MONETARY POLICY
MONETARY POLICY
It is a policy statement, traditionally bi-annual,
through which RBI targets a key set of indicators to
ensure price stability in the economy.
Besides, the policy also provides a platform for the
Apex Bank to announce norms for financial bodies
governed by it like banks, financial institutions, nonbanking finance companies, primary dealers, etc.
IMPORTANT OBJECTIVES
 To ensure the economic stability at full
employment or potential level of output.
 To achieve price stability by controlling
inflation and deflation.
 To promote and encourage economic
growth in the economy.
 Exchange Rate Stability
MONETARY POLICY
• It is concerned with changing the supply of money stock
and rate of interest for the purpose of stabilizing the
economy at full employment or potential output level by
influencing the level of aggregate demand.
• At times of recession monetary policy involves the
adoption of some monetary tools which tend to increase
the money supply and lower interest rate so as to
stimulate aggregate demand in the economy.
• At the time of inflation monetary policy seeks to contract
aggregate spending by tightening the money supply or
raising the rate of return.
Money Supply
the total stock of money which
is in circulation in an economy
at any given point of time. It
implies the total stock of money
held by the public
Money Supply
• Money is a stock as well as a flow concept
• When money supply is viewed at a given
point of time, it is a stock.
• It consists of total currency notes, coins
demand deposits (deposits in saving account
and current accounts) with the bank held by
the public.
• Thus, stock of money held by the public is
called money supply.
• When money supply is viewed over a period of
time, money supply becomes a flow concept.
• Here money may be spent several times during
a given time period, passing from one hand to
another.
• The average number of times a unit of money
circulating from one hand to another in the
process of spending during a given year is called
as the ‘velocity of circulation of money
• The flow of money supply over the period of time
can be calculated by multiplying stock of money
held by the public (M) by the velocity of
circulation of money (V)
• The flow of money supply as given by
Fisher is : MV
Definition of Money
Supply in India
•
Based on two fundamental functions of
money viz. medium of exchange and store of
value, the reserve bank of India has adopted
four measures of money supply expressed as
M1, M2, M3 and M4
Concept of M1
M1 is defined in traditional sense. It is a narrow concept
of money supply. That is why it is referred as ‘narrow
money” it is measured as follows:
M1 = C + DD + OD
C = currency with the public || DD = demand deposits
with banks || OD = other deposits held with the Reserve
Bank of India which include demand deposits of quasi
government institution, foreign central banks,
government (central and state) the International
Monetary Fund, the World Bank etc.
The usefulness of this measure of money supply lies in
the fact that it can be easily controlled by the central
bank.
Money Aggregates Old Series
Concept of M2
• M2 is a broader concept of money supply in India
than M1. In addition to the above mentioned three
items of M1, this concept of M2 includes saving
deposits with post office saving banks. Thus,
M2 = M1 + saving deposits with post office
• Post office saving banks is not as liquid as demand
deposits with banks (commercial or cooperative) as
they are not chequeable account. However, saving
deposits with post office are more liquid than time
deposits with the bank.
Money Aggregates Old Series
Concept of M3:
M3 is again a broad concept of money supply. It is based
on Milton Freidman’s approach to the definition of
money supply which include time deposits besides
demand deposits and currency money as the
components of money supply thus,
M3 = M1 + Time Deposits with Banks
This is the broadest measure of money; it is used by
economists to estimate the entire supply of money
within an economy. M3 is also called as Aggregate
Monetary Resources ( AMR )
Money Aggregates Old Series
Concept of M4
• M4 is an expanded measure of M3.
• M4 =M3 + Total Deposits with the Post Office Saving
Organization(excluding NSC)
• The Reserve Bank of India regards these four
measures of money supply i.e. M1, M2, M3 and M4 in
the descending order of liquidity. It supplies data on
them in its annual Report on Currency and Finance.
