1

INDEX SR:NO TOPIC

EXECUTIVE SUMMARY

PG:NO 7 8 11 15 23 25 28 34

1 2 3 4 5 6 7

INTRODUCTION

HISTORY OF RBI

CONTROL FUNCTIONS OF RBI

BANKER TO BANK

FOREIGN EXANGE RESERVE MANAGEMENT

DEVELOPMENTAL ROLE

ISSUE OF CURRENCY

ROLE OF RBI IN CONTROLLING INFLATION AND DEFLATION

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EXECUTIVE SUMMARY
A central bank, reserve bank, or monetary authority is a public institution that usually issues the currency, regulates the money supply and controls the interest rates in a country. Central bank often also oversee the commercial banking system of their respective countries. In contrast to a commercial bank, a central bank possesses a monopoly on printing the national currency, which usually serves as the nations legal tender. The primary function of a central bank is to provide the nations money supply, but more active duties include controlling interest rates and acting as a lendor of last resort to the banking sector to during times of financial crisis. It may also have supervisory powers, intended to prevent banks and other financial institutions from reckless or fraudulent behavior. Central bank is most developed nations are independent in that they operate under the rules designed to render them free from political interference. Central bank acts as the head of the banking institutions in the country. It seeks to manage a macro economy in such a fashion as to promote social welfare. At present there is no country in the world of any importance that does not have a central bank, thus every independent country should have a central bank for organizing, running, supervising, regulating and developing its monetary system.

1:INTRODUCTION

The Reserve Bank of India collects various data/information from the banks through periodical returns/ statements. For processing these data on a computer system, it is necessary to keep a unique identity of the source of data. This is achieved through allotting suitable code number, named as Uniform Code Numbers to all the bank offices. Evolving a code numbering system that could be uniformly used in all returns to be submitted by bank branches/offices was considered in late sixties by the Reserve Bank of India and put in place initially for commercial banks in 1972. Similarly, allotment of Uniform Code Numbers to all the co-operative credit institutions and the state financial corporations, which participated in the Lead Bank Scheme, was attempted in 1982. The Uniform codes alongwith other particulars of each and every branch/office of commercial and cooperative banks are maintained in the computer system of the Department of Statistical Analysis and Computer Services in the form of Master Office File(MOF). MOFs are being maintained separately for commercial banks and co-operative banks. Detailed information on branches/offices of banks are regularly collected in the prescribed proformae viz. Proforma-I and Proforma-II. Details of new branches/ offices opened in banked/ unbanked centres such as date of opening of branch/office, name and address of branch/ office, other locational details, population of centre, nature of business activities pursued and also some auxiliary information covering AD category, currency chest details, status of computerisation, etc., are reported through Proforma-I. The information of relocation/ closure/ merger/ conversion of a bank branch/ change of branch name/AD category/ change of any auxiliary information are collected through Proforma-II. These data on branches/ offices alongwith Part-I and Part-II of Uniform Code Number of 7 digits each, assigned by DESACS, are maintained in MOF. As the opening of new bank branches, closure/relocation, etc., of existing branches, formation/ reorganisation of new/existing districts, etc., are on an on-going process, updation of MOF is accordingly carried out. MOF updation also takes into account decennial population census and gazette notification on merger/reorganisation of centres, districts, etc. Comprehensive and updated list of branches of banks available from the MOF constitutes the frame of various BSR surveys, other bank related surveys and various foreign exchange related returns received in DESACS. MOF based data are regularly published in Statistical Tables Relating to Banks in India, Report on Currency and Finance, Report on Trend and Progress of Banking in India, etc. Parliamentary questions related to bank-branch details are attended from MOF. Besides, data from MOF are also supplied to other users from time to time. It may be mentioned here that MOF is the only official and reliable source of bank branch details in India. This publication, third in the series, brings out branch banking statistics of commercial banks as on 31st March 2002,. Some of these data are available in various publications of the Bank.

RESEARCH METHODOLOGY
1. Data collection: a) Primary data:- The primary data will be collected from manager by interview method. b) Secondary data:- The secondary data will be collected from newspapers, books, internet etc. 2. Data analysis :- collection data will be analysis by using suitable statistical techniques.

OBJECTIVE OF THE STUDY:1. 2. 3. 4. 5. 6. To study how central bank control credit. To study the economic growth. To study exchange rate stability. To study the price stability. To study why central bank is called as bankers bank. To offer suggestion for improvement.

CONCEPTUAL FRAMEWORK:-

1. According to R.P.Kent:Central bank is an institution charged with the responsibility of managing the expansion and contracting of the volume of money in the interest of the general public welfare. 2. Paul Samuelson defines central bank as a bank of bankers. Its duty is to control the monetary base or high powered money. 3. The central bank is an institution whose main function is to help, control and stabilize the monetary and banking system of the country in the national economic interest. 4. Central bank is the governments bank by sayers. 5. According to W.A.Shaw:The central bank is that bank which controls credit.

2: HISTORY OF RBI
The Reserve Bank of India (RBI) (Hindi: ) is the central banking institution of India and controls the monetary policy of the rupee as well as US$300.21 billion (2010)[1] of currency reserves. The institution was established on 1 April 1935 during the British Raj in accordance with the provisions of the Reserve Bank of India Act, 1934. The share capital was divided into shares of Rs. 100 each fully paid which was entirely owned by private shareholders in the beginning. [2] Reserve Bank of India plays an important part in the development strategy of the government. It is a member bank of the Asian Clearing Union. Reserve Bank of India was nationalised in the year 1949. The general superintendence and direction of the Bank is entrusted to Central Board of Directors of 20 members, the Governor and four Deputy Governors, one Government official from the Ministry of Finance, ten nominated Directors by the Government to give representation to important elements in the economic life of the country, and four nominated Directors by the Central Government to represent the four local Boards with the headquarters at Mumbai, Kolkata, Chennai and New Delhi. Local Boards consist of five members each Central Government appointed for a term of four years to represent territorial and economic interests and the interests of co-operative and indigenous banks

HISTORY
19351950

The old RBI Building in Mumbai The central bank was founded in 1935 to respond to economic troubles after the first world war. The Reserve Bank of India was set up on the recommendations of the Hilton-Young Commission. The commission submitted its report in the year 1926, though the bank was not set
7

up for another nine years. The Preamble of the Reserve Bank of India describes the basic functions of the Reserve Bank as to regulate the issue of bank notes, to keep reserves with a view to securing monetary stability in India and generally to operate the currency and credit system in the best interests of the country. The Central Office of the Reserve Bank was initially established in Kolkata, Bengal, but was permanently moved to Mumbai in 1937. The Reserve Bank continued to act as the central bank for Myanmar till Japanese occupation of Burma and later up to April 1947, though Burma seceded from the Indian Union in 1937. After partition, the Reserve Bank served as the central bank for Pakistan until June 1948 when the State Bank of Pakistan commenced operations. Though originally set up as a shareholders bank, the RBI has been fully owned by the government of India since its nationalization in 1949.

19501960 Between 1950 and 1960, the Indian government developed a centrally planned economic policy and focused on the agricultural sector. The administration nationalized commercial banks[5] and established, based on the Banking Companies Act, 1949 (later called Banking Regulation Act) a central bank regulation as part of the RBI. Furthermore, the central bank was ordered to support the economic plan with loans. 19601969 As a result of bank crashes, the reserve bank was requested to establish and monitor a deposit insurance system. It should restore the trust in the national bank system and was initialized on 7 December 1961. The Indian government founded funds to promote the economy and used the slogan Developing Banking. The Government of India restructured the national bank market and nationalized a lot of institutes. As a result, the RBI had to play the central part of control and support of this public banking sector. 19691985 Between 1969 and 1980, the Indian government nationalized 6 more commercial banks, following 14 major commercial banks being nationalized in 1969(As mentioned in RBI website). The regulation of the economy and especially the financial sector was reinforced by the Government of India in the 1970s and 1980s. The central bank became the central player and increased its policies for a lot of tasks like interests, reserve ratio and visible deposits. The measures aimed at better economic development and had a huge effect on the company policy of the institutes. The banks lent money in selected sectors, like agri-business and small trade companies.[ The branch was forced to establish two new offices in the country for every newly established office in a town.The oil crises in 1973 resulted in increasing inflation, and the RBI restricted monetary policy to reduce the effects. 19851991
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A lot of committees analysed the Indian economy between 1985 and 1991. Their results had an effect on the RBI. The Board for Industrial and Financial Reconstruction, the Indira Gandhi Institute of Development Research and the Security & Exchange Board of India investigated the national economy as a whole, and the security and exchange board proposed better methods for more effective markets and the protection of investor interests. The Indian financial market was a leading example for so-called "financial repression" (Mackinnon and Shaw). The Discount and Finance House of India began its operations on the monetary market in April 1988; the National Housing Bank, founded in July 1988, was forced to invest in the property market and a new financial law improved the versatility of direct deposit by more security measures and liberalisation. 19912000 The national economy came down in July 1991 and the Indian rupee was devalued. The currency lost 18% relative to the US dollar, and the Narsimahmam Committee advised restructuring the financial sector by a temporal reduced reserve ratio as well as the statutory liquidity ratio. New guidelines were published in 1993 to establish a private banking sector. This turning point should reinforce the market and was often called neo-liberal. The central bank deregulated bank interests and some sectors of the financial market like the trust and property markets. This first phase was a success and the central government forced a diversity liberalisation to diversify owner structures in 1998. The National Stock Exchange of India took the trade on in June 1994 and the RBI allowed nationalized banks in July to interact with the capital market to reinforce their capital base. The central bank founded a subsidiary companythe Bharatiya Reserve Bank Note Mudran Limitedin February 1995 to produce banknotes. Since 2000 The Foreign Exchange Management Act from 1999 came into force in June 2000. It should improve the foreign exchange market, international investments in India and transactions. The RBI promoted the development of the financial market in the last years, allowed online banking in 2001 and established a new payment system in 2004 - 2005 (National Electronic Fund Transfer). The Security Printing & Minting Corporation of India Ltd., a merger of nine institutions, was founded in 2006 and produces banknotes and coins. The national economy's growth rate came down to 5.8% in the last quarter of 2008 2009 and the central bank promotes the economic development.

