Credit policy July 2012 Review

Reserve Bank of India (RBI):

Reserve Bank of India was established in 1st April 1935, under the Reserve Bank of India Act Mumbai as head quarter. Now it has 22 Regional offices in which most of them are State capitals. Its present governor is Mr.D.Subbarao. It is the Central bank of India. Some people even call it as Bank of Bankers. Its Primary functions are: Issue of currency notes Maintaining reserves for maintaining stability in the economy Bankers bank Bank to the Government Custodian of foreign exchange reserves of the country Lender of the last resort Credit control Clearing house functions Formulate monetary policy

Secondary functions are: Regulating the banking system of the country Supervision of the banks Report publishing

Credit Control: Credit control is an important tool used by the RBI to control the demand and supply of money (liquidity) in the economy by using the monetary policy. The main objectives of monetary policy are, Rapid economic growth Price stability Exchange rate stability Neutrality of money Equal income distribution

The basic and important needs of Credit Control in the economy are: To encourage the overall growth of the priority sector i.e. those sectors of the economy which is recognized by the government as prioritized

 To keep a check over the channelization of credit so that credit is not delivered for undesirable purposes. To achieve the objective of controlling Inflation as well as Deflation. To boost the economy by facilitating the flow of adequate volume of bank credit to different sectors. Methods of Credit Control: There are two methods that the RBI uses to control the money supply in the economy(1) Qualitative Method: By qualitative methods means the control or management of the uses of bank credit or manner of channelizing of cash and credit in the economy. Tools used under this method are: Marginal Requirement: Marginal Requirement of loan can be increased or decreased to control the flow of credit for e.g. a person mortgages his property worth Rs. 1, 00,000 against loan. The bank will give loan of Rs. 80,000 only. The marginal requirement here is 20%. In case the flow of credit has to be increased, the marginal requirement will be lowered. Rationing of credit: Under this method there is a maximum limit to loans and advances that can be made, which the commercial banks cannot exceed. e.g.-If the RBI fixes x% as maximum limit the banks should not exceed that x% of total loan under particular category to single person. Publicity: RBI uses media for the publicity of its views on the current market condition and its directions that will be required to be implemented by the commercial banks to control the unrest. Direct Action: Under the banking regulation Act, the central bank has the authority to take strict action against any of the commercial banks that refuses to obey the directions given by Reserve Bank of India. Moral Suasion: This method is also known as Moral Persuasion as the method that the Reserve Bank of India, being the apex bank uses here, is that of persuading the commercial banks to follow its directions/orders on the flow of credit. (2) Quantitative Method: By Quantitative Credit Control we mean the control of the total quantity of credit. Different tools used under this method are: Bank Rate: Bank Rate also known as the Discount Rate is the official minimum rate at which the Central Bank of the country is ready to rediscount approved bills of exchange or lend on approved securities. Current rate is 8%. Open Market Operations: Open Market Operations indicate the buying/selling of government

securities in the open market to balance the money supply in the economy. During inflation, RBI sells the government securities to the commercial banks and other financial institution. This reduces their cash lending and credit creation capacities. Thus, Inflation can be controlled. And in the recession this could be happened in the reverse. Repo Rates and Reverse Repo Rates: Repo is a swap deal involving immediate sale of securities and a simultaneous re purchase of those securities at a future date at a predetermined price. Commercial banks and financial institution also park their funds with RBI at a certain rate, this rate is called the Reverse Repo Rate. Repo rates and Reverse repo rate used by RBI to make liquidity adjustments in the market. Current rates are Repo is 8% and Reverse Repo is 7%. Cash Reserve Ratio: The money supply in the economy is influenced by the cash reserve ratio. It is the ratio of a banks time and demand liabilities to be kept in reserve with the RBI. A high CRR reduces the flow of money in the economy and is used to control inflation. A low CRR increases the flow of money and is used to overcome recession. Current rate is 4.25% Statutory Liquidity Ratio: Under SLR, banks have to invest a certain percentage of its time and demand liabilities in Government approved securities. The reduction in SLR enhances the liquidity of commercial banks. Current rate is 23%. Difference between Qualitative and Quantitative Measures: Quantitative Measures: 1. Impacts the total volume or quantity of money 2. Controls credit indirectly 3. Lenders are controlled and not the borrowers Qualitative Measures (Selective Credit Control): 1. Quality or use or purpose of credit is controlled 2. Controls credit directly 3. Both lenders and borrowers are influenced

Inflation:
Inflation is the increase in the value of the goods and services over a period of time. Inflation decreases the purchasing power of currency. That implies that the goods or services have to be bought by shelling out more money. The goods prices have increased but the currency power has not changed which would result in paying more for the same goods. Inflation is a gradual process taking place over the years. Causes of Inflation: There are many intricate and complicated dynamics of economics that cause inflation. Some of

the causes include misbalanced supply and demand, increase in production and distribution costs, increase in tax on goods and services, unstable political or economical environment etc. Effects of Inflation: Inflation has the worst effect on the consumers. Since the price of commodities have increased, it becomes hard for the consumers to afford the basic commodities. The consumers have no choice but to ask for rise in wages which might not be possible. That is why government tries to decrease or control inflation. Whenever inflation increases, it is observed that many changes are introduced in the monetary and fiscal policies. Such changes do not bode well for the overall economic development of the economy. How to Tackle Inflation? Inflation results in increased value of goods and services. The customer has to take proactive steps so that inflation does not overwhelm him. By investing in such a way that the rate of return on investment is more than inflation rate, one can make sure that he is not affected by the ever changing inflation. Role of RBI in inflation control: Inflation arises when the demand increases and there is a shortage of supply there are two policies in the hands of the RBI. Monetary Policy/Credit policy, It includes the interest rates. When the bank increases the interest rates than there is reduction in the borrowers and people try to save more as the rate of interest has increased. RBI Policy Stance: Containing inflation and anchor inflation expectations has again become the top priority for RBI. After briefly shifting its policy stance towards growth briefly in Apr-12 policy, the focus is again back on inflation. Table : Policy Stance of RBI in recent Monetary Policy Reviews Jan-2011 Apr -2012 Jul -2012

environment to contain levels consistent with the anchor inflation inflation and anchor current growth expectations; inflation expectations. moderation. growth path over the ensure that it remains in demanded inflationary medium-term; and

moderate deficit, pressures remerging. consistent with effective liquidity to facilitate credit monetary transmission. liquidity cushion to the availability to productive financial system. sectors. downside risk to growth

RBI's Monetary Policy July 2012-13 Review :

In First Quarter Review of Monetary Policy 2012-13, RBI kept policy rates unchanged. The policy decision is in line with our expectations (report dated 27-Jul-12). Policy Rate Decisions Repo rate unchanged 8% Reverse Repo rate and Marginal Standing Facility (MSF) Rate automatically remain unchanged at 7% and 9% respectively. CRR remains unchanged at 4.75% of NDTL. In a surprise move, RBI lowered the SLR from 24% of NDTL to 23% of NDTL. Economic Projections GDP growth for 2012-13 lowered from 7.3% to 6.5% Inflation projection for Mar-13 increased from 6.5% to 7%. Growth in Money Supply and Non-food credit remain unchanged for 2012-13 at 15% and 17% respectively. Forward guidance statement In the current circumstances, lowering policy rates will only aggravate inflationary impulses without necessarily stimulating growth. As the multiple constraints to growth are addressed, RBI will stand ready to act appropriately. RBI will respond to any liquidity pressures in the system, including using OMOs. RBI stands ready to respond to any global shocks Background of policy: Growth Inflation control