ROLE OF MONETARY POLICY IN INDIA

2/24/2015 2
CONTENTS:
INTRODUCTION
DEFINITION
OBJECTIVES
MAJOR MONETARY OPERATIONS
MONETARY POLICY PROCEDURES
TYPES
ROLE OF MONETARY POLICY
OBSTACLES IN IMPLEMENTATION OF MONETARY POLICY
PRESENT MODI’S GOVERNMENT TOWARDS MONETARY POLICY
RECENT CHANGES IN RBI’s MONETARY POLICY
CONCLUSION
REFERENCES

 The term monetary policy is also known as the 'credit policy' or called 'RBI's
money management policy' in India. How much should be the supply of money in
the economy? How much should be the ratio of interest? How much should be
the viability of money? etc. Such questions are considered in the monetary policy.
From the name itself it is understood that it is related to the demand and the
supply of money.
 Monetary policy is the process by which monetary authority of a country,
generally a central bank controls the supply of money in the economy by
exercising its control over interest rates in order to maintain price stability and
achieve high economic growth. In India, the central monetary authority is the
Reserve Bank of India (RBI). is so designed as to maintain the price stability in
the economy.
 The Reserve Bank of India (RBI) is the central banking system of India and controls
the monetary policy of the rupee.The institution was established on 1 April 1935
and plays an important part in the development strategy of the government.
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 According to Prof. Harry Johnson,
“A policy employing the central banks
control of the supply of money as an
instrument for achieving the objectives of
general economic policy is a monetary
policy."
RESERVE BANK OF
INDIA GOVERNOR
RAGHURAM RAJAN
Harry Gordon Johnson
(1923–1977) was a Canadian
economist
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 The objectives of a monetary policy in India are similar to the objectives of
its five year plans. In a nutshell planning in India aims at growth, stability
and social justice. After the Keynesian revolution in economics, many people
accepted significance of monetary policy in attaining following objectives.
1.Rapid Economic Growth
2.Price Stability
3.Exchange Rate Stability
4.Balance of Payments (BOP)
Equilibrium
5.Full Employment
6.Neutrality of Money
7.Equal Income Distribution
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CRR Graph from 1992 to 2011 CRR Graph from 1992 to 2011
Bank Rate Graph from 1991 to 2011
Operations Meaning
CRR Cash Reserve Ratio Is A Certain PercentageOf
Bank DepositsWhich Banks Are RequiredTo
KeepWith RBI InThe Form Of Reserves Or
Balances
SLR Every Financial Institution HasTo Maintain A
Certain QuantityOf LiquidAssetsWith
Themselves AtAny Point OfTime OfTheirTotal
Time And Demand Liabilities
Bank Rate The Bank Rate,Also Known AsThe Discount
Rate, IsThe Rate Of Interest Charged ByThe
RBI For Providing Funds Or LoansToThe
Banking System.
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 The monetary policy in a developing economy will have to be quite different
from that of a developed economy mainly due to different economic conditions
and requirements of the two types of economies.
 A developed country may adopt full employment or price stabilization or
exchange stability as a goal of the monetary policy.
 But in a developing or underdeveloped country, economic growth is the primary
and basic necessity. Thus, in a developing economy the monetary policy should
aim at promoting economic growth, the monetary authority of a developing
economy can play a vital role by adopting such a monetary policy which creates
conditions necessary for rapid economic growth. Monetary policy can serve the
following developmental requirements of developing economies. EG:INDIA
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 In a developing economy, the monetary policy can play a significant
role in accelerating economic development by influencing the
supply and uses of credit, controlling inflation, and maintaining
balance of payment.
 Once development gains momentum, effective monetary policy can
help in meeting the requirements of expanding trade and
population by providing elastic supply of credit.
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 The primary aim of the monetary policy in a developing economy must be
to improve its currency and credit system. More banks and financial
institutions should be set up, particularly in those areas which lack these
facilities.
 The extension of commercial banks and setting up of other financial
institutions like saving banks, cooperative saving societies, mutual
societies, etc. will help in increasing credit facilities, mobilizing voluntary
savings of the people, and channelizing them into productive uses.