PROFILE OF RBI

Reserve Bank of India

Seal of RBI

The RBI headquarters in Mumbai

Headquarters Coordinates Established Governor Central bank of Currency ISO 4217 Code Reserves Base borrowing rate Base deposit rate Website

Mumbai, Maharashtra 18.93337N 72.836201E 1 April 1935 Duvvuri Subbarao India Indian Rupee INR US$300.21 billion (2010 8.50% 6.00% rbi.org.in

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3:CREDIT CONTROL FUNCTIONS OF RBI

Credit control is a very important function of RBI as the Central Bank of India. For smooth functioning of the economy RBI control credit through quantitative and qualitative methods. Thus, the RBI exercise control over the credit granted by the commercial bank. The reserve Bank is the most appropriate body to control the creation of credit in view if its functions as the bank of note issue and the custodian of cash reserves of the member banks. Unwarranted fluctuations in the volumeof credit by causing wide fluctuations in the value of money cause greatsocial & economic unrest in the country. Thus, RBI controls credit in such amanner, so as to bring Economic Development with stability. It means, bank will accelerate economic growth on one side and on other side it willcontrol inflationary trends in the economy. It leads to increase in realnational income of the country and desirable stability in the economy.

How did RBI control the credit; How credit is controlled by RBI; Credit control functions of RBi:
The RBI adopt two methods to control credit in modern times for regulating bank advances. They are as follows:(A) Quantitative or General Credit Control This method aims to regulate the amount of bank advance. This method includes: (a)BankRate (b) Open Market operation . (c) Variables Reserves Ratio

(a) Bank Rate: It is the rate at which central bank discounts the securities of commercial banks or advance loans to commercial banks. This rate is the minimum and it affects both cost and availability of credit. Bank rate is different from market rate. Market rate is the rate of discount prevailing in the money market among other lending institutions. Generally bank rate is higher than the market rate. If the bank rate is changed all the other rates normally change at the same direction. A central bank control credit by manipulating the bank rate. If the central bank raise the bank rate to control credit, the market discount rate and other lending rates in the money will go up. The cost of credit goes up and demand for credit goes down. As a result, the volume of bank loans and advances is curtailed. Thus raise in bank rate will contract credit. (b) Open Market Operation: It refers to buying and selling of Government securities by the central bank in the open market. this method of credit control become very popular after the 1st World War. During inflation, the bank will securities and during depression, it will purchase
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securities from the public and financial institutions. The RBI is empowered to buy and sell government securities from the public and financial institutions. The RBI is empowered to buy and sell government securities, treasury bills and other approved securities. The central bank uses the weapon to overcome seasonal stringency in funds during the slack season. When the central bank sells securities, they are purchased by the commercial banks and private individuals. So money supply is reduced in the economy and there is contraction in credit. When the securities are purchased by the central bank, money goes to the commercial banks and the customers. SO money supply is increased in the economy and there is more demand for credit. Thus open market operation is one of the superior instrument of credit control. But for achieving an ideal result both Bank Rate and Open Market Operation must be used simultaneously. (c) Variable Reserve Ratio (VRR): This is a new method of credit control adopted by central bank. Commercial banks keep cash reserves with the central bank to maintain for the purpose of liquidity and also to provide the means for credit control. The cash reserve is also called minimum legal reserve requirement. The percentage of this ratio can be changed legally by the central bank. The credit creation of commercial banks depends on the value of cash reserves. If the value of reserve ratio increase and other things remain constant, the power of credit creation by the commercial bank is decreased and vice versa. Thus by varying the reserve ratio, the lending capacity of commercial banks can be affected. (B)Qualitative or Selective Control Method: It is also known as qualitative credit control. This method is used to control the flow of credit to particular sectors of the economy. The direction of credit is regulated by the central bank. This method is used as a complementary to quantitative credit control discourage the flow of credit to unproductive sectors and speculative activities and also to attain price stability. The main instruments used for this purpose are: (1) Varying margin requirements for certain bank: While lending commercial banks accept securities, deduct a certain margin from the market value of the security. This margin is fixed by the central bank and adjust according to the requirements. This method affect the demand for credit rather than the quantity and cost of credit. This method is very effective to control supply of credit for speculative dealing in the stock exchange market. It also helps for checking inflation when the margin is raised. If the margin is fixed as 30%, the commercial banks can lend up to 70% of the market value of security. This method has been used by RBI since 1956 with suitable modifications from time to time as per the demand and supply of commodities. (2) Regulation of consumer's credit: Apart from trade and industry a great amount of credit is given to the consumers for purchasing durable goods also. RBI seeks to control such credit in the
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following ways: (a) by regulating the minimum down payments on specific goods. (b) by fixing the coverage of selective consumers durable goods. (c) by regulating the maximum maturities on all installment credit and (d) by fixing exemption costs of installment purchase of specific goods. (3) Control through Directives: Under this system, the central bank can issue directives for the credit control. There may be a written or oral voluntary agreement between the central bank and commercial banks in this regard. Sometimes the commercial banks do not follow these directives of the RBI. (4) Rationing of credit: The amount of credit to be granted is fixed by the central bank. Credit is rationed by limiting the amount available to each commercial bank. The RBI can also restrict the discounting of bills. Credit can also be rationed by the fixation of ceiling for loans and advances. (5) Direct Action: It is an extreme step taken by the RBI. It involves refusal by RBI to extend credit facilities, denial of permission to open new branches etc. RBI also gives wide publicity about the erring banks to create awareness amongst the public.

(6) Moral suasion: RBI uses persuasion to influence lending activities of banks. It sends letters to banks periodically, advising them to follow sound principles of banking. Discussions are held by the RBI with banks to control the flow of credit to the desired sectors. These were the main Credit control functions of RBI.s

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Objectives of credit control :

To obtain stability in the internal price level. To attain stability in exchange rate. To stabilize money market of a country. To eliminate business cycles-inflation and depression-by controlling supply of credit. To maximize income, employement and output in a country. To meet the financial requirements of an economy not only during snormal times but also during emergency or war. To help the economic growth of a country within specified period of time. This objective has become particularly necessary for the less developed countries of present day world.

Annual Policy Statement for the Year 2010-11

By Dr. D. Subbarao Governor The Monetary Policy for 2010-11 is set against a rather complex economic backdrop. Although the situation is more reassuring than it was a quarter ago, uncertainty about the shape and pace of global recovery persists. Private spending in advanced economies continues to be constrained and inflation remains generally subdued making it likely that fiscal and monetary stimuli in these economies will continue for an extended period. Emerging market economies (EMEs) are significantly ahead on the recovery curve, but some of them are also facing inflationary pressures. Indias growth-inflation dynamics are in contrast to the overall global scenario. The economy is recovering rapidly from the growth slowdown but inflationary pressures, which were triggered by supply side factors, are now developing into a wider inflationary process. As the domestic balance of risks shifts from growth slowdown to inflation, our policy stance must recognise and respond to this transition. While global policy co-ordination was critical in dealing with a worldwide crisis, the exit process will necessarily be differentiated on the basis of the macroeconomic condition in each country. Indias rapid turnaround after the crisis induced slowdown evidences the resilience of our economy and our financial sector. However, this should not divert us from the need to bring back into focus the twin challenges of macroeconomic stability and financial sector development. This statement is organised in two parts. Part A covers Monetary Policy and is divided into four Sections: Section I provides an overview of global and domestic macroeconomic developments; Section II sets out the outlook and projections for growth, inflation and monetary aggregates; Section III explains the stance of monetary policy; and Section IV specifies the monetary measures.Part B covers Developmental and Regulatory Policies and is organised into six
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sections: Financial Stability (Section I), Interest Rate Policy (Section II), Financial Markets (Section III), Credit Delivery and Financial Inclusion (Section IV), Regulatory and Supervisory Measures for Commercial Banks (Section V) and Institutional Developments (Section VI).

