EFFECTS OF MONETARY POLICY ON

BUSINESS ENVIRONMENT IN INDIA

Monetary Policy
By monetary policy, we mean policy
concerned with changes in the supply
of money. Issues connected with
monetary policy are: objectives or goals
of the policy, instruments of monetary
control, its efficacy, implementation,
intermediate target of the policy etc.
InIndia, the central monetary authority
is theReserve Bank of India(RBI).

Scope of the project

The study covers a period of 6
financial years starting from 2008.
Thus, the study is exclusively on the
impact of monetary policy on the
Indian Economy in the post-2008 era.
This study is exclusively based on
secondary data. Secondary data
were collected from the RBI bulletin,
RBI occasional papers, RBI Annual
Reports, World Bank Reports, Internet

Historical concept
Indias monetary policy since the first plan period
was one of 'controlled expansion- that is, a policy of
adequate financing of economic growth ensuring
reasonable price stability.
Thus, RBI helped the economy to expand via
expansion of money and credit and attempted to
check rise in prices through monetary and other
control measures.
In India, the emphasis of monetary policy shifted
towards control of inflation in 1995-96.
Ensuring price stability requires the pursuit of a
consistent policy over a period of time.

Importance
The monetary policy strategy of a Central bank
depends on a number of factors that are unique to
the country and the context.
An important factor in this context is the degree of
openness in the economy. The second factor is the
stage of development of markets, institutions and
technological development.
It is important to recognize that all the objectives
cannot be effectively pursued by any single arm of
economic policy. Hence, there is always the problem
of assigning to each instrument the most
appropriate target or objective.

Objectives

To examine the effectiveness of monetary

policy in ensuring price stability in India
To find out to what extent monetary policy
facilitated economic growth in India and its
general impact in the post- 2008 era.
To find out the relation of credit management
and monetary policy, we examined the
qualitative and quantitative controls.
To study the effectiveness of the monetary
policy keeping in mind the current scenario.

How the monetary policy is

set ?

Role of RBI
a) Issue of Bank notes.
b) Management of the monetary system.
c) Regulation and supervision of banks and Non Banking
Finance Companies (NBFCs).
d) Acting as a lender of the last resort.
e) Regulation and supervision of the Payment and
Settlement Systems.
f) Maintaining and managing the countrys foreign exchange
reserves.
g)Acting as a banker to the banks and the Governments.
h) Acting as the manager of the debt of the Governments.
i) Regulation and development of foreign exchange market.
j) Developmental functions including in the areas of rural
credit and financial inclusion.

Monetary Policy Instruments

Bank Rate
Cash Reserve
Ratio
Statutory
Liquidity Ratio
Open Market
Operations
Repo Rate
Reverse Repo
Rate

Interest rates
30
25
CRR
20
15
Percent (%)
10
5
0

SLR
MSF
Bank Rate
Repo Rate
Reverse Repo Rate

EFFECT OF MONETARY
POLICY ON:
I. Inflation and Price
Stability
II. Economic Growth
III.Credit management and
Supply

I. Inflation and Price

Stability
Inflation A sustained increase in the general level of prices
for goods and services.

Indicator of growth of economy

Cost Push Inflation- Increase in costs of any of the four factors of
production (labor, capital, land or entrepreneurship) at full
production
Demand Pull Inflation- Increase in aggregate demand, categorized
by the four sections of the macro economy: households, businesses,
governments and foreign buyers
Rapid Growth of Money Supply is main cause

Deflation- Fall in general level of prices of goods and services

Disinflation- Refers to a slowdown in the rate of inflation
Price stability is major reason to have a predictable rate of
inflation

Inflation distorts
the cost of
borrowing and
lending

Failure of other
monetary
policy , such as
those based on
the money
supply or
exchange rate

Inflation
TargetingRequires
clear
quantitative
target (CPI
4% +/- 2% in
India)
Falling prices
cause customer
to delay
purchases
leading to lower
economic
activity

Deflation causes
low real interest
rates for
depositors .More
people investing
in gold .Less
credit is
available to
industry

CPI-Consumer Price Index

Provisional CPI February 2015

for Chandigarh (Base Year 2012)
Category

Rural

Urban

Combined

Food and beverages

121.9

122.1

122.1

Pan, tobacco and

intoxicants

131.0

148.6

146.1

Clothing and footwear

120.3

121

120.9

Housing

113.2

Fuel and light

119.0

119.6

119.5

Miscellaneous

114.9

110.4

110.7

All Groups

119.3

116.2

116.4

Variation of CPI (% change in index) in 2012-2013, 2013-2014 and

2014-2015

Year
APR
MAY
JUN
JUL
AUG
SEP
OCT
NOV
DEC
JAN
FEB

2012-13
10.3
10.4
10
9.9
10
9.7
9.8
9.9
10.6
10.8
10.9

2013-14
9.4
9.3
9.9
9.6
9.5
9.8
10.1
11.2
9.9
8.8
8.1

MAR

10.4

8.3

2014-15
8.6
8.3
7.4
8
7.8
6.5
5.5
4.4
5
5.19 (BY 2012)
5.37 (BY 2012)

