Economics Hard Copy

8/6/2019 Economics Hard Copy

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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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Economics Hard Copy