 It is also the responsibility of the monetary authority to ensure that the
funds of the institutions are diverted into priority sectors or industries as
per requirements of are development plan of the country.
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 To meet the developmental needs the central bank of an developing country
must function effectively to control and regulate the volume of credit through
various monetary instruments, like bank rate, open market operations, cash-
reserve ratio etc.
 Greater and more effective credit controls will influence the allocation of
resources by diverting savings from speculative and unproductive activities to
productive uses.
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 Most developing countries are
characterized by dual monetary
system in which a small but highly
organized money market on the one
hand and large but unorganized
money market on the other hand
operate simultaneously.
 The unorganized money market
remains outside the control of the
central bank. By adopting effective
measures, the monetary authority
should integrate the unorganized
and organized sect ors of the money
market.
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 The monetary authority of a
developing country should take ap-
propriate measures to increase the
proportion of bank money in the
total money supply of the country.
This requires increase in the bank
deposits by developing the banking
habits of the people and
popularizing the use of credit
instruments (e.g., cheque, drafts,
etc.).
 An underdeveloped country is also
marked by the existence of large non-
monetarized sector. In this sector, all
transactions are made through barter
system and changes in money supply
and the rate of interest do not
influence the economic activity at all.
The monetary authority should take
measures to monetise this non-
monetised sector and bring it under its
control.
6. Monetization of Economy:
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 In an underdeveloped economy, there is absence of an integrated interest
rate structure. There is wide disparity of interest rates prevailing in the
different sectors of the economy and these rates do not respond to the
changes in the bank rate, thus making the monetary policy ineffective.
 The monetary authority should take effective steps to integrate the
interest rate structure of the economy. Moreover, a suitable interest rate
structure should be developed which not only encourages savings and
investment in the country but also discourages speculative and
unproductive loans.
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 Debt management is another function of monetary policy in a developing
country. Debt management aims at (a) deciding proper timing and issuing of
government bonds, (b) stabilizing their prices, and (c) minimizing the cost of
servicing public debt.
 The monetary authority should conduct the debt management in such a manner
that conditions are created "in which public borrowing can increase from year to
year and on a big scale without giving any jolt to the system.
 And this must be on cheap rates to keep the burden of the debt low."However,
the success of debt management requires the existence of a well- developed
money and capital market along with a variety of short- term and long-term
securities.
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 The monetary policy in a developing
economy should also solve the problem
of adverse balance of payments. Such a
problem generally arises in the initial
stages of economic development when
the import of machinery, raw material,
etc., increase considerably, but the export
may not increase to the same extent.
 The monetary authority should adopt
direct foreign exchange controls and
other measures to correct the adverse
balance of payments.
 Developing economies are highly
sensitive to inflationary pressures. Large
expenditures on developmental schemes
increase aggregate demand. But, output
of consumer's goods does not increase in
the same proportion. This leads to
inflationary rise in prices.Thus, the
monetary policy in a developing economy
should serve to control inflationary
tendencies by increasing savings by the
people, checking expansion of credit by
the banking system, and discouraging
deficit financing by the government.
10. Controlling Inflationary
Pressures
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 Monetary policy can promote
industrial development in the
developing countries by promoting
facilities of medium-term and long-
term loans to the manufacturing
units. The monetary authority should
induce these banks to grant long-
term loans to the industrial units by
providing rediscounting facilities.
Other development financial
institutions also provide long-term
productive loans.
 Rural credit system is defective and rural credit
facilities are deficient in the underdeveloped
countries. Small cultivators are poor, have no
finance of their own, and are largely
dependent on loans from village money
lenders and traders who generally exploit the
helplessness, ignorance and necessity of these
poor borrowers.
12. Reforming Rural Credit
System:
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Through The Monetary Policy Is Useful In Attaining Many Goals Of Economic Policy, It
Is Not Free From Certain Limitations. Its Scope Is Limited By Certain Peculiarities, In
Developing Countries Such As India. Some Of The Important Limitations Of The
Monetary Policy Are Given Below.
