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MONETARY POLICIES

The Monetary and is the policy statement, traditionally announced twice a year, through which the Reserve Bank of India seeks to ensure price stability for the economy. The Monetary Policy aims to maintain price stability, full employment and economic growth. It can increase or decrease the supply of currency as well as interest rate, carry out open market operations, control credit and vary the reserve requirements. The monetary management of a country is how well the central bank of a country implements the monetary policies and how well the government controls the various financial aspects of the country.

ROLE OF MONETARY POLICIES IN DEVELOPING ECONOMY


Developing countries including India suffer from the problems of low level of real per-capita income, business fluctuations, price instability, lack of credit facilities, lack of capital formation, balance of payment disequilibrium. An effective monetary policy will not only provide adequate financial resource for economic development but also help developing economies to step up and accelerate the rate of output, employment and income. Monetary policy may also

help these countries in containing inflationary pressures and achieving balance of payment equilibrium.

SOME IMPORTANT OBJECTIVES OF MONETARY POLICIES


1.) Investment and Savings The problem of inadequate savings cannot be solved merely by opening new institutions, but this problem can be solved only by having profitable investment of savings. Economic growth can not be increased unless the savings are utilized in productive activities. The investment rate is very low in developing countries on account of absence of profitable productive activities, lack of entrepreneurial ability and marginal efficiency of capital. 2.) Maintenance of monetary equilibrium The important object of monetary policy in developing economy is to direct economy towards achieving equality between economic development, there is need to expand credit facilities, but once a certain level of growth is achieved credit restrictions of different types must be imposed by the reserve bank. 3.) Price stability Internal price stability is an important objective of monetary policy in every developing country. Violent

fluctuations in the internal price level not only disrupt the smooth working of countys economy but theses also lead to insecurity and social injustice. Increasing cost of labour and materials also increases the various cost of projects, which adversely affects the rate of economic growth. The effect of price instability is always commutative in character. Thus, central banks of developing countries should pursue such type of monetary policy which may help in maintaining price stability over a long period so that development activities may go uninterrupted. 4.) Making balance of payment favourable All most all developing countries have to import capital goods, machinery, equipments, technical know-how etc. in primary stages of progress. Consequently, their imports exceed the exports and balance of payment becomes unfavourable. Monetary policy should be directed towards maintaining stability in exchange rates and removing disequilibrium in balance of payments. 5.) Inducement to saving In present time capital formation depends upon saving. Object of monetary policy in developing country is promoting savings, their mobilization and their investment in productive activities. Central bank of the country has to provide adequate banking facilities to the public so that they may deposit their small savings with the banking institutions, which may later on be utilized for investment purpose.

6.) Proper policy of interest rate The structure of interest rate is generally not conductive to economic growth in developing countries- the rates of interest do not only differ according to different time, schedules but also differ in various regions and business activities. High rates of interest discourage public and private investments. The central bank is required to formulae such a policy as regard the rate of interest which may induce the investors to go in for more loans and advances from the commercial banks and financial institutions.

RBI AND ITS FUNCTIONS

Reserve bank of India (RBI) is the central bank of India. According to preamble of the reserve bank of India act, the main function of the bank is to regulate the issue of bank notes and the keeping of reserves with a view to securing monetary stability in India and generally to operate the currency and credit system of the country to its advantage. The various functions performed by the RBI can be conveniently classified in three parts which are as follows: 1.) 2.) 3.) Traditional central banking functions. Promotional functions. Supervisory functions.

Traditional central banking functions.


1. Bank of Issue The Bank has the sole right to issue bank notes of all denominations. The distribution of one rupee notes and coins and small coins all over the country is undertaken by the Reserve Bank as agent of the Government. The Reserve Bank has a separate Issue Department which is entrusted with the issue of currency notes. 2. Banker to Government The second important function of the Reserve Bank of India is to act as Government banker, agent and adviser. The Reserve Bank is agent of Central Government and of all State Governments in India excepting that of Jammu and Kashmir. The Reserve Bank has the obligation to transact Government business, via. to keep the cash balances as deposits free of interest, to receive and to make payments on behalf of the Government and to carry out their exchange remittances and other banking operations.

