of The Narasimham Committee (1991),
in conjunction with the recommendations of theChakravarty Committee and the Vaghul Working Group,
produced far-reaching changes in the financial sectorwhich had an important bearing on the conduct of
monetary policy.
With the initiation of financial sector
reforms, the emphasis was placed on the development anddeepening of money, government securities and forex
markets, and an effort was made to move away from theuse of direct instruments of monetary control to indirect
measures such as open market operations and market-related interest rates.
In order to improve short-term liquidity and
encourage its efficient management, interbank
participation certificates, certificates of deposit (CDs) andcommercial paper (CP) were introduced. The Discount and
Finance House of India (DFHI) was set up to promote asecondary market in a range of money market instruments.
Treasury bills of varying maturities (14-, 91- and 364-day)were introduced. More importantly, interest rates on
money market instruments were left to be determined bythe market.
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In consonance with the medium-term objectives of
financial sector reform, the SLR was brought down from itspeak level of 38.50/0 in April 1992 to 250/0 of net demand
and time liabilities (NDTL) in October 1997. Moreover,there were sharp cuts in the cash reserve ratio (CRR),
progressively to 100/0 in January 1997 from 150/0 in1991.4 The Reserve Banks refinance facility was also
rationalized. The sector-specific refinance facilities werede-emphasized and simultaneously a general refinance
window was opened in April 1997.
Open market operations (OMOs) have gained considerablemomentum as the Reserve Bank now responds more
flexibly to market yields when drawing up its price list. Italso conducts repo and reverse repo transactions in order
to ensure a reasonable corridor for money market rates ofinterest. The interest rate structure was rationalized. Banks
are now free to determine their domestic term deposit ratesand prime lending rates (PLRs), except for certain
categories of export credit and small loans below Rs 0.2
million. In addition, all money market rates are also free.The most significant development in this area has,
however, been the reactivation of the bank rate by linkingit to all other rates including the Reserve Banks refinance
rate.
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CRITICAL EVALUATION ON ACHIEVEMENT
AND SUCCESS OF RBIS MONETARY
MANAGEMENT
The reform that took place in 1991 was very critical and
crucial for the Indian economy as India was facing a longterm deficit in its monetary terms.
There was a great need of reform during the early 1990s.
So, there was an economic reform in the country and all
the monetary as well as the fiscal policies were changed ormade better, which brought about a complete change in the
economic development of India.
Due to the change in the monetary policies adapted by theReserve Bank of India in 1991, at present,
Indias integration with the world economy is gettingstronger,
The use of monetary instruments in India has undergone a
shift from direct to indirect instruments,
Indias current account balance, after posting modest
surpluses during 2001-2004, has returned to a deficit inconsonance with the resurgence in investment demand in
the economy,
Indias merchandise exports have been recording a robustgrowth along with exports of services,
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CONCLUDING REMARKS
We can conclude by saying that the Reserve Bank of Indiahas played an important role in the implementation of
reforms by maintaining price and financial stability and bycontributing to building a robust external sector during a
time of great flux.
Indian economy has recovered from a major deficit in
1990s (reform period) and is growing stronger day byday. Also, through liberalization and globalization coming
in the country, there are many significant changes in thebanking sector too, and the RBI has dealt with it quite
nicely.
RBI has not only done an fantastic job in monetarymanagement, but has also helped improve the agricultural
and rural sector of the country, also it has helped improvethe industrial sector of the country, by providing them easy
loans facility etc, and has undoubtedly raised the standards
of the banking sector of the country to newer heights.
The Indian economy has been through a lot of tough times,handled the situations of deflation as well as inflation and
one can say that it will perform well in any challenge thatis lying ahead in its path because of the excellent monetary
conditions and an equally good functioning central bank ofthe nation which will help the Govt to take the Indian
economy to the global economy as an developed economyin the near future.
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GROUP NO. 1
GROUP MEMBERS
1.) Aditya Nagaraja Roll no. 01
2.) Ankesh Bhandari Roll no. 04
3.) Abhishek Chouhan Roll no. 11
4.) Dheeraj Mehta Roll no. 34
5.) Rahul Mishra Roll no. 38
6.) Mohit Singh Roll no. 42
7.) Neeraj Yadav Roll no. 51
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RBIS MONETARY
MANAGEMENT IN THE
PRE AND
POST REFORM PERIOD
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SUBMITTED TO:- Prof.
Adigal
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