Monetary Policy Notes For UPSC PDF

Download Testbook App Monetary Economy Notes For Policy UPSC  Download Testbook App Monetary Policy is nothing but an economic policy which is able to manage the growth rate and size of...

Download Testbook App Monetary Economy Notes For Policy UPSC  Download Testbook App Monetary Policy is nothing but an economic policy which is able to manage the growth rate and size of the money supply in a given economy. Monetary policy is one powerful tool that regulates macroeconomy-based variables like unemployment and inflation. In the following article, we shall learn and understand about all the major aspects related to the monetary policy in India. Monetary policy is created and adopted by the monetary authoritative body of a nation that controls the short-term borrowings, money supply, and interest rates. The monetary policy generally focuses on inflation and/ or interest rates in order to make sure that there is price stability and general trust in the currency of the economy. Monetary Policy in India is undertaken by the authority of the Reserve Bank of India (RBI). Let’s learn more about monetary policy in India in the following banking awareness study notes. Banking and finance aspirants are advised to read through the following sections carefully to prepare for the upcoming government and competitive exams. Monetary Policy - Meaning & Overview Monetary policy is implemented by way of various tools such as adjustment of the interest rates, changing the amount of cash circulating in the economy, and purchase or sale of government securities. The central bank or the RBI is responsible for formulating and implementing such monetary policies in India. The RBI controls inflation in the country through monetary policy. The RBI uses myriad monetary tools like Reverse Repo Rate, SLR, CRR, Repo Rate, etc. in order to achieve its purpose. In simpler words, monetary policy can be defined as using the monetary instruments under the guidance of the RBI for regulating interest rates, availability of credit, money supply, etc. so as to achieve the ultimate goal of economic policy. Know how to prepare for RBI Grade B Exam here! Objectives of Monetary Policy The main objectives of monetary policy is the management of inflation, maintenance of currency exchange rates, unemployment, and so on. Following are the objectives of monetary policy in India: Unemployment Monetary policies play a significant role in regulating the unemployment levels in the economy. For instance, an expansionary monetary policy would decrease the unemployment levels as the higher money supply would influence business activities that would lead to the increase in employment opportunities. Page - 2  Download Testbook App Currency Exchange Rates The RBI uses its fiscal authority to regulate the exchange rates between domestic and foreign currencies. For instance, the RBI can increase the money supply by issuing more currency. In that case, the domestic currency becomes relatively cheaper than its foreign counterparts. Inflation Monetary policies also target the levels of inflation. When there is a low level of inflation, it is considered to be a sound situation for the economy. In case of high inflation levels, a contractionary monetary policy can resolve the issue. Expansionary & Contractionary Monetary Policy As we understood, monetary policy directs the activities carried out by the RBI in order to control the money supply in the economy. This control of money supply helps in managing the inflation or deflation situations. Thus, a monetary policy can be of two types - expansionary or contractionary Expansionary Monetary Policy Contractionary Monetary Policy Focuses on expanding or increasing the Focuses on contractions or decreasing supply of money in an economy. the money supply in an economy. A monetary policy which is expansionary in A contractionary monetary policy is nature is implemented by decreasing the carried out by increasing the interest interest rates, thus increasing the market rates, resulting in reduced market liquidity. liquidity. Monetary Policy Process (MPP) The Monetary Policy Committee, also known as MPC, is responsible for determining the policy interest rates needed to resolve inflation. It is the RBI’s Monetary Policy Department (MPD) that assists the MPC to formulate the monetary policy in the country. The analytical assistance by the RBI along with the views of the key stakeholders in the economy contribute in the process of making a policy repo rate decision. The Financial Markets Operations Department (FMOD) carries out the monetary policy by way of day- to-day liquidity management operations. The Financial Market Committee (FMC) conducts a daily meeting to review the liquidity conditions in the economy. This is done to ensure that the operating target of the monetary policy is inline with the policy repo rate. It is also known as the Weighted Average Call Money Rate (WACR) Page - 3  Download Testbook App Instruments of Monetary Policy The instruments of monetary policy are categorized as direct instruments and indirect instruments. Before looking at the sub-types, let us learn more about the difference between direct instruments and indirect instruments of monetary policy in India. Direct Instruments Indirect Instruments These are used to set/ limit prices (interest rates) or These operate through the market by influencing quantities (credit) through regulations. the underlying demand and supply conditions. They are in the form of credit ceilings and mainly They focus on the balance sheet of the Reserve aimed at the balance sheets of the commercial banks. Bank. They are also known as market-based They are non-market-oriented. instruments. Eg. Bank Rate, MSF, Repo Rate, Reverse Repo Eg. SLR and CRR Rate. The following section elaborates each of the monetary policy instrument in detail: CRR (Cash Reserve Ratio) CRR is the average daily balance that a bank is needed to maintain with the RBI, one of the prime regulators of banks and financial institutions. The CRR is a share of such a percentage of its NDTL (Net Demand and Time Liabilities) that the RBI may alter on a regular basis in the Gazette of India. SLR (Statutory Liquidity Ratio) The SLR is the share of NDTL that banks are mandated to maintain in the form of safe and liquid assets. These include government