3. Bankers Bank and Lender of the Last Resort The Reserve Bank of India acts as the bankers' bank. The scheduled banks can borrow from the Reserve Bank of India on the basis of eligible securities or get financial accommodation in times of need or stringency by rediscounting bills of exchange. Since commercial banks can always expect the Reserve Bank of India to come to their help in times of banking crisis the Reserve Bank becomes not only the banker's bank but also the lender of the last resort. 4. Controller of Credit The Reserve Bank of India is the controller of credit i.e. it has the power to influence the volume of credit created by banks in India. It can do so through changing the Bank rate or through open market operations. The Reserve Bank of India is armed with many more powers to control the Indian money market. Every bank has to get a license from the Reserve Bank of India to do banking business within India, the license can be cancelled by the Reserve Bank of certain stipulated conditions are not fulfilled. Every bank will have to get the permission of the Reserve Bank before it can open a new branch. Each scheduled bank must send a weekly return to the Reserve Bank showing, in detail, its assets and liabilities. This power of the Bank to call for information is also intended to give it effective control of the credit system. The Reserve

Bank has also the power to inspect the accounts of any commercial bank. 5. Custodian of Foreign Reserves The Reserve Bank of India has the responsibility to maintain the official rate of exchange. The Reserve Bank has the responsibility of maintaining fixed exchange rates with all other member countries of the I.M.F. Besides maintaining the rate of exchange of the rupee, the Reserve Bank has to act as the custodian of India's reserve of international currencies. The vast sterling balances were acquired and managed by the Bank. Further, the RBI has the responsibility of administering the exchange controls of the country.

Promotional functions
The scope of the functions performed by the reserve bank has further widened after the introduction of economic planning in the country. The bank now performs a variety of promotional and developmental functions. The RBI has to provide facilities for agricultural and industrial finance. 1.) RBI and agricultural credit The banks responsibility in this field has been occasioned by the pre-dominantly agricultural basis

of the Indian economy and the urgent need to expand and coordinate the credit facilities available to the rural sector. The RBI has set up a separate agricultural department to maintain an expert staff to study all questions of agricultural credit and coordinate the credit facilities available to the rural sector. After the establishment of the NABARD on july12, 1982, all the functions of RBI relating to rural credit have been transferred to this new agency. 2.) Reserve bank of India and industrial finance The RBI has also helped in establishment of other financial institution such as the industrial Development bank of India, the Industrial Reconstruction Bank of India, Unit trust of India, etc.

Supervisory functions
The banking regulation act, 1949, provides wide powers to the reserve bank to regulate and control the activities of banks to safeguard the interests of depositors. The supervisory functions of RBI can be summarized as follows:It grants license to companies wishing to commence banking business in India. 2. It sets out capital, reserves and liquidity limits for the banks. 3. It grants permission to banks to establish new branches in unbanked and other areas of the country.
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4. It can inspect any banking company to safeguard the interest of the depositors and to build up and maintain a sound banking system in conformity with the banking laws and regulation as well as the countrys socio economic objectives. 5. It can prohibit banks from engaging in trading activities, exempt in realization of the security given to be held by it. 6. It takes initiative in the building up of institutional arrangements to impart training to banking personnel. In brief, the reserve bank of India is performing both traditional central banking function and developmental functions for the steady growth of Indian economy.

VARIOUS OPERATIONS OR INSTRUMENTS OF MONETARY POLICY USED BY RBI

The reserve bank of India makes use of both quantitative (general) and qualitative (selective) methods of credit control.