Outlook and Projections

Global Outlook Growth . In its World Economic Outlook Update for January 2010, the International Monetary Fund (IMF) projected that global growth will recover from (-) 0.8 per cent in 2009 to 3.9 per cent in 2010 and further to 4.3 per cent in 2011. Organisation for Economic Co-operation and Developments (OECD) composite leading indicators (CLIs) in February 2010 continued to signal an improvement in economic activity for the advanced economies. Three major factors that have contributed to the improved global outlook are the massive monetary and fiscal support, improvement in confidence and a strong recovery in EMEs. US GDP rose by 5.6 per cent on an annualised basis during Q4 of 2009. However, household spending remains constrained by high unemployment at 9.7 per cent. Though business fixed investment is turning around and housing starts are picking up, investment in commercial real estate is declining. Growth in the euro area, on a quarter-on-quarter basis, was 0.1 per cent in Q4 of 2009. It may remain moderate in 2010 because of the ongoing process of balance sheet adjustment in various sectors, dampened investment, low capacity utilisation and low consumption. Though exports are improving and the decline in business fixed investment is moderating, several euro-zone governments are faced with high and unsustainable fiscal imbalances which could have implications for medium and long-term interest rates. In Japan, improved prospects on account of exports have been offset by the levelling off of public investment and rise in unemployment. Amongst EMEs, China continues to grow at a rapid pace, led mainly by domestic demand. Malaysia and Thailand have recovered to register positive growth in the second half of 2009. Indonesia recorded positive growth throughout 2009. Inflation Globally, headline inflation rates rose between November 2009 and January 2010, softened in February 2010 on account of moderation of food, metal and crude prices and again rose marginally in some major economies in March 2010. Core inflation continued to decline in the US on account of substantial resource slack. Inflation expectations in advanced countries also remain stable. Though inflation has started rising in several EMEs, India is a significant outlier with inflation rates much higher than in other EMEs. Domestic Outlook
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Growth The Indian economy is firmly on the recovery path. Exports have been expanding since October 2009, a trend that is expected to continue. The industrial sector recovery is increasingly becoming broad-based and is expected to take firmer hold going forward on the back of rising domestic and external demand. Surveys generally support the perception of a consolidating recovery. According to the Reserve Banks quarterly industrial outlook survey, although the business expectation index (BEI) showed seasonal moderation from 120.6 in Q4 of 2009-10 to 119.8 in Q1 of 2010-11, it was much higher in comparison with the level of 96.4 a year ago. The improved performance of the industrial sector is also reflected in the improved profitability in the corporate sector. Service sector activities have shown buoyancy, especially during the latter half of 2009-10. The leading indicators of various sectors such as tourist arrivals, commercial vehicles production and traffic at major ports show significant improvement. A sustained increase in bank credit and in the financial resources raised by the commercial sector from non-bank sources also suggest that the recovery is gaining momentum. On balance, under the assumption of a normal monsoon and sustenance of good performance of the industrial and services sectors on the back of rising domestic and external demand, for policy purposes the baseline projection of real GDP growth for 2010-11 is placed at 8.0 per cent with an upside bias (Chart 1).

Headline WPI inflation, which moderated in the first half of 2009-10, firmed up in the second half of the year. It accelerated from 1.5 per cent in October 2009 to 9.9 per cent by March 2010.
16

The deficient south-west monsoon rainfall accentuated the pressure on food prices. This, combined with the firming up of global commodity prices from their low levels in early 2009 and incipient demand side pressures, led to acceleration in the overall inflation rate both of the WPI and the CPIs. The Reserve Banks baseline projection of WPI inflation for March 2010 was 8.5 per cent. However, some subsequent developments on both supply and demand sides pushed up inflation. Enhancement of excise duty and restoration of the basic customs duty on crude petroleum and petroleum products and the increase in prices of iron ore and coal had a significant impact on WPI inflation. In addition, demand side pressures also re-emerged as reflected in the sharp increase in non-food manufactured products inflation from 0.7 per cent to 4.7 per cent between December 2009 and March 2010. . There have been significant changes in the drivers of inflation in recent months. First, while there are some signs of seasonal moderation in food prices, overall food inflation continues at an elevated level. It is likely that structural shortage of certain agricultural commodities such as pulses, edible oils and milk could reduce the pace of food price moderation. Second, the firming up of global commodity prices poses upside risks to inflation. Third, the Reserve Banks industrial outlook survey shows that corporates are increasingly regaining their pricing power in many sectors. As the recovery gains further momentum, the demand pressures are expected to accentuate. Fourth, the Reserve Banks quarterly inflation expectations survey for households indicates that household inflation expectations have remained at an elevated level. Going forward, three major uncertainties cloud the outlook for inflation. First, the prospects of the monsoon in 2010-11 are not yet clear. Second, crude prices continue to be volatile. Third, there is evidence of demand side pressures building up. On balance, keeping in view domestic demand-supply balance and the global trend in commodity prices, the baseline projection for WPI inflation for March 2011 is placed at 5.5 per cent (Chart 2).

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It would be the endeavour of the Reserve Bank to ensure price stability and anchor inflation expectations. In pursuit of these objectives, the Reserve Bank will continue to monitor an array of measures of inflation, both overall and disaggregated components, in the context of the evolving macroeconomic situation to assess the underlying inflationary pressures. Notwithstanding the current inflation scenario, it is important to recognise that in the last decade, the average inflation rate, measured both in terms of WPI and CPI, had moderated to about 5 per cent from the historical trend rate of about 7.5 per cent. Against this background, the conduct of monetary policy will continue to condition and contain perception of inflation in the range of 4.0-4.5 per cent. This will be in line with the medium-term objective of 3.0 per cent inflation consistent with Indias broader integration into the global economy.

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4:BANKER TO BANK333336 Banker

to Banks33ghogjhpophoj333333333333333333a ghjgjghjghj6 Ban

ker to
Banks are required to maintain a portion of their demand and time liabilities as cash reserves with the Reserve Bank, thus necessitating a need for maintaining accounts with the Bank. Further, banks are in the business of accepting deposits and giving loans. Since different persons deal with different banks, in order to settle transactions between various customers maintaining accounts with different banks, these banks have to settle transactions among each other. Settlement of inter-bank obligations thus assumes importance. To facilitate smooth operation of this function of banks, an arrangement has to be made to transfer money from one bank to another. This is usually done through the mechanism of a clearing house where banks present cheques and other such instruments for clearing. Many banks also engage in other financial activities, such as, buying and selling securities and foreign currencies. Here too, they need to exchange funds between themselves. In order to facilitate a smooth inter-bank transfer of funds, or to make payments and to receive funds on their behalf, banks need a common banker. In order to meet the above objectives, in India, the Reserve Bank provides banks with the facility of opening accounts with itself. This is the Banker to Banks function of the Reserve Bank, which is delivered through the Deposit Accounts Department (DAD) at the Regional offices. The Department of Government and Bank Accounts oversees this function and formulates policy and issues operational instructions to DAD.

19

Reserve Bank as Banker to Banks To fulfill this function, the Reserve Bank opens current accounts of banks with itself, enabling these banks to maintain cash reserves as well as to carry out inter-bank transactions through these accounts. Inter bank accounts can also be settled by transfer of money through electronic fund transfer system, such as, the Real Time Gross Settlement System (RTGS). The Reserve Bank continuously monitors operations of these accounts to ensure that defaults do not take place. Among other provisions, the Reserve Bank stipulates minimum balances to be maintained by banks in these accounts. Since banks need to settle funds with each other at various places in India, they are allowed to open accounts with different regional offices of the Reserve Bank. The Reserve Bank also facilitates remittance of funds from a banks surplus account at one location to its deficit account at another. Such transfers are electronically routed through a computerised system. The computerisation of accounts at the Reserve Bank has greatly facilitated banks monitoring of their funds position in various accounts across different locations on a real-time basis.
As Banker to Banks, the Reserve Bank focuses on:

Enabling obligations.

smooth,

swift

and

seamless

clearing

and

settlement

of

inter-bank

Providing an efficient means of funds transfer for banks. Enabling banks to maintain their accounts with the Reserve Bank for statutory reserve requirements and maintenance of transaction balances. Acting as a lender of last resort. In addition, the Reserve Bank has also introduced the Centralised Funds Management System (CFMS) to facilitate centralised funds enquiry and transfer of funds across DADs. This helps banks in their fund management as they can access information on their balances maintained across different DADs from a single location. Currently, 75 banks are using the system and all DADs are connected to the system. As Banker to Banks, the Reserve Bank provides short-term loans and advances to select banks, when necessary, to facilitate lending to specific sectors and for specific purposes. These loans are provided against promissory notes and other collateral given by the banks.
Lender of Last Resort

As a Banker to Banks, the Reserve Bank also acts as the lender of last resort. It can come to the rescue of a bank that is solvent but faces temporary liquidity problems by supplying it with much needed liquidity when no one else is willing to extend credit to that bank. The Reserve Bank extends this facility to protect the interest of the depositors of the bank and to prevent possible failure of a bank, which in turn may also affect other banks and institutions and can have an adverse impact on financial stability and thus on the economy.