1. There exist a Non-Monetized
Sector
 In many developing countries,
there is an existence of non-
monetized economy in large
extent. People live in rural areas
where many of the transactions
are of the barter type and not
monetary type. Similarly, due to
non-monetized sector the progress
of commercial banks is not up to
the mark. This creates a major
bottleneck in the implementation
of the monetary policy.
2.Excess Non-Banking Financial
Institutions (NBFI)
 As the economy launch itself into a
higher orbit of economic growth
and development, the financial
sector comes up with great speed.
As a result many Non-Banking
Financial Institutions (NBFIs) come
up. These NBFIs also provide credit
in the economy. However, the
NBFIs do not come under the
purview of a monetary policy and
thus nullify the effect of a
monetary policy.

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3. EXISTENCE OF UNORGANIZED
FINANCIAL MARKETS
 The financial markets help in
implementing the monetary policy.
In many developing countries the
financial markets especially the
money markets are of an
unorganized nature and in
backward conditions. In many
places people like money lenders,
traders, and businessman actively
take part in money lending. But
unfortunately they do not come
under the purview of a monetary
policy and creates hurdle in the
success of a monetary policy.
4. HIGHER LIQUIDITY HINDERS
MONETARY POLICY
 In rapidly growing economy
the deposit base of many
commercial banks is
expanded.This creates excess
liquidity in the system. Under
this circumstances even if the
monetary policy increases the
CRR or SLR, it dose not deter
commercial banks from credit
creation. So the existence of
excess liquidity due to high
deposit base is a hindrance in
the way of successful
monetary policy.
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5. MONEY NOT APPEARING IN AN
ECONOMY
 Large percentage of money
never come in the mainstream
economy. Rich people, traders,
businessmen and other people
prefer to spend rather than to
deposit money in the bank. This
shadow money is used for buying
precious metals like gold, silver,
ornaments, land and speculation.
This type of lavish spending give
rise to inflationary trend in
mainstream economy and the
monetary policy fails to control
it.
6.TIME LAG AFFECTS SUCCESS OF
MONETARY POLICY
 The success of the monetary
policy depends on timely
implementation of it.
However, in many cases
unnecessary delay is found in
implementation of the
monetary policy. Or many
times timely directives are not
issued by the central bank,
then the impact of the
monetary policy is wiped out.
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7.MONETARY & FISCAL POLICY LACKS
COORDINATION
 In order to attain a maximum
of the above objectives it is
unnecessary that both the fiscal
and monetary policies should
go hand in hand. As both these
policies are prepared and
implemented by two different
authorities, there is a possibility
of non-coordination between
these two policies. This can
harm the interest of the overall
economic policy.
 These are major obstacles in
implementation of
monetary policy. If these
factors are controlled or
kept within limit, then the
monetary policy can give
expected results. Thus
though the monetary policy
suffers from these
limitations, still it has an
immense significance in
influencing the process of
economic growth and
development.
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Inflation remains a major worry, given that rainfall this year
has been below average, ranging from 20% to 40% of
normal levels in various regions. If the rainfall does not
recover in the coming weeks, it would certainly affect food
prices in the near future. The Modi ‘s government is well
aware of the political cost of inflation and has taken
necessary steps like instituting strict rules against
hoarding, banning exports of some food grains, and
bringing a few food grains under the Essential
Commodities Act. Fortunately, last year witnessed a good
harvest of around 260 million tons of food grains, giving
the government a buffer to avoid an unexpected surge in
food prices. Moreover, the present government's emphasis
on fiscal consolidation may make monetary policy more
effective and reduce core inflation over time. The
government has also linked different social schemes to
asset creation, which in the medium term might improve
goods and services.
PRESENT MODI’S GOVERNMENTTOWARDS
MONETARY POLICY
Inflation, particularly
food inflation, is very
high in India and
expected to increase
due to a water
shortage this season.
What steps has the
Modi’s government
taken to reduce
inflation, and how will
they affect India's
monetary policy and
overall growth? Let’s
see
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 Since 1991 RBI’s monetary management has undergone some major changes.