Money Aggregates Old Series
Monetary Aggregates:
New Series
• RBI has revised monetary data since April 1992,
and since 1999, has started publishing the new
monetary aggregates, namely M0 ( monetary
base), NM1(Narrow money), NM2 ( Intermediate
monetary aggregate) and NM3 ( Broad money)
based on the residency concept.
• The new series clearly distinguishes between
monetary aggregates and liquidity aggregates.
NM1= Currency with public + Demand deposits
with the banking system + other deposits with
RBI + Demand liabilities portion of savings
deposits with the banking system
NM2= NM1 + time liabilities portion of savings
deposits with the banking system + certificates of
deposits issued by banks + term deposits of
residents with a contractual maturity upto and
including one year with the banking system
Monetary Aggregates: New Series
NM3= NM2+ Long-term deposits of residents +
Call/Term funding from financial institutions
NM1 includes only non-interest bearing assets,
monetary liabilities of the banking sector.
NM3, on the other hand, is an all encompassing
measure that includes long-term deposits.
NM2 is an intermediate monetary aggregate that
stands in between narrow money NM1 and Broad
money NM3.
Monetary Aggregates: New Series
Liquidity Indicators
Along with the above monetary aggregates for the
proper assessment of the liquidity the RBI also
compiles and evaluates three different liquidity
indicators L1, L2 and L3.
L1 = NM3 + All deposits with the post office
savings banks ( excluding National Savings
Certificate)
Liquidity Indicators
L2 = L1+ Term deposits with term lending
institutions and refinancing institutions (FIs)
+ Term borrowing by FIs + Certificate of
deposits issued by FIs
L3 = L2 + Public deposits of non- banking
financial companies.
TOOLS OF MONETARY POLICY
•
•
•
•
Bank rate
Open market operations
Changing reserve ratio (CRR/SLR)
Undertaking selective credit controls
BANK RATE
• Bank rate is the minimum rate at which the
central bank of a country provides loan to the
commercial bank of the country.
• Bank rate is also called discount rate because bank
provide finance to the commercial bank by
rediscounting the bills of exchange.
• When central bank raises the bank rate, the
commercial bank raises their lending rates, it
results in less borrowings and reduces money
supply in the economy.
LIMITATIONS
• Well organized money market should exist in
the economy.
• It is useful during the times of inflation but it
does not fullfill its purpose during the time of
recession or depression.
OPEN MARKET
OPERATIONS
• It means the purchase and sale of securities by
central bank of the country.
• The sale of security by the central bank leads
to contraction of credit and purchase there of
to credit expansion.
LIMITATIONS
 The bank will expand and contract credit according to
prevailing economic and political circumstances and not
merely with reference to their cash reserves.
 When the commercial bank cash balance increases, the
demand for loan and advance should increase. This may
not happen due to economic and political uncertainty.
 The circulation of bank credit should have a constant
velocity.
CHANGING THE CRR/SLR
• CRR - Scheduled banks are required to
maintain with the RBI an average cash balance,
the amount of which shall not be less than
certain % of the total of the Net Demand and
Time Liabilities (NDTL), on a fortnightly basis
• Increase in the CRR leads to the contraction of
credit
• Decrease in the CRR leads to the expansion of
credit and banks tends to make more money
available to borrowers.
CHANGING THE CRR/SLR
• Statutory liquidity ratio (SLR) that the
commercial banks in India require to maintain
in the form of gold, government approved
securities before providing credit to the
customers.
• Increase in the SLR leads to the contraction of
credit
• Decrease in the SLR leads to the expansion of
credit and banks tends to make more money
available to borrowers.