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5:FOREIGN EXANGE RESERVE MANAGEMENT

The Reserve Bank, as the custodian of the countrys foreign exchange reserves, is vested with the responsibility of managing their investment. The legal provisions governing management of foreign exchange reserves are laid down in the Reserve Bank of India Act, 1934. The Reserve Banks reserves management function has in recent years grown both in terms of importance and sophistication for two main reasons. First, the share of foreign currency assets in the balance sheet of the Reserve Bank has substantially increased. Second, with the increased volatility in exchange and interest rates in the global market, the task of preserving the value of reserves and obtaining a reasonable return on them has become challenging. The basic parameters of the Reserve Banks policies for foreign exchange reserves management are safety, liquidity and returns. Within this framework, the Reserve Bank focuses on: a) Maintaining markets confidence in monetary and exchange rate policies. b) Enhancing the Reserve Banks intervention capacity to stabilise foreign exchange markets. c) Limiting external vulnerability by maintaining foreign currency liquidity to absorb shocks during times of crisis, including national disasters or emergencies. d) Providing confidence to the markets that external obligations can always be met, thus reducing the costs at which foreign exchange resources are available to market participants. e) Adding to the comfort of market participants by demonstrating the backing of domestic currency by external assets.

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Investment of Reserves:
The Reserve Bank of India Act permits the Reserve Bank to invest the reserves in the following types of instruments: 1) Deposits with Bank for International Settlements and other central banks 2) Deposits with foreign commercial banks 3) Debt instruments representing sovereign or sovereign-guaranteed liability of not more than 10 years of residual maturity 4) Other instruments and institutions as approved by the Central Board of the Reserve Bank in accordance with the provisions of the Act 5) Certain types of derivatives

While safety and liquidity continue to be the twin-pillars of reserves management, return optimisation has become an embedded strategy within this framework. The Reserve Bank has framed policy guidelines stipulating stringent eligibility criteria for issuers, counterparties, and investments to be made with them to enhance the safety and liquidity of reserves. The Reserve Bank, in consultation with the Government, continuously reviews the reserves management strategies

Deployment of Reserves
The foreign exchange reserves include foreign currency assets (FCA), Special Drawing Rights (SDRs) and gold. SDRs are held by the Government of India. The foreign currency assets are managed following the principles of portfolio management In deploying reserves, the Reserve Bank pays close attention to currency composition, interest rate risk and liquidity needs. All foreign currency assets are invested in assets of top quality and a good proportion is convertible into cash at short notice. The counterparties with whom deals are conducted are also subject to a rigorous selection process. In assessing the returns from deployment, the total return (both interest and capital gains) is taken into consideration. One crucial area in the process of investment of the foreign currency assets in the overseas markets relates to the risks involved in the process. While there is no set formula to meet all situations, the Reserve Bank follows the accepted portfolio management principles for risk management.

Foreign Exchange Reserves Management: The RBIs Approach

The Reserve Banks approach to foreign exchange reserves management has also undergone a change. Until the balance of payments crisis of 1991, Indias approach to foreign exchange reserves was essentially aimed at maintaining an appropriate import cover. The approach underwent a paradigm shift following the recommendations of the High Level Committee on Balance of Payments chaired by Dr. C. Rangarajan (1993). The committee stressed the need to
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maintain sufficient reserves to meet all external payment obligations, ensure a reasonable level of confidence in the international community about Indias capacity to honour its obligations, and counter speculative tendencies in the market. After the introduction of system of marketdetermined exchange rates in 1993, the objective of smoothening out the volatility in the exchange rates assumed importance. The overall approach to the management of foreign exchange reserves also reflects the changing composition of Balance of Payments (BoP) and liquidity risks associated with different types of flows. In 1997, the Report of the Committee on Capital Account Convertibility under the chairmanship of Shri S.S. Tarapore, suggested alternative measures for adequacy of reserves. The committee in addition to trade-based indicators also suggested money-based and debt-based indicators. Similar views have been held by the Committee on Fuller Capital Account Convertibility (Chairman: Shri S. S. Tarapore, July 2006).

The traditional approach of assessing reserve adequacy in terms of import cover has been widened to include a number of parameters about the size, composition, and risk profiles of various types of capital flows. The Reserve Bank also looks at the types of external shocks to which the economy is potentially vulnerable. The objective is to ensure that the quantum of reserves is in line with the growth potential of the economy, the size of risk-adjusted capital flows and national security requirements.

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6: DEVELOPMENTAL ROLE

12
The Reserve Bank is one of the few central banks that has taken an active and direct role in supporting developmental activities in their country. The Reserve Banks developmental role includes ensuring credit to productive sectors of the economy, creating institutions to build financial infrastructure, and expanding access to affordable financial services. Over the years, its developmental role has extended to institution building for facilitating the availability of diversified financial services within the country. The Reserve Bank today also plays an active role in encouraging efficient customer service throughout the banking industry, as well as extension of banking service to all, through the thrust on financial inclusion. Towards this goal, which has evolved over many years, the Reserve Bank has taken various initiatives. RURAL CREDIT Given the predominantly agrarian character of the Indian economy, the Reserve Banks role has been to ensure timely and adequate credit to the agricultural sector at affordable cost. Section 54 of the RBI Act, 1934 states that the Bank may maintain expert staff to study various aspects of rural credit and development and in particular, it may tender expert guidance and assistance to the National Bank (NABARD) and conduct special studies in such areas as it may consider necessary to do so for promoting integrated rural development. Priority Sector Lending The focus on priority sectors can be traced to the Reserve Banks credit policy for the year 196768, and institution of a scheme of social control over commercial banks in 1967 by the Government of India to remove certain deficiencies observed in the functioning of the banking system, such as, bulk of bank advances directed to large and medium-scale industries and
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established business houses. In order to provide access to credit to the neglected sectors, a target based priority sector lending was introduced from the year 1974, initially with public sector banks. The scheme was gradually extended to all commercial banks by 1992. The scope and extent of priority sectors have undergone several changes since the formalisation of description of the priority sectors in 1972. The guidelines on lending to priority sector were revised with effect from April 30, 2007. The guiding principle of the revised guidelines on lending to priority sector has been to ensure adequate flow of bank credit to those sectors of the society/ economy that impact large segments of the population and weaker sections, and to the sectors which are employment-intensive, such as, agriculture and small enterprises. The broad categories of advances under priority sector now include agriculture, micro and small enterprises sector, microcredit, education and housing.

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Targets for Lending to the Priority Sector

Domestic Commercial Banks Foreign Banks

Total priority sector advances

40 per cent of Adjusted Net Bank Credit (ANBC) [Net Bank Credit plus investments made by banks in nonSLR bonds held in held to maturity (HTM) category] or credit equivalent amount of Off-Balance Sheet Exposure, whichever is higher 18 per cent of ANBC or credit equivalent amount of Off- Balance Sheet Exposure, whichever is higher. Of this, indirect lending in excess of 4.5 per cent of ANBC or credit equivalent amount of OffBalance Sheet Exposure, whichever is higher, will not be reckoned for computing performance under 18 per cent target. However, all agricultural advances under the categories direct and indirect will be reckoned in computing performance under the overall priority sector target of 40 per cent of ANBC or credit equivalent amount of Off- Balance Sheet Exposure, whichever is higher. Advances to small enterprises sector will be reckoned in computing performance under the overall priority sector target of 40 per cent of ANBC or credit equivalent amount of Off-Balance Sheet Exposure, whichever is higher (i) 40 per cent of total advances to small enterprises sector should go to micro (manufacturing) enterprises having investment in plant and machinery up to Rs 5 lakh and micro (service) enterprises having investment in equipment up to Rs. 2 lakh; (ii) 20 per cent of total advances to small enterprises sector should go to micro (manufacturing) enterprises with investment in plant and machinery above Rs 5 lakh and up to Rs. 25 lakh, and micro (service) enterprises with investment in equipment above Rs. 2 lakh and up to Rs. 10 lakh. (Thus, 60 per cent of small enterprises advances should go to the micro enterprises).

32 per cent of ANBC or credit equivalent amount of Off-Balance Sheet Exposure, whichever is higher.

Total agricultural advances

No target.