securities, cash, and gold. If there is any change in the SLR, it influences the availability of resources in the banking industry for extending loans to the private sector. Repo Rate The rate of interest the RBI charges from its customer base on their short-term borrowings is the Repo Rate. Hence, it is basically an abbreviated form of “rate of purchase”. In practical form, it is not called an interest rate. Instead, it is considered as a discount on the dated government securities that are deposited by the institution to borrow for a short term. Repo Rate is fixed to be in the range of 5% to 9% Reverse Repo Rate It is the rate of interest that the RBI pays to its customer base that offers short-term loans to it. Page - 4  Download Testbook App As the name suggests, it is the reverse of the repo rate and it was started in November 1966 as a part of the LAF (Liquidity Adjustment Facility) by the RBI. An LAF enables the banks to get money through repurchase agreements. The Reverse Repo Rate is utilized by the RBI in the wake of over money supply with the banks and lower loan disbursal to serve both the purposes of cutting down losses in the prevailing interest rates. The reverse repo rate ranges from 5% to 9% Read more about Basics of Banking, here. Marginal Standing Facility (MSF) The MSF enables the banks to borrow overnight up to 1% of their NDTL from the RBI at the interest rate 1% higher than the current repo rate. The RBI increased the gap between the Repo Rate and MSF to 3% in a bid to strengthen the rupee and check its falling exchange rate. The minimum amount of MSF of INR 1 crore is accepted by the RBI. The MSF is fixed to be in the range of 6% to 10% Bank Rate Bank Rate is the rate of interest which the RBI charges on its long-term lendings. Borrowers who borrow through this route are the government of India, state government, other banks, Non Banking Financial Companies (NBFCs), financial institutions, cooperative banks, etc. The bank rate is fixed in the range of 5% to 7% Qualitative Measures Qualitative measures are the ones that are related to the financial system and are managed like flow according to rates or taxes. In these, the volume of money is not controlled. Below are some of the qualitative measures used in the monetary policy: Margin Requirement The RBI follows the margin requirement strategy to avoid bank loss. Under this system, the RBI provides loans less than the requirement of the bank. It is done at some calculated extent (Security value - Loan amount = Margin Requirement) Know more about Loans in Banking Sector, here Moral Suasion Sometimes it is not possible or required to control the flow of money directly. At such times, the RBI releases informal advisories to the customers and the banks. Here, the banks and customers are not compelled. Page - 5  Download Testbook App Direct Action When the banks fail to follow the rules and guidelines passed by the RBI, then it has to take some steps against such banks. Selective Credit Control (SCC) In this, selective commodities are decided by the RBI on which the loans are risky. Such commodities usually include: Food grains Cotton textiles Sugar, jaggery, etc. Raw cotton Selected major oil seeds Credit Scores Apart from the above given instruments, the RBI also uses some other important tools to activate the right kind of credit and monetary policy. These are called as credit scores, as mentioned below: Call Money Market The call money is an important instrument of the money market, wherein, borrowing and lending of funds take place on overnight basis. Participants in the call money market include scheduled commercial banks, regional rural banks, insurance companies, cooperative banks, etc. Banks are allowed to borrow only 1% of their NDTL in this market at repo rate by April 2016. Open Market Operations (OMOs) The OMOs are organized by the RBI via the sale and/ or purchase of securities of the government to/ from the market with the main intention of regulating rupee liquidation in the market. OMOs are effective quantitative tools in the RBI’s inventory, however, they are constrained by the stock of government securities available with it at a point of time. Standard Deposit Facility Scheme (SDFS) The SDFS scheme has been proposed by the Union Budget of 2018-19. However, such a tool was proposed by the RBI back in November 2015. The scheme is aimed at helping the RBI to manage liquidity in a better way, especially when the economy is flush with excess funds (after demonetization of the high value currency notes in November 2016) Page - 6  Download Testbook App Monetary Policy Committee (MPC) Currently, it is the Monetary Policy Committee (MPC) that decides the policy interest rates required to achieve the inflation targets. The MPC is constituted by 6 members appointed by the central government as per the Section 45ZB of the amended RBI Act 1934. The MPC meets at least four times annually. The quorum of the MPC meeting is four members. Each member has one vote, however, the governor has a second or casting vote in the event of equality of votes. After the conclusion of every MPC meeting, the resolution adopted by the MPC is published. The RBI is required to publish the Monetary Policy Report once every six months. This policy explains the sources of inflation and the forecast of inflation for 6 to 18 months ahead Current Monetary Policy Committee The central government formed the current MPC (Monetary Policy Committee) consisting of the following: Governor of the RBI - Chairperson, ex officio Deputy Governor of the RBI, in-charge of Monetary Policy - Member, ex officio One officer of the RBI to be nominated by the Central Board - Member, ex officio Shashanka Bhide, Senior advisor at NCAER (National Council for Applied Economic Research) - Member Ashima Goyal, Professor at the Indira Gandhi Institute of Development Research in Bombay - Member Jayanth Verma, Professor, IIM (Ahmedabad) - Member You might also be interested in: Alternative Sources of Finance study notes! The above banking awareness study notes on Monetary Policy of India is intended to guide candidates preparing for various types of competitive exams. We have more such important and relevant study-related resources available on our Testbook App. Get the App now for live coaching, doubt clearing sessions, mock tests, practice sets, and much more! Page - 7