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these important concepts/events. This article explains India’s monetary policy.

Monetary
policy as laid down by the RBI (our central bank) are strategies that
help to regulate money supply in the economy by controlling interest rates. The
aim is to maintain price stability, stimulate high economic growth and to
ensure stability of the rupee vis-à-vis other foreign currencies.

Objectives of the Monetary Policy

1. Ensure price stability: Price stability is a pre requisite for
sustainable growth and overall financial stability. The emphasis on price
stability varies periodically depending on the changing macroeconomic
environment. It is important for smooth implementation of the monetary policy thereby
other financial market policies including macro-prudential policies. Price
stability also keeps inflation in check.

2. Control Bank Credit: Through the monetary policy the RBI
regulates bank credit or the total amount of funds commercial banks can lend to
organisations of individuals.

3. Raise productivity of investments: Change in interest rates affect
investments. The policy aims to increase productivity of investments by
discouraging non-essential fixed investments (investments on fixed/physical
assets like machinery, vehicles etc.).

4. Restriction of excess inventories- The policy restricts production of excess
stock that may become outdated leading to sickness of the unit. The main
objective is to avoid over-stocking and idle money in the organisation.

5. Boost Exports: Increasing
level of exports is a special function of the monetary policy as it helps to
enhance trade.

6. Regulate distribution of credit: The monetary policy is framed in a manner that ensures flow of credit to
priority sectors and small borrowers. It also emphasises the percentage of
credit to be allocated to the respective sectors. However, this does not lead
to inequitable credit distribution as the RBI’s aim is to ensure credit
availability to different sectors and people at large.

7. Encourage operational efficiency: The monetary policy brings about structural changes for efficient
functioning of the financial system, like deregulate interest rates, rid the credit
delivery system of unwanted restrictions, introduce new money market instruments,
etc.

8. Increase flexibility: The RBI through its monetary policy aims
to increase flexibility in the economy by encouraging healthy competition and
diversification while ensuring control, discipline and caution in the
operations of the country’s financial system.

Instruments of Monetary Policy

There are direct and indirect
instruments used in the implementation of India’s monetary policy.

1. Cash Reserve Ratio (CRR): The share of net demand deposits (like SB account) and time deposits (fixed deposit, recurring deposit etc.) that banks must maintain as cash balance with RBI.

2. Statutory Liquidity Ratio (SLR): The share of net deposits that banks
must maintain as safe and liquid assets, like government bonds, cash and gold
reserves. Changes in SLR often affect the availability of resources in the
banking system for lending to the private sector.

3. Refinance facilities: Refinance facilities aim at achieving
sector-specific objectives through provision of liquidity (cash) at a cost
linked to the policy repo rate. The RBI has, however, progressively
de-emphasised sector-specific policies as they interfere with the transmission machinery.

4. Term Repos: Since October 2013, the RBI has
introduced term repos (of different tenors, such as, 7/14/28 days), to add
liquidity over a period longer than overnight. The aim of term repo is to help
develop inter-bank money market, which can set market-based benchmarks for
pricing of loans and deposits. This in turn will improve transmission of
monetary policy.

5. Liquidity Adjustment Facility (LAF): It consists of overnight and term
repo/reverse repo auctions. Over time, the RBI has increased the proportion of
liquidity introduced in the LAF through term-repos.

6. Marginal Standing Facility (MSF): Under this, scheduled commercial
banks can borrow additional amount of overnight money from the RBI by dipping
into their SLR portfolio up to a limit (currently two per cent of their net
demand and time liabilities deposits) at a penal rate of interest (currently
100 basis points above the repo rate). This ensures a safety valve against unexpected
liquidity shocks. MSF rate and reverse repo rate determine the corridor for daily
movement in short term money market interest rates.

7. Open Market Operations (OMOs): These include outright purchase and sale
of government securities (for both injection and absorption of liquidity)

8. Bank Rate: It is the rate at which the RBI buys
or rediscounts bills of exchange and other commercial papers. This rate has
been aligned to the MSF rate and, therefore, changes automatically when the MSF
rate changes and policy repo rate changes.

9. Market Stabilisation Scheme (MSS): This instrument was introduced in 2004.
Surplus liquidity that is enduring in nature and arises from large capital
inflows is absorbed through sale of short-term government securities and
treasury bills. The cash so mobilised is held in a separate government account
with the RBI. The instrument thus has features of both, SLR and CRR.

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