Small enterprise advances

10 per cent of ANBC or credit equivalent amount of Off-Balance Sheet Exposure, whichever is higher

Micro enterprises within small enterprises sector

Same as for domestic banks

Export credit

Export credit is not a part of priority sector for domestic commercial banks

12 per cent of ANBC or credit equivalent amount of Off-Balance Sheet Exposure, whichever is higher

Advances to weaker sections

10 per cent of ANBC or credit equivalent amount of OffBalance Sheet Exposure, whichever is higher.

No target

Differential rate of interest scheme

1 per cent of total advances outstanding as at the end of the previous year. It should be ensured that not less than 40 per cent of the total advances granted under DRI scheme goes to scheduled caste / scheduled tribes. At least two third of DRI advances should be granted through rural and semi-urban branches

No target

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The domestic scheduled commercial banks, both in the public and private sector, having shortfall in lending to priority sector and/or agricultural lending and/or weaker section lending targets, are required to deposit in Rural Infrastructure Development Fund (RIDF) established with NABARD or other Funds set up with other financial institutions. RIDF was established with NABARD in April 1995 to assist State Governments / State-owned corporations in quick completion of projects relating to irrigation, soil conservation, watershed management and other forms of rural infrastructure (such as, rural roads and bridges, market yards, etc.). Since then, the RIDF has been extended on a year-to-year basis to presently RIDF XV through announcements in the Union Budgets. The interest rates charged from State Governments and payable to banks under the Rural Infrastructure Development Fund (RIDF) have been brought down over the years in accordance with the reduction of market interest rates. As a measure of disincentive for non-achievement of agricultural lending target, effective RIDF-VII, the rate of interest on RIDF deposits has been linked to the banks performance in lending to agriculture. Accordingly, while the State Governments are required to pay interest at Bank Rate plus 0.5 percentage points, the rates of interest on deposits vary between Bank Rate and Bank Rate minus 3 percentage points depending on the individual banks shortfall in lending to agriculture target of 18 per cent.

Lead Bank Scheme

The Reserve Bank introduced the Lead Bank Scheme in 1969. Here designated banks were made key instruments for local development and were entrusted with the responsibility of identifying growth centres, assessing deposit potential and credit gaps and evolving a coordinated approach for credit deployment in each district, in concert with other banks and other agencies. The Reserve Bank has assigned a Lead District Manager for each district who acts as a catalytic force for promoting financial inclusion and smooth working between government and banks.

Special Agricultural Credit Plan

With a view to augmenting the flow of credit to agriculture, Special Agricultural Credit Plan (SACP) was instituted and has been in operation for quite some time now. Under the SACP, banks are required to fix self-set targets showing an increase of about 30 per cent over previous years disbursements on yearly basis (April March). The public sector banks have been formulating SACP since 1994. The scheme has been extended to Private Sector banks as well from the year 2005-06.

Kisan Credit Cards

The Kisan Credit Card (KCC) Scheme was introduced in the year 1998-99 to enable the farmers to purchase agricultural inputs and draw cash for their production needs. On revision of the KCC Scheme by NABARD in 2004, the scheme now covers term credit as well as working capital for agriculture and allied activities and a reasonable component for consumption needs. Under the scheme, the limits are fixed on the basis of operational land holding, cropping pattern and scales of finance. Seasonal sub-limits may be fixed at the discretion of the banks. Limits may be fixed taking into account the entire production credit needs along with ancillary activities relating to crop production, allied activities and also non-farm short term credit needs (consumption needs).

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Limits are valid for three years subject to annual review. Security, margin and rate of interest are as per RBI guidelines issued from time to time.

Natural Calamities Relief Measures

In order to provide relief to bank borrowers in times of natural calamities, the Reserve Bank has issued standing guidelines to banks. The relief measures include, among other things, rescheduling / conversion of short-term loans into term loans; fresh loans; relaxed security and margin norms; treatment of converted/rescheduled agriculture loans as current dues; noncompounding of interest in respect of loans converted / rescheduled; and moratorium of at least one year. With the enactment of the Micro, Small and Medium Enterprises Development (MSMED) Act, 2006, the services sector has also been included in the definition of micro, small and medium enterprises, apart from extending the scope to medium enterprises. The Act sought to modify the definition of micro, small and medium enterprises engaged in manufacturing or production and providing or rendering of services. Some of the major measures by RBI/ GOI to improve the credit flow to the SMSE sector are as under: Collateral Free Loans: Reserve Bank has issued instructions/ guidelines advising banks to sanction collateral free loans up to Rs.5 lakh to the MSE borrowers. Further, banks have also been advised to lend collateral free loans up to Rs.25 lakh, based on good track record and financial position of the units. Micro, Small and Medium Enterprises Development Credit Guarantee Scheme for Small Industries by SIDBI: The main objective of the Credit Guarantee Scheme (CGS) for MSEs is to make available bank credit to first generation entrepreneurs for setting up their MSE units without the hassles of collateral/third party guarantee. The Scheme envisages that the lender availing guarantee facility would give composite credit so that the borrowers obtain both term loan and working capital facilities from a single agency. The Trust at present is providing guarantee to collateral free loans up to Rs. 1 crore under the scheme. Specialised MSE Branch in every District: Public sector banks were advised in August 2005 to operationalise at least one specialized MSE branch in every district and centre having a cluster of MSE enterprises. At the end of March 2009, 869 specialised MSE bank branches were operationalised by banks. Formulation of Banking Code for MSE Customers: The Banking Codes and Standards Board of India (BCSBI) has formulated a voluntary Code of Banks Commitment to Micro and Small Enterprises and has set minimum standards of banking practices for banks to follow when they are dealing with MSEs. Working Group on Rehabilitation/Nursing of Potentially Viable Sick SME Units: Detailed guidelines have been issued to banks advising them to evolve Board approved policies for the MSE sector relating to: (i) Loan policy governing extension of credit facilities.
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(ii) Restructuring / Rehabilitation policy for revival of potentially viable sick units / enterprises. (iii) Non-discretionary one time settlement scheme for recovery of non-performing loans.

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7:ISSUE OF CURRENCY

Management of currency is one of the core central banking functions of the Reserve Bank for which it derives the necessary statutory powers from Section 22 of the RBI Act, 1934. Along with the Government of India, the Reserve Bank is responsible for the design, production and overall management of the nations currency, with the goal of ensuring an adequate supply of clean and genuine notes. In consultation with the Government, the Reserve Bank routinely addresses security issues and targets ways to enhance security features to reduce the risk of counterfeiting or forgery of currency notes. The Paper Currency Act of 1861 conferred upon the Government of India the monopoly of note issues, thus ending the practice of private and presidency banks issuing currency. Between 1861 and 1935, the Government of India managed the issue of paper currency. In 1935, when the Reserve Bank began operations, it took over the function of note issue from the Office of the Controller of Currency, Government of India.