A.) QUANTITATIVE CONTROLS


These are also known as traditional or monetary methods of credit control. These controls affect the cost and availability of bank credit. Quantitative controls include the following measure of credit control. 1.) Bank rate policy The bank rate is defined as a standard rate at which the reserve bank rediscounts or buys the first class bills and securities of the commercial banks. During the period of business prosperity and inflation the Reserve bank increases the bank rate. This signified high cost of credit and restricted availability of credit, and thus, adversely affects business borrowings. Conversely, during the phase of business depression the reserve bank decreases the bank rate making credit cheaper and easier. A fall in the bank

rate is generally followed by a fall in the interest rate which encourages investments. 2.) Open market operations Open market operations refer, broadly, to the purchase and sale by the central bank of a variety of assets such as foreign exchange, gold, government securities and even company shares. The reserve bank of India is authorized under the RBI Act, 1934, to purchase or sell the Government securities. After 1951, the reserve bank decided not to purchase the Govt. securities; instead, the bank provides temporary accommodation against collateral of Govt. securities. 3.) Variable Reserve Requirement The commercial banks in India are required to maintain statutory cash reserves wit the reserve bank of India and are required to maintain statutory liquidity requirements. Statutory cash reserves refer to that portion of total deposits of a commercial bank which it has to keep with the reserve bank in the form of cash reserves. Originally, scheduled commercial banks were required to maintain with the reserve bank statutory cash reserve of an amount equal to not less than 3 per cent of their demand and time liabilities. At present, banks are required to maintain a cash reserve of 15.0 % of their total demand and time liabilities.

Statutory Liquidity Ratio (SLR) refers to that portion of daily total demand and time liabilities of a commercial bank which it has to keep with itself in the form of liquid assets. These liquid assets consist of the following: a.) Excess reserves of the banks b.) Unencumbered Govt. and other approved securities and c.) Current account balances with other banks.

B.) QUALITATIVE CONTROLS


Qualitative or selective controls comprise such measures of credit control which aim at the regulation of credit for specific purposes or to discourage it from being used for undesirable purposes. Selective credit control operate o the distribution of total credit. The reserve bank of India has used the following qualitative measures of credit control: 1.) Margin Requirements The RBI has prescribed higher margins against the loans based on the security of good grains, cotton and kapas, sugar, textiles etc. higher margins have restricted the borrowing capacity of the stockholders of these commodities.

2.) Credit Rationing Through this method the RBI fixes the party wise ceiling of loans and advances on the basis of crop prospects, supply position and price trends. 3.) Fixation of Minimum Lending Rates The RBI also prescribes minimum lending rate in case of advances against all commodities with certain expectations. 4.) Direct Action The reserve Bank takes the following direct actions against the commercial banks: (i) To refuse rediscounting facilities to the banks who do not co-operate with the policies of the RBI; (ii) To refuse loans; (iii) To impose monetary penalties; and (iv) To alter the conditions of rediscounting.

FINANCIAL MARKET CONDITIONS BEFORE THE REFORM PERIOD


In the pre-reform era, the financial market in India was highly segmented and regulated. The money market lacked depth, with only the overnight interbank market in place. The interest rates in the government Securities market and the credit market were tightly regulated. The dispensation of credit to the Government took place through a statutory liquidity ratio (SLR) process whereby the commercial banks were made to set aside substantial portions of their liabilities for investment in government securities at below market interest rates. Furthermore, credit to the commercial sector was regulated, with prescriptions of multiple lending rates and a prevalence of directed credit at highly subsidized interest rates. The Reserve Bank had to subscribe to the government dated securities which were not taken up by the market. As a result, net Reserve Bank credit to the Central government, which constituted about threequarters of the monetary base (reserve money) during the 1970s, rose to over 920/0 during the 1980s.

In such an environment, monetary policy had to address itself to the task of neutralizing the inflationary impact of the growing deficit. The Reserve Bank had to resort to direct instruments of monetary control, in particular the cash reserve ratio. This ratio was used to neutralize the financial impact of the Governments budgetary operations rather than as an independent monetary instrument.

