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Monetary Policy Notes

(Lecture -1 (B-1) to Lecture 5 (B-5)
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Lecture-1 Link : https://www.youtube.com/watch?v=dKetmLtngSY&t=486s

Lecture-2 Link : https://www.youtube.com/watch?v=a1pa8gapBEw&t=2s

Lecture-3 Link : https://www.youtube.com/watch?v=9HkGdErOGtE&t=23s

Lecture-4 Link : https://www.youtube.com/watch?v=YorT3lKdWKQ

Lecture-5 Link : https://www.youtube.com/watch?v=tU7nzmaL27o&feature=youtu.be

Let’s Start it

Meaning of monetary policy

 Responsibility of central bank of country

 It controls the flow of money in the economy
 It decides how much money will stay with the public
Objectives of monetary policy

 To control inflation
 To manage economic growth
 To maintain a stable exchange rate of a system
Some facts

 Formulated twice in a year

 April and October

Instruments under monetary policies

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Cash reserve ratio (CRR)

 That part of NDTL that bank has to maintain with the RBI in the form of cash
 At present – 4%****
 money goes out of the economy
 Earlier lower and upper limits were there – 15% and 3% , RBI amendment act 2006 was passed
 No interest rate is given to the banks
 CRR is calculated every fortnightly

How does it work?

Statutory liquidity ratio (SLR)

 That part of NDTL that banks has to keep with RBI in the form of gold , cash or g – sec.
 At present – 19.5%***
 SLR – only in the form of g-sec (why ??)
 However, SLR is not very effective tool but still it is used becz it tells the direction. becz money reaches to economy
only.
 Earlier there were limits on SLR as well but removed from RBI amendment act 2006 only lower ceiling was
removed.
Reserve ratio

 CRR
 SLR

Open market operation

 Mechanism – RBI sells govt. securities in the form of bonds and bills to banks
 Even NBFCS can participate
 Buy back option
 Not mandatory – only if they have surplus

Policies

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Bank rate

• The rate at which RBI used to lend to banks for long term

How it used to work?

• At present – 6.25%
• Whenever the banks borrow they have to pledge the securities and it is 105% of the total loan.
• It can’t be a part of SLR
• 2nd Narasimham committee recom. – LAF was brought in 1999 tempo. And then in 2000 full flegedly and bank rate
became dormant and at the end bank rate is used as a penalty rate.
Loan taking system

Some imp facts

• Security issue same as of bank rate
• How does it work

Liquidity adjustment facility

MARGINAL STANDING FACILITY

• It is a facility of overnight lending and borrowing

• Under MSF banks may borrow for 24 Hrs.
• At present – 6.25%
• Bank can’t borrow an amount of more than 2.5% of NDTL
• 105% securities to be pledged but SLR can be used as well.
Rate of reference

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Qualitative tools

• When quantitative tools fails

Why it can fail –

 Made effective only by the banks – bad impact on consumers

 Moral responsibility
 Warning
 Penalize
 Rule making
 In case of priority sector lending
Prime lending rate

 Rate used to be the ROI at which banks used to provide loan to their best customer
 Good customer -
 Good credit history
 Permanent source of income
 Except to their own employees and farmers
 Losses were compensated by rest of the customer.
Base rate

• Below which banks can’t lend to anyone except farmers and their own employees

Factors –

 Cost of deposit
 Operational cost
 Profit margin
 Negative return on CRR
• The RBI expected that the moment monetary tools are modified even the banks could modify the interest rate.

Reasons

• Factors have no impact of base rate

• If ROI will be changed for new customer, existing customer will feel the same and on deposits roi can’t be reduced
and at the same time they need to compete with small saving schemes of govt. hence it will be a loss to the banks
• RBI argued that total cost of deposit is low as current account deposit also comes into play
Marginal cost of fund based lending rate (MCLR)

• Below which banks can’t lend to anyone except farmers and their employees

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• Made effective from 1st April 2016 but still banks are struggling
• MCLR to be declared in advance
Factors have been made into consideration
 Operational cost
 Negative return on crr
 Marginal cost of fund
 Term period of loan
Non traditional tools

Negative interest rate

Monetary policy committee

 Earlier there was a technical advisory committee was present , view of only governor – veto power
 Urjit Patel committee recommended – monetary policy committee
 To take govt view also – FD
 To make it democratic and experts views only
 Hence monetary and fiscal policy left proper coordination
 It consists of 6 members
 RBI– RBI governor and 2 deputy governor
 Govt. – no political appointee
 Casting vote to governor
 Headed by governor
Exchange rate determination of domestic currency

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How rupees appreciate and depreciate

Market stabilization scheme

 Was introduced in 2004

 Too much dollar was infiltrated
 RBI started purchasing more and more dollar but at the end it infused more rupees and MSS was used.
 Revived in post demonetization
How depreciation is handled

 RBI can sell more and more dollar but not more than 6%
 Increase ROI on NRI deposit but not that much effective
 Increase the limit of external commercial borrowing for corporates, not effective
 Rationing of dollar – sell dollar only for essential commodities
 Foreign investment rules may be eased.

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