Currency Unit and Denomination The Indian Currency is called the Indian Rupee (abbreviated as Re. in singular and Rs. in plural), and its sub-denomination the Paisa (plural Paise). At present, notes in India are issued in the denomination of Rs.5, Rs.10, Rs.20, Rs.50, Rs.100, Rs.500 and Rs.1,000. The printing of Re.1 and Rs.2 denominations has been discontinued. However, notes in these denominations issued earlier are still valid and in circulation. The Reserve Bank is also authorised to issue notes
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in the denominations of five thousand rupees and ten thousand rupees or any other denomination, but not exceeding ten thousand rupees, that the Central Government may specify. Thus, in terms of current provisions of RBI Act 1934, notes in denominations higher than ten thousand rupees cannot be issued. Coin Denomination Coins in India are available in denominations of 10 paisa, 20 paisa, 25 paisa, 50 paisa, one rupee, two rupees, five rupees and ten rupees. Coins up to 50 paisa are called small coins and coins of Rupee one and above are called Rupee coins. As per the provisions of Coinage Act, 1906, coins can be issued up to the denomination of Rs.1,000. Currency Management The Reserve Bank carries out the currency management function through its Department of Currency Management located at its Central Office in Mumbai, 19 Issue Offices located across the country and a currency chest at its Kochi branch . To facilitate the distribution of notes and rupee coins across the country, the Reserve Bank has authorised selected branches of banks to establish currency chests. There is a network of 4,281 Currency Chests and 4,044 Small Coin Depots with other banks. Currency chests are storehouses where bank notes and rupee coins are stocked on behalf of the Reserve Bank. The currency chests have been established with State Bank of India, six associate banks, nationalised banks, private sector banks, a foreign bank, a state cooperative bank and a regional rural bank. Deposits into the currency chest are treated as reserves with the Reserve Bank and are included in the CRR. The reverse is applicable for withdrawals from chests. Like currency chests, there are also small coin depots which have been established by the authorised bank branches to stock small coins. The small coin depots distribute small coins to other bank branches in their area of operation. The Department of Currency Management makes recommendations on design of bank notes to the Central Government, forecasts the demand for notes, and ensures smooth distribution of notes and coins throughout the country. It arranges to withdraw unfit notes, administers the provisions of the RBI (Note Refund) Rules, 2009 (these rules deal with the payment of value of the soiled or mutilated notes) and reviews/rationalises the work systems and procedures at the issue offices on an ongoing basis. The RBI Act requires that the Reserve Banks affairs relating to note issue and its general banking business be conducted through two separate departments the Issue Department and the Banking Department. All transactions relating to the issue of currency notes are separately conducted, for accounting purposes, in the Issue Department. The Issue Department is liable for the aggregate value of the currency notes of the Government of India (currency notes issued by the Government of India prior to the issue of bank notes by the Reserve Bank) and bank notes of the Reserve Bank in circulation from time to time and it maintains eligible assets for equivalent value. The assets which form the backing for note issue are kept wholly distinct from those of the Banking Department. The Issue Department is permitted to issue notes only in exchange for notes of other denominations or against prescribed assets. This Department is also responsible
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for getting its periodical requirements of notes/coins from the currency printing presses/mints, distribution of notes and coins among the public as well as withdrawal of unserviceable notes and coins from circulation. The mechanism for putting currency into circulation and its withdrawal from circulation (that is, expansion and contraction of currency, respectively) is effected through the Banking Department. Currency Distribution The Government of India on the advice of the Reserve Bank decides on the various denominations of the notes to be printed. The Reserve Bank coordinates with the Government in designing the banknotes, including their security features. For printing of notes, the Security Printing and Minting Corporation of India Limited (SPMCIL), a wholly owned company of the Government of India, has set up printing presses at Nashik, Maharashtra and Dewas, Madhya Pradesh. The Bharatiya Reserve Bank Note Mudran Pvt. Ltd. (BRBNMPL), a wholly owned subsidiary of the Reserve Bank, also has set up printing presses at Mysore in Karnataka and Salboni in West Bengal. The Reserve Bank estimates the quantity of notes (denominationwise) that is likely to be required and places indents with the various presses. The notes received from the presses are then issued for circulation both through remittances to banks as also across the Reserve Bank counters. Currency chests, which are maintained by banks, store soiled and reissuable notes, as also fresh banknotes. The banks send notes, which in their opinion are unfit for circulation, back to the Reserve Bank. The Reserve Bank examines these notes and re-issues those that are found fit for circulation. The soiled notes are destroyed, through shredding, so as to maintain the quality of notes in circulation. Coin Distribution The Indian Coinage Act, 1906 governs the minting of rupee coins, including small coins of the value of less than one rupee. One rupee notes (no longer issued now) and coins are legal tender in India for unlimited amounts. Fifty paisa coins are legal tender for any sum not exceeding ten rupees and smaller coins for any sum not exceeding one rupee. The Reserve Bank acts as an agent of the Central Government for distribution, issue and handling of the coins (including one rupee note) and for withdrawing and remitting them back to Government as may be necessary. SPMCIL has four mints at Mumbai, Noida (UP), Kolkata and Hyderabad for coin production. Similar to distribution of banknotes, coins are distributed through various channels such as Reserve Bank counters, banks, post offices, regional rural banks and urban cooperative banks. The Reserve Bank offices also sometimes organise special coin melas for exchanging notes into coins through retail distribution. Just as unfit banknotes are destroyed, unfit coins are also withdrawn from circulation and sent to the mint for melting.

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Special Type of Notes A special Star series of notes in three denominations of rupees ten, twenty and fifty have been issued since August 2006 to replace defectively printed notes at the printing presses. The Star series banknotes are exactly like the existing Mahatma Gandhi Series banknotes, but have an additional character a (star) in the number panel in the space between the prefix and the number. The packets containing these banknotes will not, therefore, have sequential serial numbers, but contain 100 banknotes, as usual. This facility has been further extended to Rs. 100 notes with effect from June 2009. The bands on such packets indicate the presence of such notes.

Exchange of Notes Basically there are two categories of notes which are exchanged between banks and the Reserve Bank soiled notes and mutilated notes. While soiled notes are notes which have become dirty and limp due to excessive use or a two-piece note, mutilated note means a note of which a portion is missing or which is composed of more than two pieces. While soiled notes can be tendered and exchanged at all bank branches, mutilated notes are exchanged at designated bank branches and such notes can be exchanged for value through an adjudication process which is governed by Reserve Bank of India (Note Refund) Rules, 2009. Under current provisions, either full or no value for notes of denomination up to Rs.20 is paid, while notes of Rs.50 and above would get full, half, or no value, depending on the area of the single largest undivided portion of the note. Special adjudication procedures exist at the Reserve Bank Issue offices for notes which have turned extremely brittle or badly burnt, charred or inseparably stuck together and, therefore, cannot withstand normal handling.

Combating Counterfeiting To combat the incidence of forged notes, the Reserve Bank has taken certain measures like publicity campaigns on security features of bank notes and display of Know Your Bank note poster at bank branches including at offsite ATMs. The Reserve Bank, in consultation with the Government of India, periodically reviews and upgrades the security features of the bank notes to deter counterfeiting. It also shares information with various law enforcement agencies to address the issue of counterfeiting. It has also issued detailed guidelines to banks and government treasury offices on how to detect and impound counterfeit notes.

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8: ROLE OF RBI IN CONTROLLING INFLATION AND DEFLATION

WHO Controls RBI?

The Reserve Bank's affairs are governed by a central board of directors. The board is appointed by the Government of India in keeping with the Reserve Bank of India Act. Appointed/nominated for a period of four years Constitution: Official Directors Full-time : Governor and not more than four Deputy Governors Non-Official Directors Nominated by Government: ten Directors from various fields and one government Official Others: four Directors - one each from four local boards

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Current Focus of RBI.

Some of the initiatives taken by RBI include:
Restructuring of the system of bank inspections. Introduction of off-site surveillance. Strengthening of the role of statutory auditors. Strengthening of the internal defences of supervised institutions. Supervision of financial institutions. Consolidated accounting. Legal issues in bank frauds. Divergence in assessments of non-performing assets and Supervisory rating model for banks.

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INFLATION

In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.[1] When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money a loss of real value in the internal medium of exchange and unit of account in the economy.[2][3] A chief measure of price inflation is the inflation rate, the annualized percentage change in a general price index (normally the Consumer Price Index) over time.[4] Inflation's effects on an economy are various and can be simultaneously positive and negative. Negative effects of inflation include a decrease in the real value of money and other monetary items over time, uncertainty over future inflation may discourage investment and savings, and high inflation may lead to shortages of goods if consumers begin hoarding out of concern that prices will increase in the future. Positive effects include ensuring central banks can adjust nominal interest rates (intended to mitigate recessions),[5] and encouraging investment in nonmonetary capital projects.

Inflation can be defined as a sustained upward movement in the aggregate price level that is shared by most products. It can also be viewed as a fall in the purchasing power of money. The opposite of inflation is deflation.

Types of Inflation
The expected rate of inflation is the level of inflation people expect to occur in future.

There are 3 main types of inflation

Demand-pull inflation-due to high GDP & low unemployment. Supply shock inflation-due to adverse changes in price of raw materials(e.g oil) Built in inflation-induced by expectations based on previous inflation levels.

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1: Demand-pull inflation-due to high GDP & low unemployment:There really can be too much of a good thing when it comes to economic growth, and the concept of demand-pull inflation bears that out. Demand-pull inflation explains why certain items or services rise in price even when they appear to be in plentiful supply. A booming economy means that factories are hiring more workers and those workers are producing more products. However, these additional employees are also earning more money and want to spend that money on products they may not have able to afford while unemployed or underemployed. Because the demand for these products rises but the supply cannot be increased fast enough to meet it, the price of the products often rises. This price rise during seemingly strong economic times is called demand-pull inflation by those who ascribe to the Keynesian economics model. 2: Supply shock inflation-due to adverse changes in price of raw materials(e.g oil):An adverse supply shock such as an increase in oil prices would increase inflation, lower real GDP and increase unemployment. If it is a one time shock as inflation subsidies aggregate demand would recover and the economy would gradually return to potential GDP and to the original inflation level. 3:Built in inflation-induced by expectations based on previous inflation levels. Induced by adaptive expectations, often linked to the "price/wage spiral" because it involves workers trying to keep their wages up with prices and then employers passing higher costs on to consumers as higher prices as part of a "vicious circle." Built-in inflation reflects events in the past, and so might be seen as hangover inflation.

Consequences of Inflation

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Tax Distortions:
Personal income tax increases with the consumer price index. When inflation increases, the actual value of the tax deductions is much less than it should be due to the declining purchase power.

Unfair gains & loses: Effects on production, that is, changes in the tempo of economic activity.
Effects on income distribution, that is, re- distribution of income and wealth. Effects on consumption and welfare.