FINANCIAL MARKET CONDITIONS AFTER THE REFORM PERIOD


The reform period took place in the early 1990s. The financial sector reforms initiated following the recommendations of The Narasimham Committee (1991), in conjunction with the recommendations of the Chakravarty Committee and the Vaghul Working Group, produced far-reaching changes in the financial sector which had an important bearing on the conduct of monetary policy. With the initiation of financial sector reforms, the emphasis was placed on the development and deepening of money, government securities and forex markets, and an effort was made to move away from the use of direct instruments of monetary control to indirect measures such as open market operations and marketrelated interest rates. In order to improve short-term liquidity and encourage its efficient management, interbank participation certificates, certificates of deposit (CDs) and commercial paper (CP) were introduced. The Discount and Finance House of India (DFHI) was set up to promote a secondary market in a range of money market instruments. Treasury bills of varying maturities (14-, 91- and 364-day) were introduced. More importantly, interest rates on money market instruments were left to be determined by the market.

In consonance with the medium-term objectives of financial sector reform, the SLR was brought down from its peak level of 38.50/0 in April 1992 to 250/0 of net demand and time liabilities (NDTL) in October 1997. Moreover, there were sharp cuts in the cash reserve ratio (CRR), progressively to 100/0 in January 1997 from 150/0 in 1991.4 The Reserve Banks refinance facility was also rationalized. The sector-specific refinance facilities were de-emphasized and simultaneously a general refinance window was opened in April 1997. Open market operations (OMOs) have gained considerable momentum as the Reserve Bank now responds more flexibly to market yields when drawing up its price list. It also conducts repo and reverse repo transactions in order to ensure a reasonable corridor for money market rates of interest. The interest rate structure was rationalized. Banks are now free to determine their domestic term deposit rates and prime lending rates (PLRs), except for certain categories of export credit and small loans below Rs 0.2 million. In addition, all money market rates are also free. The most significant development in this area has, however, been the reactivation of the bank rate by linking it to all other rates including the Reserve Banks refinance rate.

CRITICAL EVALUATION ON ACHIEVEMENT AND SUCCESS OF RBIS MONETARY MANAGEMENT


The reform that took place in 1991 was very critical and crucial for the Indian economy as India was facing a long term deficit in its monetary terms. There was a great need of reform during the early 1990s. So, there was an economic reform in the country and all the monetary as well as the fiscal policies were changed or made better, which brought about a complete change in the economic development of India. Due to the change in the monetary policies adapted by the Reserve Bank of India in 1991, at present, Indias integration with the world economy is getting stronger, The use of monetary instruments in India has undergone a shift from direct to indirect instruments, Indias current account balance, after posting modest surpluses during 2001-2004, has returned to a deficit in consonance with the resurgence in investment demand in the economy, Indias merchandise exports have been recording a robust growth along with exports of services,

CONCLUDING REMARKS
We can conclude by saying that the Reserve Bank of India has played an important role in the implementation of reforms by maintaining price and financial stability and by contributing to building a robust external sector during a time of great flux. Indian economy has recovered from a major deficit in 1990s (reform period) and is growing stronger day by day. Also, through liberalization and globalization coming in the country, there are many significant changes in the banking sector too, and the RBI has dealt with it quite nicely. RBI has not only done an fantastic job in monetary management, but has also helped improve the agricultural and rural sector of the country, also it has helped improve the industrial sector of the country, by providing them easy loans facility etc, and has undoubtedly raised the standards of the banking sector of the country to newer heights. The Indian economy has been through a lot of tough times, handled the situations of deflation as well as inflation and one can say that it will perform well in any challenge that is lying ahead in its path because of the excellent monetary conditions and an equally good functioning central bank of the nation which will help the Govt to take the Indian economy to the global economy as an developed economy in the near future.

GROUP NO. 1
GROUP MEMBERS
1.) Aditya Nagaraja 2.) Ankesh Bhandari 3.) Abhishek Chouhan 4.) Dheeraj Mehta 5.) Rahul Mishra 6.) Mohit Singh 7.) Neeraj Yadav Roll no. 01 Roll no. 04 Roll no. 11 Roll no. 34 Roll no. 38 Roll no. 42 Roll no. 51

RBIS MONETARY MANAGEMENT IN THE PRE AND POST REFORM PERIOD

SUBMITTED TO:-

Prof. Adigal

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