Let us explain
1) Multiple Indicator Approach :-
Up to late 1990s, RBI used the ‘Monetary targeting approach’ to its monetary policy. Monetary
targeting refers to a monetary policy strategy aimed at maintaining price stability by focusing on
changes in growth of money supply. After 1991 reforms this approach became difficult to follow. So
RBI adopted Multiple indicator Approach in which it looks at a variety of economic indicators and
monitor their impact on inflation and economic growth.
2) Selective Methods Being Phased Out :-
With rapid progress in financial markets, the selective methods of credit control are being slowly
phased out. Quantitative methods are becoming more important.
3) Reduction In Reserve Requirements :-
In post-reform period the CRR and SLR have been progressively lowered. This has been done as a
part of financial sector reforms. As a result, more bank funds have been released for lending. This has
led to the growth of economy.
4) Deregulation Of Administered Interest Rate System :-
Earlier lending rate of banks was determined by RBI. Since 1990s this system has changed and
lending rates are determined by commercial banks on the basis of market forces.
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5) Delinking Of Monetary Policy From Budget Deficit :-
In1994 government phased out the use of adhoc treasury Bills.These bills were used by
government to borrow from RBI to finance fiscal deficit. With phasing out of Bills, RBI would no longer
lend to government to meet fiscal deficit.
6) Liquidity Adjustment Facility (LAF):-
LAF allows banks to borrow money through repurchase agreement LAF was introduced by RBI
during June, 2000, in phases. The funds under LAF are used by banks to meet day-to-day mismatches in
liquidity.
7) Provision Of Micro Finance
By linking the banking system with Self Help Groups, RBI has introduced the scheme of micro
finance for rural poor. Along with NABARD, RBI is promoting various other microfinance institutions.
8) External Sector
With globalization large amount of foreign capital is attracted. To provide stability in financial
markets, RBI uses sterilization and LAF to absorb the excess liquidity that comes in with huge inflow
of foreign capital.
9) Expectation As A Channel Of Monetary Transmission
Traditionally, there were four key channels of monetary policy transmission :-Interest rate,
credit availability, asset prices and exchange rate channels. Interest rate is the most dominant
transmission channel as any change in monetary policy has immediate effect on it. In recent years
fifth channel, Expectation has been added. Future expectations about asset prices, general price and
Income levels influence the four traditional channels.
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CONCLUSION:
With the changing framework of monetary policy in Indian from monetary targeting to an
augmented multiple indictors approach, the operating targets and processes have also
undergone a change. There has been a shift from quantitative intermediate targets to
interest rates, as the development of financial markets enabled transmission of policy
signals through the interest rate channel. At the same time, availability of multiple
instruments such as CRR, OMO including LAF and MSS has provided necessary flexibility
to monetary operations. While monetary policy formulation is a technical process, it has
become more consultative and participative with the involvement of market participant,
academics and experts. The internal process has also been re-engineered with more
technical analysis and market orientation. In order to enhance transparency in
communication the focus has been on dissemination of information and analysis to the
public through the Governor’s monetary policy statements and also through regular
sharing of policy research and macroeconomic and financial information.
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 To conclude, monetary policy is helpful in attaining growth with stability. However,
there are challenges in maintaining the momentum. Six most important challenges
are agricultural growth, infrastructure development, fiscal consolidation, social
infrastructure particularly primary education and basic health, managing globalization
and good governance. The conduct of monetary policy will continue to provide
support to these areas.
Stability, especially price and financial stability; will undoubtedly facilitate accelerated
growth.
 India, today, stands at a new threshold, with greater triumphs and
achievements in sight. Never before in recorded history have so many people
been in a position to rise and that so quickly.
 Jai Hind!
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REFERENCES:
 en.wikipedia.org/wiki/ Monetary_policy_of_India
 www.slideshare.net/BharathiRaj3/monetary-and-fiscal-policy-of-india
 www.jstor.org/stable/4406238
 kalyan-city.blogspot.com/.../monetary-policy-its-meaning-definitions.html
 ess.anu.edu.au/narayanan/mobile_devices/ch05.html
 Book reference : Impacts of Monetary policy,himalaya publishing house,
Author L.M Bhole First edition
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ROLE OF MONETARY POLICY IN INDIA

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