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Disinflating Inflation.
The Reserve Bank of India has proclaimed a sudden 50-basis-point raise in the banks' reserve requirements, in order to bring the inflationary conditions prevailing in the country under control from near three-year peaks. The Reserve Bank of India (RBI) may go in for further tightening of money supply as there is no likelihood of inflation coming to single digit in the next six months, according to indications given by the central bank governor to a parliamentary panel. To give a fillip to investment in textile industry, the RBI has proposed to allow banks to issue guarantees or standby letters of credit (LCs) for companies undertaking expansion and technological upgradation.

Deflation.
A general decline in prices, often caused by a reduction in the supply of money or credit. Deflation can be caused also by a decrease in government, personal or investment spending. The opposite of inflation, deflation has the side effect of increased unemployment since there is a lower level of demand in the economy, which can lead to an economic depression.

Causes of deflation
Decreasing Money Supply. Increasing Supply of Goods. Decreasing Demand of Goods. Increasing Demand for Money.

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Measures to control Deflation.

Deflation can be checked by making attempts to raise the level of aggregate effective demand. Effective demand can be uplifted partly by inducing the people to spend more on consumption and partly by stimulating investment expenditure in the economy. Marginal propensity to consume in an economy can be raised by a redistribution of income from the rich to the poor classes. Similarly, measures should be taken to induce investment. As an antideflationary measure, a programme of public investment should be financed by borrowing rather than taxation.

IS DEFLATION GOOD OR BAD?

Actually, deflation itself is neither good nor bad. It depends on the cause of the deflation whether people will suffer or rejoice. As I said, if the cause is increasing supply of goods that would be good. Another example of this is in the late 1800s as the industrial revolution dramatically increased productivity. However, if deflation is caused by a decreasing supply of money as in the great depression, that would be bad. The stock market crash sucked all the liquidity out of the market place, the economy contracted, people lost their jobs and then banks stopped loaning money because people were defaulting. The problem compounded as more people lost their jobs and money supply fell further causing more people to lose their jobs, etc. etc. During the Depression demand for money was high (but no one could afford it) because supply was low. So deflation can be caused by several different things and thus can be good or bad depending on the cause.

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RBI POLICY REVIEW

RBI SHIFTS FOCUS TO GROWTH, RATES ON HOLD

The Reserve Bank of India sent a strong signal that its next move is likely to be an easing of monetary policy as risks to economic growth increase, but left its policy rate on hold at a threeyear high as it acknowledged high inflation. As expected, the RBI opted to pause an aggressive tightening cycle that involved lifting rates 13 times since March 2010, as the Indian economy tussles with a worrying combination of weak growth and high inflation. The RBI held its policy repo rate at 8.5 percent in the wake of data two days ago that showed November wholesale price index inflation held above 9 percent for the 12th month in a row. However at 9.11 percent, it fell from 9.73 percent a month earlier. "While inflation remains on its projected trajectory, downside risks to growth have clearly increased," the RBI said in a statement, adding that inflation risks remained high and a slump in the rupee was also exerting price pressures. In late October, the RBI said further rate hikes might not be warranted, and reiterated that view on Friday. "From this point on, monetary policy actions are likely to reverse the cycle, responding to the risks to growth," it said. The RBI left the cash reserve ratio, the percentage of deposits banks must maintain with the RBI, unchanged at 6 percent despite market speculation that it might cut the ratio in order to bolster liquidity.

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"It is pretty clear that they are now shifting towards growth, but it's not a complete move," said Anubhuti Sahay, an economist with Standard Chartered in Mumbai, who expects interest rates to be cut early in the second quarter of 2012. "But since they have said growth will be important in determining monetary policy stance, if we see more bad news on the growth front, then the possibility of rate cuts coming earlier is there," she said. The RBI did not announce new measures to bolster liquidity in the money markets, although it has been buying back bonds and said it would continue to do so. On Thursday, the rupee was down nearly 20 percent from a July peak before the RBI took measures to defend the currency, buying rupees in the market and announcing steps to curb speculation. The plunge in the currency has added a sense of alarm to concerns about Asia's third-biggest economy. The RBI did not unveil further steps on Friday to support the currency. "I ... welcome the governor's resolve to check speculative interventions in the forex exchange markets, which among other factors has contributed to the sharp depreciation of the Indian rupee," Finance Minister Pranab Mukherjee said, adding that he expects inflation to ease in coming weeks. Bond yields and swap rates fell after the policy statement, while the rupee edged lower to 52.80 per dollar after jumping early in the day off the back of the RBI's Thursday moves. Stocks turned sharply lower late in the day to close down 2.2 percent after hitting a two-year low. "The central bank is walking a very tight rope. They are battling too many challenges at the same time, be it the slowing growth, rupee and the inflation," said Jagannadham Thunuguntla, research head at SMC Global Securities, who does not expect a rate cut before March. The RBI does not set a target for the rupee but does sometimes step into the market to smooth market volatility. It is constrained from mounting a more forceful defence of the rupee by the need to fund a widening current account deficit. EXCEPTIONAL INDIA The RBI had been a global outlier by keeping up its fight against high inflation, lifting rates as recently as late October. Central banks in China, Brazil, Indonesia and elsewhere have begun to ease monetary policy to protect their economies from the impact of the euro-zone debt crisis. While food inflation has dropped sharply in India, manufacturing inflation remains stubbornly high, partly the result of late from the rupee's slide. India's economic growth of 6.9 percent in the September quarter was the slowest pace in over two years. Data on Monday showed October index of industrial output fell 5.1 percent, far worse
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than expected , with annual capital goods output plunging 25.5 percent, a sign of dismal corporate sentiment. "When there is so much gloom and doom around, RBI should have cut the CRR by at least 0.25 percentage points," said R. Ramakrishnan, executive director of equipment maker Bajaj Electricals . Policy-making gridlock as the government is distracted by a series of corruption scandals and a fractious coalition has scared off investors and deterred approvals of projects needed to add capacity in an economy prone to overheating. "It would have given a shot in the arm to banking and the industry. It would have given the signals to everyone that it is interested in spurring the demand and the domestic production," Ramakrishnan said. Analysts have been ratcheting down their growth forecasts for India, with some expecting the economy will struggle to grow 7 percent in the fiscal year that ends in March, below last year's 8.5 percent and the government's heady forecast made early in 2011 for 9 percent growth this fiscal year.

RBI SETS UP WORKING GROUP TO IMPROVE LIQUIDITY

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The Reserve Bank of India (RBI) said on Friday it has set up a working group to examine and suggest ways of increasing secondary market liquidity in government bond and interest rate derivative markets. The working group will comprise representatives from the market and the RBI.

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BIBLIOGRAPHY

BANKING AND INSURANCE

WIBLIOGRAPHY www.rbi.org.in
www.cpolicy.rbi.org.in www.in.reuters.com

Troublesome to aquire, troublesome to protect, troublesome if lost, troublesome if spent; money is nothing but trouble, from beginning to end. -panchatantra, 200 BC

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Celebrating 75 years:

Operations begin on April 1 India embarks on planned economic development. The Reserve Bank becomes active agent and participant

1935
Nationalisation of the Reserve Bank; Banking Regulation Act enacted

1949 1950 1966

Cooperative banks come under RBI regulation RBI strengthens exchange controls by amending Foreign Exchange Regulation Act (FERA)

1973
Regional Rural Banks set up

1975
India faces balance of payment crisis; pledges gold to shore up reserves. Rupee devalued

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1991
Board for Financial Supervision set up

1994
Nationalisation of 14 major commercial banks (six more were nationalised in 1980)

1969
Introduction of priority sector lending targets

1974
Financial market reforms begin with Sukhamoy Chakravarty and Vaghul Committee Reports

1985
Exchange rate becomes market determined

FOREIGN EXANGE RESERVE MANAGEMENT

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The Reserve Bank, as the custodian of the countrys foreign exchange reserves, is vested with the responsibility of managing their investment. The legal provisions governing management of foreign exchange reserves are laid down in the Reserve Bank of India Act, 1934.

The Reserve Banks reserves management function has in recent years grown both in terms of importance and sophistication for two main reasons. First, the share of foreign currency assets in the balance sheet of the Reserve Bank has substantially increased. Second, with the increased volatility in exchange and interest rates in the global market, the task of preserving the value of reserves and obtaining a reasonable return on them has become challenging. The basic parameters of the Reserve Banks policies for foreign exchange reserves management are safety, liquidity and returns. Within this framework, the Reserve Bank focuses on: a) Maintaining markets confidence in monetary and exchange rate policies. b) Enhancing the Reserve Banks intervention capacity to stabilise foreign exchange markets. c) Limiting external vulnerability by maintaining foreign currency liquidity to absorb shocks during times of crisis, including national disasters or emergencies. d) Providing confidence to the markets that external obligations can always be met, thus reducing the costs at which foreign exchange resources are available to market participants. e) Adding to the comfort of market participants by demonstrating the backing of domestic currency by external assets.

