PROJECT ON:
“India’s monetary policy: recent trends”
SUBMITTED TO:
Mr. Deepak Gupta
SUBMITTED BY:
PALLAVI KASHYAP
LL.B. 1ST YEAR
ENROLLMENT ID: 22FLUCDDN01010
ABSTRACT
In recent times money market is undergoing structural
change in India. Many steps have been taken by RBI
for the development of Indian money market. Some
important measures are adopted in this direction; one
of them is introduction of innovative instruments i.e.
Repo and Reverse Repo transactions. The introduction
of Liquidity Adjustment Facility (LAF) has been one of the
most important innovations in the Indian money market as a
technique of monetary policy in India in the recent year.
Liquidity Adjustment Facility (LAF) came into being on
June 2000. In view of the Covid–19 pandemic and its
adverse impact on economy, the RBI reduced police rates.
repo rate and reverse repo rate. RBI noted that the
economic activity had started tore cover from the lows of
April-May. However, the recovery momentum is petering out
due to the new trend of rising COVID-19 infections. The
purpose of the research paper is to study the recent trends in
the repo and reverse repo rates in India. The study showed
that repo and reverse repo rates have continuously declined
during the recent period of global slowdown or recession, and
recently the Covid–19 pandemic
MONETARY POLICY – MEANING AND
OVERVIEW
Monetary policy is a wonderful economic tool which is able
to manage the growth rate and size of supply of money is an
economy and regulate macroeconomy-based variables like
unemployment and inflation.
By various tools such as interest rates adjustments, changes in
amount of cash that is circulating in the economy, and
purchase or sale of government securities. Central banks,
hence Reserve Bank of India in India, is responsible for
formulating and implementing such policies in the economy.
RBI controls variables of macro economy like inflation and
unemployment with these policies
OBJECTIVES OF MONETARY POLICY IN
INDIA:
‘Growth with stability’ is considered to be the backbone of
Indian economy and the policy helps in regulating the
availability, cost and use of money in the economy
Growth with stability: traditionally, controlling
inflation is the focus of Indian monetary policy.
Therefore, RBI adopted new GROWTH WITH
STABILITY policy to provide sufficient credit to
different sectors and their increasing needs in the
economy.
Financial stability: Financial stability makes an
economy able to absorb internal and external shocks and
saves economy from being destabilize.
Generation of employment: A monetary policy of an
economy influences the investment in different sector of
the society having different labour rates. Hence inducing
high investment in an economic activity will generate
employment opportunities in the economy.
Encouraging saving and investment: By offering
attractive interest rates, RBI encourage people to shift
their monies from the home locker to the banks, which
then is circulated in the economy for further betterment
of the standard of living of them.
Redistribution of income and wealth: Deploying
affordable credit to weaker section and controlling
inflation with monetary tools, RBI redistributes income
and wealth to the weaker section of the economy.
NBFIs: Non-Banking Financial Institutions plays an
important role of loans and advances to deploy credit and
mobilize savings in Indian economy. Even though RBI
does not control NBFIs directly but control them with the
help of monetary policies indirectly.
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.
We have discussed that monetary policies are made for the
best operations of money in the economy, but now the doubt
is- WHO MAKES THESE POLICIES FOR OUR USD 3.5
TRILLION ECONOMY? The answer is THE MONETARY
POLICY COMMITTEE
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 by notification in
the Official Gazette. The first such MPC was constituted on
September 29, 2016. The present MPC members, as notified
by the Central Government in the Official Gazette of October
5, 2020, are as under:
1. Governor of the Reserve Bank of India—Chairperson, ex
officio;
2. Deputy Governor of the Reserve Bank of India, in charge
of Monetary Policy—Member, ex officio;
3. One officer of the Reserve Bank of India to be nominated
by the Central Board—Member, ex officio;
4. Prof. Ashima Goyal, Professor, Indira Gandhi Institute of
Development Research —Member;
5. Prof. Jayanth R. Varma, Professor, Indian Institute of
Management, Ahmedabad—Member; and
6. Dr. Shashanka Bhide, Senior Advisor, National Council of
Applied Economic Research, Delhi—Member.
(Members referred to at 4 to 6 above, will hold office for a
period of four years or until further orders, whichever is
earlier)
The MPC determines the policy repo rate required to achieve
the inflation target.