CHANGING THE REPO/REVERSE
• REPO
• REVERSE REPO
Selective Credit Control
•
•
•
•
•
Rationing of credit
Margin Requirement
Variable interest rates
Regulation of consumer credit
Moral Suasion
EXPANSIONARY MONETARY POLICY
Problem: Recession and unemployment
Measures: (1) Central bank buys securities through
open market operation
(2) It reduces cash reserve ratio
(3) It lowers the bank rate
Money supply increases
Investment increases
Aggregate demand increases
Aggregate output increases by a
multiple of the increase in investment
TIGHT MONETARY POLICY
Problem: Inflation
Measures: (1) Central bank sells securities through OMO
(2) It raises CRR and SLR
(3) It raises bank rate
(4) It raises maximum margin against holding of
stocks of goods
Money supply decreases
Interest rate raises
Investment expenditure declines
Aggregate demand declines
Price level falls
ROLE OF MONETARY POLICY IN
ECONOMIC GROWTH
• Monetary policy and savings.
• Monetary policy and investment.
• Cost of credit..
• Monetary policy and public investment.
• Monetary policy and private investment.
• Allocation of investment funds.
RBI’S ANNUAL POLICY STATEMENT
2015-16
The macroeconomic environment is expected to
improve in 2015-16, with fiscal policy gearing to an
investment-led growth strategy
The Reserve Bank’s consumer confidence survey
(CCS) points to growing consumer optimism since
June 2014, reflecting purchasing power gains arising
from lower inflation as well as improved perception of
income, spending and employment growth
RBI’S ANNUAL POLICY STATEMENT
2015-16
CPI inflation will remain below the target of 6 per cent set
for January 2016, hovering around 5 per cent in the first
half of 2015-16, and a little above 5.5 per cent in the
second half.
Uncertainties surrounding commodity prices, monsoon
and weather-related disturbances, volatility in prices of
seasonal items and spillovers from external developments
through exchange rate, inflation is projected to be 3.7 per
cent to 7.9 per cent around the baseline inflation projection
of 5.8 per cent for Q4 of 2015-16.
RBI’S ANNUAL POLICY STATEMENT
2015-16
Monetary Policy Stance
• Faced by the combination of deflationary/ disinflationary
pressures and weak growth, central banks in both AEs and
EMEs have pursued accommodative monetary policies. In
the US, monetary policy remains highly accommodative
with interest rates close to zero.
• Facing persistent deflation, the Bank of Japan has
continued with its target of monetary base expansion of 80
trillion yen per year.
RBI’S ANNUAL POLICY STATEMENT
2015-16
Monetary and Liquidity Measures
• On the basis of an assessment of the current and evolving
macroeconomic situation, it has been decided to:
• keep the policy repo rate under the liquidity adjustment
facility (LAF) unchanged at 7.5 per cent;
• keep the cash reserve ratio (CRR) of scheduled banks
unchanged at 4.0 per cent of net demand and time
liability (NDTL); and
RBI’S ANNUAL POLICY STATEMENT
2015-16
• continue to provide liquidity under overnight repos at
0.25 per cent of bank-wise NDTL at the LAF repo rate
and liquidity under 7-day and 14-day term repos of up to
0.75 per cent of NDTL of the banking system through
auctions; and
• The reverse repo rate under the LAF will remain
unchanged at 6.5 per cent, and the marginal standing
facility (MSF) rate and the Bank Rate at 8.5 per cent.
• SLR is 21.5 %
RBI’S Fourth Bimonthly review of
Monetary Policy 2015-16
30th September 2015
Monetary and Liquidity Measures
• On the basis of an assessment of the current and evolving
macroeconomic situation, it has been decided to:
• reduce the policy repo rate under the liquidity adjustment
facility (LAF) by 50 basis points from 7.25 per cent to
6.75 per cent with immediate effect;
RBI’S Fourth Bimonthly review of
Monetary Policy 2015-16
keep the cash reserve ratio (CRR) of scheduled banks
unchanged at 4.0 per cent of net demand and time liability
(NDTL);
Consequently, the reverse repo rate under the LAF stands
adjusted to 5.75 per cent, and the marginal standing facility
(MSF) rate and the Bank Rate to 7.75 per cent.