WPI- Wholesale Price Index

Number of items
Published by
in index is
Represents the
Office of Economic
changed to give
price of goods at a
Adviser and used
true picture of
wholesale stage
by Ministry of
economy (676
i.e. bulk trading
Finance
items used
currently)
May be replaced
by Producer Price
Gives true picture
Index which takes
of Industrial
into account
situation
sellers price rather
than buyers

Variation in WPI Index (Base Year 2004-05)

Year

All
commodities

Primary
articles

Food
articles

Non-food Fuel and

articles
Power

Manufactured
products

2013-14

177.6

241.6

238.9

213.2

205.4

151.5

2012-13

167.6

220.0

211.8

201.9

186.5

147.1

2011-12

156.1

200.3

192.7

182.7

169.0

139.5

2010-11

143.3

182.4

179.6

166.6

148.3

130.1

2009-10

130.8

154.9

155.4

136.2

132.1

123.1

2008-09

126.0

137.5

134.8

129.2

135.0

120.4

2007-08

116.6

123.9

123.6

114.4

121.0

113.4

2006-07

111.4

114.3

115.5

102.3

120.9

108.2

2005-06

104.5

104.3

105.4

96.7

113.6

102.4

2004-05

100.0

100.0

100.0

100.0

100.0

100.0

Variation in WPI Index

CPI for Chandigarh

II. ECONOMIC GROWTH

Various types of Indian economic
(monetary) indicators are used for
various periods of time
The real gross domestic product
(GDP),
Money
supply,
Credit
availability, Interest rates, Foreign
trade, & balance of payment (BOP)
are the other key macro economic
indicators.

Achievement of economic growth by two ways:

1) Management of Aggregate Demand:

The monetary authority should keep the aggregate
monetary demand in balance with the aggregate
supply ofgoods and services. For this a flexible
monetary policy is called for.
2) Encouragement to Saving and Investment:
The monetary authority can help economic
development by creating a favourable environment for
saving and investment which greatly influence
economic growth. For this, the monetary policys aim of
price stabilisation is very important. Reasonable
pricestability encourages both saving and investment.

A comparison between interest rates

and GDP growth
Interest rates
GDP (trillion USD)
30

2
1.8

25

1.6
1.4

20

1.2
1
0.8
0.6

GDP (trillion USD)

15

Percent (%)
10

0.4
0.2
0

5
0

CRR
SLR
MSF
Bank Rate
Repo Rate
Reverse Repo Rate

Foreign Direct Investment (FDI) and

Monetary policy
Interest rates

FDI(US $ million)
40000
35000
30000
25000
20000
15000
10000
5000
0

30

FDI(US $ million)

SLR

20

MSF

15
Percent (%)

CRR

25

10
5
0

Bank Rate
Repo Rate
Reverse Repo Rate

Balance of Payment (BOP)

Balance of payment is the monetary expression of trade balance which

is the balance between total exports and imports.
The Indias balance-of-payments (BoP) position improved dramatically
in 2013-14, particularly in the last three quarters.

STOCK MARKETS
Interest rates
30
25

CRR
SLR

20

MSF

15

Bank Rate

Percent (%)10

Repo Rate
Reverse Repo Rate

5
0

Monetary policy impacts stock prices but this is temporary and

largely a sudden reaction to the degree of change in interest rate
vis--vis the expectations of the market.

Currency

III. CREDIT SUPPLY

The various methods employed by the
RBI to control credit creationpowerof
the commercial banks can be classified
in two groups, viz., quantitative
controls and qualitative controls.
Quantitative controls are designed to
regulate the volume of credit created
by the banking system qualitative
measures or selective methods are
designed to regulate the flow of credit

Quantitative methods
Bank Rate
Open Market
Operations
Cash Reserve
Ratio
Statutory
Liquidity Ratio
Repo and
Reverse Repo
Rate

Rate payable by commercial banks on the

loans from the Central Bank.

Sale and purchase of securities by the Central

bank to the commercial banks.