The MPC is required to meet at least four times in a year. The
quorum for the meeting of the MPC is four members.
Each member of the MPC has one vote, and in the event of an
equality of votes, the Governor has a second or casting vote.
Each Member of the Monetary Policy Committee writes a
statement specifying the reasons for voting in favour of, or
against the proposed resolution.1
NEXT QUESTION to raise is what are these instruments used
by RBI. Following are the instruments used directly or
indirectly for implementing the monetary policy.
1. Repo Rate: The interest rate at which the Reserve Bank
provides liquidity under the liquidity adjustment facility
(LAF) to all LAF participants against the collateral of
government and other approved securities.
1
Monetary policy committee, RBI act, https://www.rbi.org.in/scripts/FS_Overview.aspx?fn=2752
2. Standing Deposit Facility (SDF) Rate: The rate at
which the Reserve Bank accepts uncollateralised
deposits, on an overnight basis, from all LAF
participants. The SDF is also a financial stability tool in
addition to its role in liquidity management. The SDF
rate is placed at 25 basis points below the policy repo
rate. With introduction of SDF in April 2022, the SDF
rate replaced the fixed reverse repo rate as the floor of
the LAF corridor
3. Marginal Standing Facility (MSF) Rate: The penal
rate at which banks can borrow, on an overnight basis,
from the Reserve Bank by dipping into their Statutory
Liquidity Ratio (SLR) portfolio up to a predefined limit
(2 per cent). This provides a safety valve against
unanticipated liquidity shocks to the banking system. The
MSF rate is placed at 25 basis points above the policy
repo rate.
4. Liquidity Adjustment Facility (LAF): The LAF refers
to the Reserve Bank’s operations through which it
injects/absorbs liquidity into/from the banking system. It
consists of overnight as well as term repo/reverse repos
(fixed as well as variable rates), SDF and MSF. Apart
from LAF, instruments of liquidity management include
outright open market operations (OMOs), forex swaps
and market stabilisation scheme (MSS).
5. LAF Corridor: The LAF corridor has the marginal
standing facility (MSF) rate as its upper bound (ceiling)
and the standing deposit facility (SDF) rate as the lower
bound (floor), with the policy repo rate in the middle of
the corridor.
6. Main Liquidity Management Tool: A 14-day term
repo/reverse repo auction operation at a variable rate
conducted to coincide with the cash reserve ratio (CRR)
maintenance cycle is the main liquidity management tool
for managing frictional liquidity requirements.
7. Fine Tuning Operations: The main liquidity operation
is supported by fine-tuning operations, overnight and/or
longer tenor, to tide over any unanticipated liquidity
changes during the reserve maintenance period. In
addition, the Reserve Bank conducts, if needed, longer-
term variable rate repo/reverse repo auctions of more
than 14 days.
8. Reverse Repo Rate: The interest rate at which the
Reserve Bank absorbs liquidity from banks against the
collateral of eligible government securities under the
LAF. Following the introduction of SDF, the fixed rate
reverse repo operations will be at the discretion of the
RBI for purposes specified from time to time.
9. Bank Rate: The rate at which the Reserve Bank is ready
to buy or rediscount bills of exchange or other
commercial papers. The Bank Rate acts as the penal rate
charged on banks for shortfalls in meeting their reserve
requirements (cash reserve ratio and statutory liquidity
ratio). The Bank Rate is published under Section 49 of
the RBI Act, 1934. This rate has been aligned with the
MSF rate and, changes automatically as and when the
MSF rate changes alongside policy repo rate changes.
10. Cash Reserve Ratio (CRR): The average daily
balance that a bank is required to maintain with the
Reserve Bank as a per cent of its net demand and time
liabilities (NDTL) as on the last Friday of the second
preceding fortnight that the Reserve Bank may notify
from time to time in the Official Gazette.
11. Statutory Liquidity Ratio (SLR): Every bank shall
maintain in India assets, the value of which shall not be
less than such percentage of the total of its demand and
time liabilities in India as on the last Friday of the second
preceding fortnight, as the Reserve Bank may, by
notification in the Official Gazette, specify from time to
time and such assets shall be maintained as may be
specified in such notification (typically in unencumbered
government securities, cash and gold).
