Monetary Policy

What are the instruments of monetary policy of RBI? How does RBI stabilize money supply against exogenous shocks? Examine. (200 Words)

Monetary policy refers to the credit control measures adopted by the central bank of a country. RBI Performs Various Operation to Stabilise the Currency In the market:
  1. OMO – Open market Operation of sale of Govt securities on basis of Liquidity Adjustment Facility [Repo + reverse + MSF[ for SCB]] . Such operation injects and Squeeze money
  1. Deficit Financing
  2. Lender of last Resort
  3. Bank rate – For Long term lending
  4. CRR, SLR
  1. Sterilisation– Foreign currency is beefed Up In order to Depreciate the domestic currency through FCNR deposits , and other instrument like Buying Bonds in foreign currency through commercial banks
  1. Moral Suasion
External shocks Can well be managed by sterilisation , FCNR , Convertibility, RFPI etc.
To strengthen against the External Causes there are also Bond buying in time of tapering and Quantitative easing by Foreign Central Banks . In this way Both type of shocks gets managed
What is Cash Reserve Ratio (CRR). How is it different from Statutory Liquidity Ratio. Some economists and bankers have demanded phasing out of CRR. Examine why. (200 Words)
Cash Reserve Ratio(CRR) is the proportion of total deposits of banks that they must park with RBI. Statutory Liquidity Ratio(SLR) is the proportion of deposits that banks must hold with themselves in the form of gold, govt securities etc. CRR will help in easing or tightening liquidity whereas SLR is to address the adhoc requirements of the bank liabilities like customer deposits etc. Banks earn interest on SLR whereas they do not on CRR.
Suggestion by economists and bankers to phase out CRR is due to following reasons.
  1. It will help in generating liquidity in market and in turn help in investment for new ventures.
  2. CRR is burden to banks which in order to maintain resort to high interest borrowings from other banks overnight.
  3. It can help in meeting Basel III norms otherwise which need capital infusion by governments.
  4. Growing need for public investment due to slump in global market and rising NPAs of banks resulting in low development.
  5. Issues of defaulters, long term funding resulting in blocking of money, low liquidity and high demand.
Phasing out CRR, economists opine, will create a harmony between fiscal deficit and development as well and may result in handling economy in an efficient way both wrt fiscal and monetary aspects.
What is a ‘Foreign Exchange Intervention’?
  • A foreign exchange intervention is a monetary policy tool in which a central bank takes an active participatory role in influencing the monetary funds transfer rate of the national currency.
  • Central banks, especially those in developing countries, intervene in the foreign exchange market in order to build reserves, stabilize the exchange rate and to correct misalignments
  • The success of foreign exchange intervention depends on how the central bank sterilizes the impact of its interventions, as well as general macroeconomic policies set by the government
What is delayed monetary transmission?
  • Delayed monetary transmission means that banks does not pass on the benefit of RBI’s rate reduction to their customers. For ex. If RBI decreases its RR by 1% than bank should also provide loan at 1% cheaper rates. But does not do that.
  • Due to this delay, monetary policy becomes ineffective. Because RBI changes its rate in the hope that entire economy will have similar reductions or increments.
What are the factors that led to low inflation in past year?
  • Sharp drop in petroleum prices and the accompanying decline in primary commodity prices 
  • Metal and mineral prices declined sharply in the last two years and various agricultural commodities also witnessed a sharp fall in prices
  • The distress in rural areas that had started building up since November 2013 has continued until now
  • There was also a decline in farm business income and a drop in construction and other non-farm activities
  • The cutback in rural spending, partly a result of the Fourteenth Finance Commission award and partly as a result of the government’s decision to cut back spending on rural programmes, also resulted in low rural demand
  • The continued recession in major markets outside India meant that exports fell throughout the last two years



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