By Monetary policy is important tool of reserve bank of India. Through which RBI manage the money supply in the country to achieve specific economic objectives. Such as credit availability and control of inflation in the economy. It is important tool to manage price stability, promote economic growth and ensure financial stability in the country.
In simple terms Monetary policy is the RBI’s strategy for managing money and credit in the economy to achieve stable price, economic growth and financial stability.
Objectives of monetary policy
1. Price stability – A main objective is to maintain low and stable inflation. protecting the purchasing power of currency and enhance economic certainty.
2. financial stability – RBI actively monitor the financial system and manage systematic risks within the financial sector to prevent disruptions.
3. Economic Growth – the RBI aim to promote sustainable economic growth by ensuring that adequate credit is available to all sector of the economy, encouraging investment and consumption.
4. Exchange rate stability – the RBI manage the exchange rate of the Indian rupee to mitigate excessive volatility. Supporting international trade and investment.
Type of Monetary policy
1. Expansionary monetary policy –
The policy involves increasing the money supply and reducing interest rates to encourage borrowing and spending by consumers and stimulate economic growth during slowdown.
RBI takes measure steps are as follows :
- Decrease the Repo rate
- Reduce CRR and SLR
- Purchase government securities
2. contractionary Monetary policy –
Contractionary monetary policy is used when inflation is high and there is excessive money supply in the economy. The objective is to reduce liquidity and control rising price.
RBI takes actions are as follows :
- Increase Repo rate
- Increase CRR and SLR
- Sale government securities.
Monetary Policy Committee (MPC)
Introduction –
The Monetary Policy Committee (MPC) is a statutory body constituted by the Reserve Bank of India under the amended RBI Act, 1934. It is responsible for determining India’s monetary policy and setting the policy interest rate (Repo Rate) to achieve the inflation target while supporting economic growth.
The MPC was established in 2016 to bring transparency, accountability, and collective decision-making to India’s monetary policy process. It operates under the framework of Flexible Inflation Targeting (FIT), where the government has set an inflation target of 4% with a tolerance band of ±2%.
The monetary policy committee has six members three members appointed by reserve bank of India and three members are appointed by government of India. Each member has tenure of four years.
Tools of Monetary Policy in India
1. Quantitative (General) Tools
1. Repo Rate
The Repo Rate is the rate at which the Reserve Bank of India lends short-term money to commercial banks against government securities. When the RBI increases the repo rate, borrowing becomes more expensive for banks, which reduces lending and helps control inflation. When the repo rate is reduced, banks can borrow at a lower cost and provide cheaper loans to customers, which encourages investment and economic growth.
2. Reverse Repo Rate
The Reverse Repo Rate is the rate at which the RBI borrows money from commercial banks. When the reverse repo rate is increased, banks prefer to deposit more money with the RBI because they earn higher returns. This reduces the amount of money available for lending in the economy and helps control inflation. A lower reverse repo rate encourages banks to lend more money to businesses and individuals.
3. Cash Reserve Ratio (CRR)
The Cash Reserve Ratio (CRR) is the percentage of a bank’s total deposits that must be kept as cash with the RBI. Banks cannot use this money for lending or investment. When the RBI increases the CRR, banks have less money available for loans, reducing the money supply in the economy. When the CRR is reduced, banks can lend more money, increase liquidity and support economic growth.
4. Statutory Liquidity Ratio (SLR)
The Statutory Liquidity Ratio (SLR) is the minimum percentage of deposits that banks must maintain in the form of cash, gold, or approved government securities. This requirement ensures that banks remain financially stable and have sufficient liquid assets. A higher SLR reduces the amount of money available for lending, while a lower SLR increases banks’ lending capacity.
5. Bank Rate
The Bank Rate is the rate at which the RBI provides long-term loans and advances to commercial banks without any repurchase agreement. Changes in the bank rate influence the lending and borrowing rates of banks. An increase in the bank rate makes borrowing more expensive and helps control inflation, whereas a decrease encourages borrowing and investment.
6. Open Market Operations (OMO)
Open Market Operations (OMO) refer to the buying and selling of government securities by the RBI in the open market. When the RBI purchases securities, it injects money into the banking system, increasing liquidity and encouraging lending. When it sells securities, money is withdrawn from the economy, reducing liquidity and helping control inflation.
2. Qualitative (Selective) Tools
1. Margin Requirement
The Margin Requirement is the difference between the value of a security pledged as collateral and the amount of loan granted against it. By changing the margin requirement, the RBI can control the amount of credit available for specific purposes. A higher margin requirement reduces borrowing, while a lower margin requirement increases access to credit.
2. Credit Rationing
Credit Rationing is a method by which the RBI limits the amount of credit that commercial banks can provide to borrowers. This tool is used to control excessive lending and direct credit towards priority sectors of the economy. It helps prevent overexpansion of credit and reduces inflationary pressures.
3. Moral Suasion
Moral Suasion refers to the RBI’s efforts to persuade commercial banks to follow its monetary policy objectives through advice, meetings, and guidelines rather than through legal measures. Banks often cooperate with RBI recommendations to maintain a healthy and stable financial system.
4. Direct Action
Direct Action is a measure taken by the RBI against banks that fail to comply with its regulations or policy directives. The RBI may impose penalties, restrict certain banking operations, or take other corrective actions to ensure compliance and maintain financial discipline.