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Investment of Reserves:
The Reserve Bank of India Act permits the Reserve Bank to invest the reserves in the following types of instruments: 1) Deposits with Bank for International Settlements and other central banks 2) Deposits with foreign commercial banks 3) Debt instruments representing sovereign or sovereign-guaranteed liability of not more than 10 years of residual maturity 4) Other instruments and institutions as approved by the Central Board of the Reserve Bank in accordance with the provisions of the Act 5) Certain types of derivatives

While safety and liquidity continue to be the twin-pillars of reserves management, return optimisation has become an embedded strategy within this framework. The Reserve Bank has framed policy guidelines stipulating stringent eligibility criteria for issuers, counterparties, and investments to be made with them to enhance the safety and liquidity of reserves. The Reserve Bank, in consultation with the Government, continuously reviews the reserves management strategies

Deployment of Reserves
The foreign exchange reserves include foreign currency assets (FCA), Special Drawing Rights (SDRs) and gold. SDRs are held by the Government of India. The foreign currency assets are managed following the principles of portfolio management

In deploying reserves, the Reserve Bank pays close attention to currency composition, interest rate risk and liquidity needs. All foreign currency assets are invested in assets of top quality and a good proportion is convertible into cash at short notice. The counterparties with whom deals are conducted are also subject to a rigorous selection process. In assessing the returns from deployment, the total return (both interest and capital gains) is taken into consideration. One
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crucial area in the process of investment of the foreign currency assets in the overseas markets relates to the risks involved in the process. While there is no set formula to meet all situations, the Reserve Bank follows the accepted portfolio management principles for risk management.

Foreign Exchange Reserves Management: The RBIs Approach

The Reserve Banks approach to foreign exchange reserves management has also undergone a change. Until the balance of payments crisis of 1991, Indias approach to foreign exchange reserves was essentially aimed at maintaining an appropriate import cover. The approach underwent a paradigm shift following the recommendations of the High Level Committee on Balance of Payments chaired by Dr. C. Rangarajan (1993). The committee stressed the need to maintain sufficient reserves to meet all external payment obligations, ensure a reasonable level of confidence in the international community about Indias capacity to honour its obligations, and counter speculative tendencies in the market. After the introduction of system of marketdetermined exchange rates in 1993, the objective of smoothening out the volatility in the exchange rates assumed importance. The overall approach to the management of foreign exchange reserves also reflects the changing composition of Balance of Payments (BoP) and liquidity risks associated with different types of flows. In 1997, the Report of the Committee on Capital Account Convertibility under the chairmanship of Shri S.S. Tarapore, suggested alternative measures for adequacy of reserves. The committee in addition to trade-based indicators also suggested money-based and debt-based indicators. Similar views have been held by the Committee on Fuller Capital Account Convertibility (Chairman: Shri S. S. Tarapore, July 2006).

The traditional approach of assessing reserve adequacy in terms of import cover has been widened to include a number of parameters about the size, composition, and risk profiles of various types of capital flows. The Reserve Bank also looks at the types of external shocks to which the economy is

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potentially vulnerable. The objective is to ensure that the quantum of reserves is in line with the growth potential of the economy, the size of risk-adjusted capital flows and national security requirements.

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FOREIGN EXANGE RESERVE MANAGEMENT

The Reserve Bank, as the custodian of the countrys foreign exchange reserves, is vested with the responsibility of managing their investment. The legal provisions governing management of foreign exchange reserves are laid down in the Reserve Bank of India Act, 1934.

The Reserve Banks reserves management function has in recent years grown both in terms of importance and sophistication for two main reasons. First, the share of foreign currency assets in the balance sheet of the Reserve Bank has substantially increased. Second, with the increased volatility in exchange and interest rates in the global market, the task of preserving the value of reserves and obtaining a reasonable return on them has become challenging. The basic parameters of the Reserve Banks policies for foreign exchange reserves management are safety, liquidity and returns. Within this framework, the Reserve Bank focuses on:
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a) Maintaining markets confidence in monetary and exchange rate policies. b) Enhancing the Reserve Banks intervention capacity to stabilise foreign exchange markets. c) Limiting external vulnerability by maintaining foreign currency liquidity to absorb shocks during times of crisis, including national disasters or emergencies. d) Providing confidence to the markets that external obligations can always be met, thus reducing the costs at which foreign exchange resources are available to market participants. e) Adding to the comfort of market participants by demonstrating the backing of domestic currency by external assets.

Investment of Reserves:

The Reserve Bank of India Act permits the Reserve Bank to invest the reserves in the following types of instruments: 1) Deposits with Bank for International Settlements and other central banks 2) Deposits with foreign commercial banks 3) Debt instruments representing sovereign or sovereign-guaranteed liability of not more than 10 years of residual maturity 4) Other instruments and institutions as approved by the Central Board of the Reserve Bank in accordance with the provisions of the Act 5) Certain types of derivatives

While safety and liquidity continue to be the twin-pillars of reserves management, return optimisation has become an embedded strategy within this framework. The Reserve Bank has framed policy guidelines stipulating stringent eligibility criteria for issuers, counterparties, and investments to be made with them to enhance the safety and liquidity of reserves. The Reserve
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Bank, in consultation with the Government, continuously reviews the reserves management strategies

Deployment of Reserves
The foreign exchange reserves include foreign currency assets (FCA), Special Drawing Rights (SDRs) and gold. SDRs are held by the Government of India. The foreign currency assets are managed following the principles of portfolio management

In deploying reserves, the Reserve Bank pays close attention to currency composition, interest rate risk and liquidity needs. All foreign currency assets are invested in assets of top quality and a good proportion is convertible into cash at short notice. The counterparties with whom deals are conducted are also subject to a rigorous selection process. In assessing the returns from deployment, the total return (both interest and capital gains) is taken into consideration. One crucial area in the process of investment of the foreign currency assets in the overseas markets relates to the risks involved in the process. While there is no set formula to meet all situations, the Reserve Bank follows the accepted portfolio management principles for risk management.

Foreign Exchange Reserves Management: The RBIs Approach

The Reserve Banks approach to foreign exchange reserves management has also undergone a change. Until the balance of payments crisis of 1991, Indias approach to foreign exchange reserves was essentially aimed at maintaining an appropriate import cover. The approach underwent a paradigm shift following the recommendations of the High Level Committee on Balance of Payments chaired by Dr. C. Rangarajan (1993). The committee stressed the need to maintain sufficient reserves to meet all external payment obligations, ensure a reasonable level of confidence in the international community about Indias capacity to honour its obligations, and counter speculative tendencies in the market. After the introduction of system of marketdetermined exchange rates in 1993, the objective of smoothening out the volatility in the exchange rates assumed importance.

54

The overall approach to the management of foreign exchange reserves also reflects the changing composition of Balance of Payments (BoP) and liquidity risks associated with different types of flows. In 1997, the Report of the Committee on Capital Account Convertibility under the chairmanship of Shri S.S. Tarapore, suggested alternative measures for adequacy of reserves. The committee in addition to trade-based indicators also suggested money-based and debt-based indicators. Similar views have been held by the Committee on Fuller Capital Account Convertibility (Chairman: Shri S. S. Tarapore, July 2006).

The traditional approach of assessing reserve adequacy in terms of import cover has been widened to include a number of parameters about the size, composition, and risk profiles of various types of capital flows. The Reserve Bank also looks at the types of external shocks to which the economy is potentially vulnerable. The objective is to ensure that the quantum of reserves is in line with the growth potential of the economy, the size of risk-adjusted capital flows and national security requirements.

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Concluding Remarks To conclude, the role of RBI has been redefined through gradual evolution and adaptation, along with some statutory changes, and not through any radical restructuring. Further, while assessing the autonomy of the RBI, one should recognise that RBI is not a pure monetary authority but is responsible for several other functions also, as a central bank. The developments in the recent past lead one to the conclusion that, de facto, there has been enhancement of the autonomy of the RBI. As regards monetary policy framework, the objectives remained the same but the framework has been changed from time to time in a gradual fashion in response to the evolving circumstances. Contextually, there are three important issues in the conduct of monetary policy viz., the assessment of potential output, the measurement of unemployment and appropriate measure of inflation. While the policy tries to cope with these issues, a combination of instruments is necessarily used in a flexible manner to meet these complexities. Every effort has been made to improve the transmission channels especially through the financial markets, and through regulatory and institutional reforms. In addition, there are some constraints in the conduct of monetary policy, in particular, the fiscal impact, predominant public ownership, prevalence of administered interest rate, etc. While these challenges and dilemmas persist in the Indian context, every effort is made by the RBI to meet the broader objectives set forth, from time to time. Let me conclude by thanking Professor Vyas for giving me this opportunity to be with you. I enjoyed being here despite the onset of uncertainties in my travel back to Mumbai due to disruptions caused by the monsoon conditions in Mumbai. Thank

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