12. Open Market Operations (OMOs): These include
outright purchase/sale of government securities by the
Reserve Bank for injection/absorption of durable
liquidity in the banking system. 2
RECENT TRENDS IN INDIAN MONETARY
POLICIES:
2
Instruments of monetary policy, RBI, https://www.rbi.org.in/scripts/FS_Overview.aspx?fn=2752
In recent times money market in India has gone through many
changes. The introduction of Liquidity Adjustment Facility
has been one of the most important innovations in the Indian
money market which came in existence in the June of year
2000.
Liquidity adjustment facility (LAF)-
RBI uses LAF as a liquidity adjusting and money supply
instrument. The types of LAF are:
Repo rate: it is the rate at which banks borrow from RBI on
short term basis against a repurchase agreement and provide
government securities as collateral.
Reverse repo rate: it is the rate that RBI pays to banks for
lending amount to RBI. Repo and reverse repo rate are linked
following way:
Reverse Repo Rate = Repo Rate – 1
Flexible Inflation Targeting Framework (FITF):
The Flexible Inflation Targeting Framework (FITF) was
introduced via an amendment by RBI in RBI act, 1934 in
2016. In accordance with the RBI Act, government of India
sets targets for inflation every 5 years after consulting with
RBI
In this framework, there are chances of not achieving the
inflation target fixed for a particular amount of time. This can
happen when:
The average more than the upper tolerance level of the
inflation targets as predetermined by the central
government for 3 consecutive quarters in a row.
The average inflation is less than the lower tolerance
level of the target inflation fixed by the central
government beforehand for 3 consecutive quarters.
Following table shows the recent rates of key indicators in
India money market:
Key indicators Current rate
CRR 4.50%
SLR 18%
Repo Rate 6.50%
Reverse repo rate 3.35%
Marginal Standing facility rate 6.75%
Bank Rate 6.75%
Steps to improve monetary transmission:
Both the government and RBI has taken and plans to
take some steps in order to accelerate the transmission
of monetary policy.
Government intends to bring down the interest
rates on small saving accounts. If the small saving
rates are linked to the bank rate, this could serve as
a permanent solution.
In order to improve monetary transmission, RBI
wants banks to change the calculation methodology
of base rate to marginal cost of funds from average
cost of funds.
Despite banks raising the lending rates immediately
after RBI's rate cuts, the Central Bank is unable to
control inflation due to the following reasons:
Financial deficit in the higher government.
Issues at the supply side, such as crude oil prices,
issues in agri marketing, etc.
Lack of financial inclusion as borrowers still
depend on moneylenders, who are not under RBI's
control.
Non-monetised economy in certain rural areas.
CONCLUSION:
The Reserve Bank of India has increased the repo rate by 25
basis points on 8 February 2023. The current repo rate is
6.50% while the reverse repo rate is 3.35%. The Bank Rate
and the Marginal Standing Facility (MSF) rate has increased
to 6.75%. The Standing Deposit Facility Rate is now 6.25%.
This is the sixth hike in repo rate since May 2022 leading to a
total increase of 250 basis points.
And RBI changes the rates as per the needs of the economy
and to tackle the shocks of inflation and other variables of
macroeconomics
The global economy plunged into its deepest contraction
in living memory in April- June 2020 as COVID-19 took its
toll. In India, real GDP fell by a record low. TheCovid-19
pandemic has fundamentally altered the setting and conduct of
monetary policy across the world. The impact of Covid-
19 on various sectors of the economy, the Monetary Policy
Committee (MPC) decided to cut the policy repo rate from
4.40 percent to 4.00 percent. The pace of monetary
transmission has quickened, but credit growth remains
feeble, clouding the outlook. Going forward, liquidity
world continues to be calibrated, consistent with the stance of
monetary policy while ensuring normalcy in the functioning
of financial markets and institutions and conducive
financial conditions. Efficient monetary policy transmission,
particularly to the credit market, world continue to assume
priority in the hierarchy of policy objectives. Thus, it is
observed that RBI is emphasizing on these new
instruments to regulate the money market to stabilize
the Indian economy. Compared to traditional monetary
tools these new instruments have played the vital role in
regulating the money market in India.
