MONETARY POLICY

Monetary policy in India underwent significant changes in the 1990s as the Indian
Economy became increasing open and financial sector reforms were put in place. in the
1980s,monetary policy was geared towards controlling the qunatam,cost and directions
Of credit flow in the economy. the quantity variables dominated as the transmission
Channel of monetary policy. Reforms during the 1990s enhanced the sensitivity of price
Signals of price signals from the central bank, making interest rates the increasingly
Dominant transmission channel of monetary policy in India.

The openness of the economy, as measured by the ratio of merchandise trade(exports

Plus imports) to GDP, rose from about 18% in 1993-94 to about 26% by 2003-04.
Including services trade plus invisibles, external transactions as a proportion of GDP
Rose from 25% to 40% during the same period.Alongwith the increase in trade as a
Percentage of GDP, capital inflows have increased even more sharply,foreign currency
Assets of the reserve bank of India(RBI) rose from USD 15.1 billion in the march 1994
To over USD 140 billion by march 15,2005.these changes have affected liquidity and
Monetary management. monetary policy has responded continuously to changes in
Domestics and international macroecomic conditions. In this process, the current
monetary operating framework has relied more on outright open market operations and
Daily repo and reserve repo operations than on the use of direct instruments.overight
Rate are now gradually emerging as the principal operating target.

The Monetary and Credit Policy is the policy statement, traditionally announced
twice a year, through which the Reserve Bank of India seeks to ensure price stability for
the economy. These factors include - money supply, interest rates and the inflation.
Objectives :-

The objectives are to maintain price stability and ensure adequate flow of credit to the
productive sectors of the economy. Stability for the national currency (after looking at
prevailing economic conditions), growth in employment and income are also looked into.
The monetary policy affects the real sector through long and variable periods while the
financial markets are also impacted through short-term implications.

There are four main 'channels' which the RBI looks at:

• Quantum channel: money supply and credit (affects real output and price level
through changes in reserves money, money supply and credit aggregates).
• Interest rate channel.
• Exchange rate channel (linked to the currency).
• Asset price.

What do the terms CRR and SLR mean?

Bank Rate

Bank rate is the minimum rate at which the central bank provides loans to the commercial
banks. It is also called the discount rate.

Usually, an increase in bank rate results in commercial banks increasing their lending
rates. Changes in bank rate affect credit creation by banks through altering the cost of
credit.
Cash Reserve Ratio

All commercial banks are required to keep a certain amount of its deposits in cash with
RBI. This percentage is called the cash reserve ratio. The current CRR requirement is 8
per cent.

CRR, or cash reserve ratio, refers to a portion of deposits (as cash) which banks have to
keep/maintain with the RBI. This serves two purposes. It ensures that a portion of bank
deposits is totally risk-free and secondly it enables that RBI control liquidity in the
system, and thereby, inflation. Besides the CRR, banks are required to invest a portion of
their deposits in government securities as a part of their statutory liquidity ratio (SLR)
requirements.

The government securities (also known as gilt-edged securities or gilts) are bonds issued
by the Central government to meet its revenue requirements. Although the bonds are
long-term in nature, they are liquid as they can be traded in the secondary market. Since
1991, as the economy has recovered and sector reforms increased, the CRR has fallen
from 15 per cent in March 1991 to 5.5 per cent in December 2001. The SLR has fallen
from 38.5 per cent to 25 per cent over the past decade.

Bank rate 6%
CRR 8%
Repo rate 7.75%
Reverse Repo rate 6%