Monetary policy
- Monetary policy refers to the policy of the central bank with regard to the use of monetary instruments under its control to achieve the goals specified in the Act.
- The Reserve Bank of India (RBI) is vested with the responsibility of conducting monetary policy. This responsibility is explicitly mandated under the Reserve Bank of India Act, 1934.
- The primary objective of monetary policy is to maintain price stability while keeping in mind the objective of growth. Price stability is a necessary precondition to sustainable growth.
Instruments of Monetary Policy (Quantitative measures)
- Repo Rate: The interest rate at which the Reserve Bank provides overnight liquidity to banks against the collateral of government and other approved securities under the liquidity adjustment facility (LAF). (Interest rate at which banks takes loan from RBI)
- Reverse Repo Rate: The interest rate at which the Reserve Bank absorbs liquidity, on an overnight basis, from banks against the collateral of eligible government securities under the LAF. (Interest rate at which RBI takes money from Banks)
- Liquidity adjustment facility (LAF): A liquidity adjustment facility (LAF) is a tool used in monetary policy, primarily by the Reserve Bank of India (RBI), that allows banks to borrow money through repurchase agreements (repos) or for banks to make loans to the RBI through reverse repo agreements. This arrangement manages liquidity pressures and assures basic stability in the financial markets. The RBI introduced the LAF as a result of the Narasimham Committee on Banking Sector Reforms (1998).
- Marginal Standing Facility (MSF): Marginal Standing Facility is an overnight liquidity support provided by RBI to commercial banks with a higher interest rate over the repo rate. MSF can be used by a bank after it exhausts its eligible security holdings for borrowing under other options like the LAF repo. Under MSF, banks can borrow funds from the RBI by pledging government securities within the limits of the SLR.
- Bank rate: A bank rate is the interest rate at which a nation’s central bank lends money to domestic banks, often in the form of very short-term loans.
- Cash Reserve Ratio (CRR): Cash Reserve Ratio (CRR) is a specified minimum fraction of the total deposits of customers, which commercial banks have to hold as reserves either in cash or as deposits with the central bank.
- Statutory liquidity ratio (SLR):Â It is the reserve requirement that commercial banks are required to maintain in the form of cash, gold reserves, Reserve Bank of India (RBI)- approved securities before providing credit to the customers.
- Open Market Operations (OMOs): An open market operation (OMO) is an activity by a central bank to give (or take) liquidity in its currency to (or from) a bank or a group of banks. The central bank can either buy or sell government bonds in the open market or enter into a repo or secured lending transaction with a commercial bank. The central bank gives the money as a deposit for a defined period and synchronously takes an eligible asset as collateral. A central bank uses OMO as the primary means of implementing monetary policy. The usual aim of open market operations is – supplying commercial banks with liquidity and sometimes taking surplus liquidity from commercial banks, to manipulate the short-term interest rate , supply of base money in an economy, and thus indirectly control the total money supply, in effect expanding money or contracting the money supply.
- Market Stabilisation Scheme (MSS): Market Stabilization scheme (MSS) is a monetary policy intervention by the RBI to withdraw excess liquidity (or money supply) by selling government securities in the economy. The MSS was introduced in April 2004.
Qualitative / Selective / Direct Control measures
It is used to control and check the rising tendency of the prices of certain individual commodities that are generally used. RBI uses three kinds of selective credit controls which are –
- Minimum margins for lending against specific securities.
- Ceiling on the amount of credit for certain purposes.
- Discriminatory rate of interest charged on certain types of advances.
Tools of Qualitative measures-
- Credit Ceiling:Â In this operation RBI issues prior information or direction that loans to the commercial banks will be given up to a certain limit. In this case commercial bank will be tight in advancing loans to the public. They will allocate loans to limited sectors. Few example of ceiling are agriculture sector advances, priority sector lending.
- Moral suasion: Moral Suasions are suggestion and guidelines  by the RBI to the commercial banks to take so and so action and measures in so and so trend of the economy. RBI may request commercial banks not to give loans for unproductive purpose which does not add to economic growth but increases inflation in the economy.
- Credit Authorization Scheme:Â Credit Authorization Scheme was introduced in November, 1965 when P C Bhattacharya was the chairman of RBI. Under this instrument of credit regulation RBI as per the guideline authorizes the banks to advance loans to desired sectors.
Monetary Policy Committee
- 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.
- The resolution adopted by the MPC is published after conclusion of every meeting of the MPC in accordance with the provisions of Chapter III F of the Reserve Bank of India Act, 1934.
- On the 14th day, the minutes of the proceedings of the MPC are published which include:
a. the resolution adopted by the MPC;
b. the vote of each member on the resolution, ascribed to such member; and
c. the statement of each member on the resolution adopted. - Once in every six months, the Reserve Bank is required to publish a document called the Monetary Policy Report to explain:
a. the sources of inflation; and
b. the forecast of inflation for 6-18 months ahead.
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