Ratio which banks maintain between their

holdings of cash and their deposit liabilities
Net demand as liquid assets in the form of
cash, gold and unencumbered approved
securities.
rate at which the RBI lends short term money to
banks.
rate at which the central bank absorbs liquidity from
the banks

Qualitative Methods
Margin
Requirement
s
Credit
Rationing
Regulation of
Consumer
Credit
Moral
Suasion

designed to influence the flow of credit

against specific commodities

method by which the Central Bank seeks to

limit the maximum amount of loans and
advances

designed to check the flow of credit for

consumer durable goods

will succeed only if the Central Bank is strong

enough to influence the commercial banks

Money Supply
Money supply is the amount of money in
circulation in the economy at any point of
time. It not only includes the currency & coins
in circulation, but it also includes demand &
time deposits of banks, post office deposits
and such related instruments.
Valuation and analysis of the money supply
helps the economist and policy makers to
frame the policy or to alter the existing policy
of increasing or reducing the supply of money.

 The different types of money are

typically classified as "M"s. The "M"s
usually range from M0 (narrowest) to
M3 (broadest) but which "M"s are
actually focused on in policy
formulation depends on the country's
central bank.
In India, the Reserve Bank of India
follows M0, M1, M2, M3 and M4
monetary aggregates.

M0 (Reserve
Money):

M4: M3 + All
deposits with
post office
savings
banks

M3: M1+
Time
deposits
with the
banking
system

Monetar
y
Aggregat
es

M1:Currency
with the
public +
Deposit
money of the
public

M2: M1 +
Savings
deposits
with Post
office
savings
banks

Money supply

EFFECTIVENESS OF MONETARY POLICY

The factors impeding smooth monetary policy transmission to the

credit market include1. Rigidities in re-pricing for fixed deposits
2. A large unorganized market in India.
3. The large size of government borrowings,
4. practice of yearly resetting of interest rates on small savings
linked to G-sec yields,
5. Interest rate subventions that break the link between monetary
policy and lending rates,
6. Preferential tax benefits on fixed maturity plans of debt mutual
funds of tenor one year or more vis-a-vis fixed deposits of
corresponding maturities, high level of NPAs, an oligopolistic
credit market and a significant presence of informal finance.
These factors effectively dampen the policy rate transmission to
the final outcome, by making alternate investment vehicles more
attractive, especially during periods of monetary easing.

Analysis of economy as given in the

2013-14 monetary policy
During 2013-14, amid slow growth and high inflation, the Indian economy
had to contend with serious challenges to external stability emanating
from an unsustainably high current account deficit (CAD), capital outflows
and consequent exchange rate pressures.
After two consecutive years of moderation, GDP growth improved
marginally in 2013-14 due to a rebound in the growth of agriculture
and allied activities and electricity, besides buoyant activity in
financing, insurance, real estate and business services.
Growth continues to be slow with contraction in mining and
manufacturing.
Inflation declined during latter months of 2013- 14, but remains above
the level that could secure sustainable growth
Central government finances continued to improve in 2013- 14 with the
gross fiscal deficit (GFD) at 4.5 per cent of GDP lower than 4.8 per cent
budgeted for the year and also realised for 2012-13.
The external sector adjustment over the year was even more
remarkable. Though the current account deficit was large in Q1 of 201314 at 4.9 per cent of GDP, a correction in CAD subsequently helped
compress full year CAD to 1.7 per cent of GDP

FUTURE PROSPECTS FOR INDIA

The year 2014-15 has begun on a promising note. Index of
Industrial Production (IIP) growth is beginning to look up, while
inflation on an average, so far, has been lower than in the
corresponding period of the previous year.
The Union Budget aims to keep the economy on the path of fiscal
consolidation.
Export growth has improved, while capital inflows remain adequate.
Going forward, the fiscal deficit is likely to reduce further in 201415. The budgetary targets are realisable, though concerted efforts
will be necessary to achieve these targets.
With greater political stability, commitment to fiscal consolidation,
strengthening of the monetary policy framework and better policy
implementation, GDP growth is expected to be around 5.5 per cent in
2014-15 from the sub-5 per cent growth in the preceding two years.

What to worry about ?

1. Food price pressures witnessed in 2013-14 despite a normal
monsoon raised concerns over supply chain inefficiencies as well
as the need for improving the agro-marketing infrastructure in
the country. Sharp swings in vegetable prices often have a
destabilising impact on inflation expectations and concomitantly
raise the general level of prices.
2. Achievement of budgetary targets was made possible by a sharp
cutback in expenditures and higher non-tax revenues, aided in a
large part by higher dividend receipts from various public sector
enterprises (PSEs) and public sector banks (PSBs). While many
PSEs were already cash rich with inadequate investment plans, it
is important to ensure that this practice does not affect the
internal financing or reserves of the public enterprises that could
hamper their investments in the future.

Thank You
Questions ?