Business Environment &

Business Laws

Monetary Policy

TPK
Compare and contrast different economic
systems?
India has opted for mixed economy. Do you think
this has worked well for the Indian economy?
Justify.
What are growth drivers in Indias economic
development?

Agenda
Types of economic policies
Economic liberalization, fiscal and monetary

policies and budget

WTO and International Economy
Industrial policy
Trade Policy
Economic Development and role of government
Privatization & Public Systems Management

Hope is not a strategy.

~ John Mauldin

Monetary Policy
o Monetary and Credit Policy is the policy statement,
announced twice a year, through which the Reserve
Bank of India seeks to ensure price stability for the
economy.
o Aims at regulating money supply (M3), interest rates and
the inflation.
o RBI also announces norms for the banking and financial
sector and the institutions which are governed by it.

Monetary Policy vs. Fiscal Policy

o Monetary Policy:
o Regulates the supply of money;
o Cost and availability of credit; Deals with both the lending
and borrowing rates of interest for commercial banks.
o Aims to maintain price stability, full employment and
economic growth.
o Fiscal Policy:
o Used to overcome recession and control inflation.
o A deliberate change in government revenue and
expenditure to influence the level of national output and
prices.

Objectives of Monetary Policy

Price stability
Credit availability
Stability of exchange rare
Full employment
High rate of economic growth
Distribution of money
Monetary policy is carried out via central bank (RBI). It is a
transmission mechanism. Banks decisions influence
households and firms.

Tools for Monetary Policy

Open market operations

Buying and selling of securities, normally government

securities, in order to increase or decrease supply of money.

Expansionary open market operation Downward pressure on

short-term interest rates.

Contractionary open market operation Upward pressure on

short-term interest rates.

Tools for Monetary Policy

Reserve requirements

Cash Reserve Ratio (CRR): A specified minimum fraction

of the total deposits of customers, which commercial
banks have to hold as reserves with the central bank.
Used for controlling money supply in the economy.

Statutory Liquidity Ration (SLR): Amount that the

commercial banks require to maintain in the form of gold
or govt. approved securities (bond and shares of different
companies) before providing credit to the customers.
Used to control the expansion of bank credit.

Tools for Monetary Policy

Reserve requirements

Open Market Operations: Buying and selling of Govt.

securities in the open market . During inflation RBI sells
securities in the open market which leads to transfer of
money to RBI. Thus money supply is controlled in the
economy.

Tools for Monetary Policy

Lending by central bank at Bank Rate

Rate at which a nation's central bank lends money to

domestic banks.

These loans are very short in duration.

Managing the bank rate is a preferred method by which

central banks can regulate the level of economic activity.

Lower bank rates can help to expand the economy, when

unemployment is high, by lowering the cost of funds for
borrowers.

Conversely, higher bank rates help to reign in the

economy, when inflation is higher than desired.

Tools for Monetary Policy

Repo rates

Repos Repurchase agreements.

Repo or repurchase option is a means of short-term

borrowing, wherein banks sell approved government
securities to RBI and get funds in exchange.

It is a short-term interest-bearing loan against collateral.

Annualized rate of interest paid on the loan is known as

repo rate.

Central bank uses repos to manage aggregate reserves

of banking system.

Tools for Monetary Policy

Reverse Repo rates

Banks purchase government securities from RBI and lend

money to the banking regulator, thus earning interest.

It amounts to RBI borrowing money from banks.

Monetary Policy in the 21st Century

Monetary policy in operation

Desire to monitor inflation vs. desire to boost output and

employment.

Use of money as an Intermediate target

Central bank can only decide the amount of money supply in a

given year, but cannot set the amount of money in the financial
system.

E-money and falling demand for central bank money

Electronic substitutes for cash threaten to reduce demand for

central bank money.

Monetary Policy in the 21st Century

Central banks ability to influence interest rates, exchange

rates, and money supply are eroding.

Implications of a declining demand for base money

Base money becomes less significant eroding central bank

influencing the broader monetary system.

Prices and interest rates would be more vulnerable to external

shocks.

Globalization of monetary policy

Monetary policy requires global orientation.

From administered regime of interest rate to market based

process.

Monetary Policy in the 21st Century

Monetary policy and inflation

The practice of inflation targeting.

Two tools Open market operations; Interest rate charged by

banks on advances.

Maintenance of price stability fosters greater output and

employment.

Central bank independence

Personnel matters: Appointment and dismissal of top brass.

Financial aspects: Funding of government expenditure.

Conduct of policy: Flexibility to central bank.

Monetary Policy in India

Bank Rate

Deposit Rate: > 1 year 8.00 9.05

PLR: Rate at which most creditworthy borrowers are given

loans.

Repo Rate : 8.0%

CRR: 4%; SLR: 22.5%
Monetary Policy Operations

Liquidity management: RBIs two committees Working group

on instruments of sterilization and an internal group on
Liquidity Adjustment Facility.

Monetary Policy in India

Market Stabilization Scheme (MSS): Aligning interest rates on

capital inflows to that of international rates. Operationalized in
April 2004.

Liquidity Adjustment Facility (LAF): Repo and Reverse repo.

Interest rate policy: Transparency in pricing of loan products by

banks through Benchmark Prime Lending Rates.

Credit delivery: Ensures adequate flow of credit to agriculture,

SMEs and infrastructure at reasonable rates.

Refer http://www.rbi.org.in/scripts/BS_ViewBulletin.aspx for RBI Bullletin

How does monetary policy affect the business

environment of a company?