Monetary Policy

The Monetary Policy of India is formulated and executed by Reserve Bank of India to achieve specific objectives. It refers to that policy by which central bank of the country controls(i) the supply of money, and (ii) cost of money or the rate of interest, with a view to achieve particular objectives. The main objectives of monetary policy are to achieve price stability, financial stability and adequate availability of credit for growth.

Recent Developments

RBI Releases Financial Stability Report

  • The Reserve Bank of India has released the 18th issue of the Financial Stability Report (FSR) on 31st December, 2018.
  • The FSR reflects the overall assessment of the stability of India’s financial system and its resilience to risks emanating from global and domestic factors.
  • As per the report, India’s banking sector shows signs of improvement where the asset quality of banks showed an improvement with the gross non-performing assets (GNPA) ratio of commercial banks declining from 11.5% in March, 2018 to 10.8% in September, 2018.

Section 7(1) of RBI act vs. Government of India Debate

  • According to the RBI Act’s Section 7 (1), “the central government may from time to time give such directions to the Bank as it may, after consultation with the Governor of the Bank, consider necessary in the public interest”.
  • Section 7 (1) of The Reserve Bank of India Act, 1934, became a contentious issue after the tension between the central bank and government turned into a public spat with the intervention of media.
  • No government has so far invoked this section in the central bank’s 83-year history.
  • The issue of invoking Section 7 (1) of RBI Act came up during the hearing of Allahabad high court in a case filed by the Independent Power Producers Association of India challenging RBI’s circular. The high court, later, said the government could issue directions to RBI under Section 7 of RBI Act.

PAiSA - Portal

  • A centralized electronic platform for processing interest subvention on bank loans to beneficiaries under Deendayal Antyodaya Yojana – National Urban Livelihoods Mission (DAY-NULM) named “PAiSA – Portal for Affordable Credit and Interest Subvention Access” was launched in November, 2018.
  • This web platform has been designed and developed by Allahabad Bank which is the Nodal bank.
  • PAiSA is yet another effort by the government to connect directly with the beneficiaries, ensuring that there is greater transparency and efficiency in delivery of services. DBT of subvention on monthly basis under DAY-NULM will give the necessary financial support to small entrepreneurs in a timely manner.

Committee on Formation of an ARC

The government has set up a committee to give recommendations on formation of an Asset Reconstruction Company (ARC) for quick resolution of stressed accounts. This committee is headed by Punjab National Bank Non-Executive chairman Sunil Mehta.

  • The committee will provide recommendations to set up an Asset Reconstruction Company (ARC) and/or an Asset Management Company (AMC) for faster resolution of stressed assets.
  • ARC is a company registered under Section 3 of the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002. The RBI regulates ARCs as Non-Banking Financial Companies (NBFCs).

Debate on Marginal Cost of Funds based Lending Rate (MCLR)

  • The Reserve Bank of India (RBI) is yet to mandate banks to allow customers who signed up for loans in the erstwhile ‘Base Rate’ regime and who are paying higher rates, to shift to the current ‘MCLR’ structure, which is lower than the base rate.
  • MCLR: The marginal cost of funds based lending rate (MCLR) refers to the minimum interest rate of a bank below which it cannot lend, except in some cases allowed by the RBI. It is an internal benchmark or reference rate for the bank. MCLR actually describes the method by which the minimum interest rate for loans is determined by a bank - on the basis of marginal cost or the additional or incremental cost of arranging one more rupee to the prospective borrower. The MCLR methodology for fixing interest rates for advances was introduced by the Reserve Bank of India with effect from April 1, 2016.

Elements of Monetary Policy of India

The main aim of the monetary policy of the Reserve Bank is to control the money supply in such a manner as to expand it to meet the needs of economic growth and at the same time contract it to curb inflation. In other words, monetary policy is aimed at expanding and contracting money supply according to the needs of the economy.

Main objectives of Monetary Policy:

  • To Regulate Money Supply in the Economy
  • To Attain Price Stability
  • To promote Economic Growth
  • To Promote saving and Investment
  • To Control Business Cycles
  • To Promote Exports and Substitute Imports
  • Others: To Manage Aggregate Demand; To Ensure more Credit for Priority Sector; To Promote Employment; To Develop Infrastructure; To Regulate and Expand Banking; Instruments of Monetary Policy.

Instrument of Monetary Policy

The instrument of monetary policy is tools/device which is used by the monetary authority in order to attain some predetermined objectives. There are two types of instruments -

1. Quantitative Instruments or General Tools: The Quantitative Instruments aka the General Tools of monetary policy (these tools are related to the quantity/volume of the money). They are designed to regulate or control the total volume of bank credit in the economy. These tools are indirect in nature and are employed for influencing the quantity of credit in the country. The quantitative measures of credit control are:

  • Bank Rate Policy (BR): The Bank Rate is the Official interest rate at which RBI re discounts the approved bills held by commercial banks. For controlling the credit, inflation and money supply, RBI will increase the Bank Rate.
  • Open Market Operations (OMO): OMO refers to direct sales and purchase of securities and bills in the open market by Reserve bank of India. The aim is to control volume of credit.
  • Cash Reserve Ratio (CRR): CRR refers to that portion of total deposits in commercial Bank which it has to keep with RBI as cash reserves.
  • Statutory Liquidity Ratio (SLR): SLR refers to that portion of deposits with the banks which it has to keep with itself as liquid assets (Gold, approved govt. securities etc.)
  • Note: If RBI wishes to control credit and discourage credit it would increase CRR & SLR.

2. Qualitative Instruments: The Qualitative Instruments aka the Selective Tools of Monetary Policy. These tools are not directed towards the quality of credit or the use of the credit. They are used for discriminating between different uses of credit. This method can have influence over the lender and borrower of the credit. The Selective Tools of credit control comprises of following instruments:

  • Margin requirements: This refers to difference between the securities offered and amount borrowed by the banks.
  • Consumer Credit Regulation: Under this method, consumer credit supply is regulated through hire-purchase and installment sale of consumer goods. Under this method the down payment, installment amount, loan duration, etc. is fixed in advance. This can help in checking the credit use and then inflation in a country.
  • Rationing of credit: Central Bank fixes credit amount to be granted. Credit is rationed by limiting the amount available for each commercial bank. This method controls even bill rediscounting. For certain purpose, upper limit of credit can be fixed and banks are told to stick to this limit. This can help in lowering banks credit exposure to unwanted sectors.
  • Moral Suasion: It implies to pressure exerted by the RBI on the Indian banking system without any strict action for compliance of the rules. It is a suggestion to banks. It helps in restraining credit during inflationary periods. Commercial banks are informed about the expectations of the central bank through a monetary policy. Under moral suasion central banks can issue directives, guidelines and suggestions for commercial banks regarding reducing credit supply for speculative purposes.
  • Direct Action: This step is taken by the RBI against banks that don’t fulfill conditions and requirements. RBI may refuse to re discount their papers or may give excess credits or charge a penal rate of interest over and above the Bank rate, for credit demanded beyond a limit. ww

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