RBI Monetary Policy

RBI Monetary Policy

Subject :Economy

Context:

A premature pause in monetary policy action would be a costly policy error at this juncture, the RBI governor stated in the MPC minutes.

Concept:

Monetary policy 

• It refers to the use of monetary instruments under the control of the central bank to regulate magnitudes such as interest rates, money supply and availability of credit with a view to achieving the ultimate objective of economic policy.

RBI Monetary Policy Instances:

• Hawkish Monetary Policy Stance
  •  In order to keep inflation in check, the Hawkish stance favours high-interest rates.
  • A tight monetary policy is implemented to contract economic growth. Converse to accommodative monetary policy, a tight monetary policy involves increasing interest rates to constrain borrowing and to stimulate savings.
• Dovish Monetary Policy Stance
  • This monetary policy stance involves low interest rates.
  • Low-Interest Rates would entice consumers to take credit (loans) from Banks and other sources.
  • Economists who recommend Dovish Monetary Policy Stance, typically believe that lower interest rates will lead to a hike in Employment and an increase in Economic Growth.
  • This stance might also lead to a possible weakening of the country’s currency.

• Accommodative Monetary Policy Stance
  •  This happens when a central bank (RBI) attempts to expand the overall money supply to boost the economy when the economic growth is slowing down. The major aim is to increase spending.
  • This is also known as “easy monetary policy”.
  • It does this by running a succession of decreases in the Interest rates, making the cost of borrowing cheaper.
• Neutral Monetary Policy Stance
  •  The policy rates neither stimulate (speed up) nor restrains (slowdown) the economic growth by taxation and government spending. Economic conditions are just right.
  • The Key Policy Rates are neither increased or decreased.

Instruments of monetary policy:

• Statutory Liquidity ratio (SLR)
  • To combat inflation, the RBI must raise the SLR. When the SLR is raised, banks are required to keep a larger amount in safe and liquid assets. As a result, the bank’s ability to lend to the market declines, lending rates rise. Market liquidity will shrink, as a result, inflation is controlled.
  • The RBI must decrease SLR to fight deflation, which works the opposite way.
• Cash Reserve Ratio (CRR)
  • To combat inflation, the RBI must raise the CRR. When the CRR is raised, banks are required to keep a larger amount of cash with the RBI.
  •  As a result, the bank’s ability to lend to the market declines, lending rates rise. Market liquidity will shrink, as a result, inflation is controlled.
• Repo Rate   
  • During periods of high inflation, the RBI raises the repo rate to reduce the flow of money in the economy. A rise in the repo rate disincentivizes banks from borrowing from the RBI.
  • As a result, market liquidity decreases. Lending rates rise, making borrowing more expensive for businesses and industries, slowing investment and money supply in the market. It aids in the control of inflation.
• Reverse Repo rate
  • To combat high levels of inflation, the RBI raises the reverse repo rate. It encourages banks to park funds with the RBI (more certainty of return + higher interest rate) rather than lend to the private sector.
  • As a result, market liquidity is reduced and borrowing interest rates rise. Borrowing will be more expensive for private players, reducing investment. It aids in the control of inflation.
•  Standing deposit facility
  • The standing deposit facility is a collateral-free liquidity absorption mechanism implemented by the RBI with the intention of transferring liquidity out of the commercial banking sector and into the RBI.
  • Increase in the SDF would reduce the money supply in the economy.
• Marginal Standing Facility (MSF)  
  • Marginal Standing Facility (MSF) is a provision made by the Reserve Bank of India through which scheduled commercial banks can obtain liquidity overnight, if inter-bank liquidity completely dries up.
• Open Market Operation (OMO)     
  • To combat higher levels of inflation, the RBI drains the market of excess liquidity by selling government securities. Banks lend money to the RBI by borrowing government securities. This reduces the economy’s excess liquidity. Lending rates rise, making borrowing more expensive, stifling private investment. As a result, it prevents inflation.
• Market Stabilisation Scheme (MSS)    
  • To combat inflation, the RBI, in a manner similar to the Open Market Operations, sucks out excess liquidity in the economy by selling government securities. Banks lend money to the RBI by borrowing government securities. This reduces the economy’s excess liquidity. Lending rates rise, making borrowing more expensive, stifling private investment. As a result, it prevents inflation.