SLR is 21.5 %
Finance Commission of India
 The Finance Commission of India came into existence
in 1951.
 It was established under Article 280 of the Indian
Constitution by the President of India.
 It was formed to define the financial relations between
the centre and the state.
 The Finance Commission Act of 1951 states the terms of
qualification, appointment and disqualification, the
term, eligibility and powers of the Finance Commission.
Finance Commission of India
 As per the Constitution, the commission is appointed
every five years and consists of a chairman and four
other members.
 Parliament may by law determine the requisite
qualifications for appointment as members of the
Commission and the procedure of selection.
Finance Commission of India
Functions
Distribution of net proceeds of taxes between Centre
and the States, to be divided as per their respective
contributions to the taxes.
Determine factors governing Grants-in Aid to the states
and the magnitude of the same.
to make recommendations to President as to the
measures needed to augment the Consolidated Fund of
a State to supplement the resources of the panchayats
and municipalities in the state on the basis of the
recommendations made by the Finance Commission of
the state.
Finance
Commission
First
Second
Third
Year of
Establishment
1951
1956
1960
K. C. Neogy
K. Santhanam
A.K. Chanda
Operational
Duration
1952–57
1957–62
1962–66
Fourth
1964
P.V. Rajamannarr
1966–69
Fifth
1968
Mahaveer Tyagi
1969–74
Sixth
1972
K. Brahmananda Reddy 1974–79
Seventh
Eighth
Ninth
1977
1983
1987
J.M. Shelat
Y. B. Chavan
N.K.P. Salve
1979–84
1984–89
1989–95
Tenth
Eleventh
Twelfth
Thirteenth
1992
1998
2003
2007
Late shri K. C. Pant
A.M.Khusro
C. Rangarajan
Dr. Vijay L. Kelkar
1995–2000
2000–2005
2005–2010
2010–2015
Fourteenth
2012
Yaga Venugopal Reddy 2015–2020
Chairman
key recommendations of the FC-XIII
• The share of States in net proceeds of shareable
Central taxes shall be 32 per cent every year for
the period of the award.
• Centre is to review the levy of cesses and
surcharges with a view to reducing their share in
its gross tax revenue.
• The indicative ceiling on overall transfers to States
on revenue account may be set at 39.5 per cent of
gross revenue receipts of the Centre.
key recommendations of the FC-XIII
• Revenue deficit to be progressively reduced and
eliminated, followed by revenue surplus by 2013–14.
• Fiscal deficit to be reduced to 3% of the GDP by 2014–15.
• A target of 68% of GDP for the combined debt of centre
and states.
• The Medium Term Fiscal Plan(MTFP)should be reformed
and made the statement of commitment rather than a
statement of intent.
key recommendations of the FC-XIII
• State Governments are to be eligible for the
general performance and special area
performance grants only if they comply with the
prescribed stipulation in terms of grants to local
bodies.
• States are expected to be able to get back to their
fiscal correction path by 2011-12 and amend their
Fiscal Responsibility and Budget Management
(FRBM) Acts to the effect.
key recommendations of the FC-XIII
• A total non-Plan revenue grant of Rs 51,800
crore is recommended over the award period for
eight States. A performance grant of Rs 1500
crore is recommended for three special category
States that have graduated from a non-Plan
revenue deficit situation.
• An amount of Rs 19,930 crore has been
recommended as grant for maintenance of roads
and bridges for four years (2011-12 to 2014-15).
key recommendations of the FC-XIII
• An amount of Rs 24,068 crore has been
recommended as grant for elementary education.
• An amount of Rs 27,945 crore has been
recommended for State-specific needs.
• Amounts of Rs 5,000 crore each as forest,
renewable energy and water sector-management
grants have been recommended.
• A total sum of Rs 3,18,581 crore has been
recommended for the award period as grants-inaid to States
THANK U