RBI – India’s Central Bank Essay Example

in significant repercussions.

The Reserve Bank of India (RBI) and monetary policy in India have a negative impact on economic development. The RBI regulates money and credit in the country by controlling its supply. Monetary policy aims to regulate both the volume and value of currency and credit.

MONETARY POLICY

The monetary authorities in India do not adhere to any specific model; instead, they take an eclectic approach. This means that it no longer relies solely on Keynesianism or Monetarism. One major concern is the relevance of money supply, particularly regarding changes in its volume and growth rate.

The relevant official document always mentions the trends in the growth of money supply and highlights the importance of maintaining an appropriate rate of growth. Unlike monetarists, monetary authorities in India believe in discretionary monetary policy and have chosen not to set a specific monetary rule or target for the growth of money supply in their monetary management. They believe that fixing such a rule would be detrimental because monetary policy needs to adapt to changing circumstances. The monetary authorities recognize that money supply is not the control variable of monetary policy, as it is not completely under their control. This realization has led them to adopt the approach indicated.

Thus, the problem of controlling monetary expansion lies in two elements that are largely beyond our control. First, there is the increase in monetary supply resulting from inward remittances of foreign exchange. And second, there is the requirement of credit for financing the purchase of food grains.

The Reserve Bank of India (RBI) considers money supply and the volume of bank credit as the two main intermediate variables. It is believed that changes

in money supply are not independent but occur due to underlying developments in bank credit. The expansion of money supply and bank credit are seen as interconnected.

There is a perception that the monetary authorities have adopted a monetarist stance since the Chakravarty Committee submitted its report on the Indian monetary system. In October 2009, the RBI announced the first phase of exiting from expansionary monetary policy by terminating certain sector-specific facilities and restoring the statutory liquidity ratio (SLR) of scheduled commercial banks to a pre-crisis level in the Second Quarter Review.

There are several techniques employed for monetary control:
1. Bank Rate
2. Open Market Operation
3.

The text includes a list of various methods used for regulating and controlling credit in the financial system. These methods are as follows: Cash Reserve Ratio, Statutory Liquidity Ratio, Changes In Marginal Requirement Of Loans, Moral Persuasion / Inspiration, Rationing Of Credit, and Regulation Of Consumer Credit.

The central bank charges member banks for issuing loans, known as the bank rate, to control credit. Increasing the bank rate by the central bank leads commercial banks to raise their interest rates, making loans more expensive and reducing credit flow. Conversely, decreasing the bank rate allows commercial banks to obtain advances and loans at a lower rate, lowering their interest rates and stimulating cash flow through loans.

Open market operation encompasses all actions taken by the central bank in buying and selling securities of member banks in the open market.

The RBI can reduce credit by selling the member bank's security, which stops the flow of cash. During a recession, if the RBI wants to increase credit, it can buy the member bank's security and give cash

to the banks so they can issue more loans. Furthermore, the cash reserve ratio is the minimum percentage of deposits that banks must keep as reserves with the central bank.

The cash reserve ratio, an instrument utilized by the RBI to regulate credit in India's economy, can be adjusted to either contract or expand credit. When the RBI aims to reduce credit, it raises the cash reserve ratio. Consequently, all banks are required to augment their reserves with the RBI, resulting in reduced funds for enterprises and subsequently decreased loan availability.

The Reserve Bank of India (RBI) has two tools for expanding credit and controlling inflation. The first tool is decreasing the reserve ratio, which requires banks to keep less funds as reserve with the RBI. This allows banks to issue more credit to the public. The second tool is called the Statutory Liquidity Ratio (SLR), which serves two purposes: a) Restricting bank credit expansion, and b) Encouraging banks to invest in Government securities.

c) To ensure the solvency of banks.

Formula SLR Rate = Total Demand x 100 Time Liabilities

5. Changes in Marginal Requirement of loan

Marginal requirement is the difference between the value of security and the actual loan accepted by the bank.

Suppose a person wants to take a loan of Rs.

When 80 is given, we have to provide security of Rs. 100, so the marginal requirement is Rs. 00 - Rs. 80 = Rs. 20.

6. Moral Persuasion / Inspiration: The RBI, as the central bank of the country, has the ability to control credit through moral persuasion. This involves the RBI convening a meeting with all commercial banks and advising them that they should not provide loans

for speculative purposes.

7. Rationing of Credit: The RBI has the authority to ration credit under its monetary policy. This can be accomplished by setting a specific loan amount for each bank.

b) Fixing quotas for all banks and c) fixing quotas for different traders. 8. Consumer credit regulations: In the event of inflation, prices increase. To control prices, the central bank contracts credit, reducing the total installment amount for payment.

In order to control prices during deflation, the central bank increases credit by raising installment amounts. According to the Annual Report of RBI for the year ending June 2009, despite facing the global financial crisis and subsequent recession, the Indian economy demonstrated resilience in 2008-09. However, challenges arose due to the spread of the global crisis, requiring prompt and suitable utilization of fiscal and monetary policies to maintain market function, financial stability, and moderate dampening effects on growth. Slower growth in 2008-09 affected all major segments of GDP compared to the previous five years.

In 2008-09, the evaluation of economic growth was based on agriculture, industry, and services. The growth rate decreased due to a cyclical slowdown in the first half of the year and worsened in the second half as a result of the global crisis. As a consequence, there was weak growth of 5% for two consecutive quarters, representing the lowest growth recently observed. In the final quarter, industrial growth turned negative while services continued to decline throughout the year. The Fiscal Responsibility and Budget Management (FRBM) Act's fiscal consolidation process had to be temporarily deviated from due to the magnitude and complexity of this challenge. The combined fiscal deficit, which includes special securities issued to

oil marketing and fertilizer companies, reached 10%.

In 2008-09, the percentage of GDP experienced a notable increase in credit growth. This surge was primarily influenced by corporates altering their resource mobilization approach in response to the global credit squeeze. Moreover, there was also a rise in credit extended to oil marketing companies as a result of escalating international oil prices and the costly importation of crude oil. However, from October 2008 onwards, international oil prices plummeted significantly, leading to reduced demand from oil companies. Furthermore, factors such as declining commodity prices, the necessity to clear expensive inventories, dwindling demand and prices, alongside weakening business confidence all contributed to a substantial decline in credit growth. Notably, private and foreign banks witnessed a more pronounced decrease in credit growth compared to nationalized banks.

The Reserve Bank of India maintained ample surplus liquidity in the system to ensure a continuous flow of credit to productive sectors and preserve banks' asset quality. This was achieved by expanding its net domestic assets (NDA) through open market operations (OMOs), such as buying government securities in the secondary market and providing liquidity through repos under the LAF. Additionally, inflation, as measured by year-on-year changes in the Wholesale Price Index (WPI), dropped significantly from 12.91 percent on August 02, 2008, to 0.84 percent by March 2009.

Despite fluctuations, WPI inflation (excluding fuel and metals) ranged from 10.2% in August 2008 to 4.8% in March 2009, suggesting reduced volatility. However, the global economic conditions make the future uncertain for 2009-10. Despite improvements in financial markets and a decrease in global activity contraction, advanced nations are expected to remain in recession throughout the year. This external economic environment

is unlikely to support India's recovery.

Furthermore, the growth prospects of many countries may be affected by the rebalancing of global growth to address recent years' accumulated global imbalances. To mitigate the economic slowdown, fiscal stimulus measures were implemented, necessitating adjustments in the composition of aggregate demand to prioritize government demand. Consequently, initiatives like the Farmer Debt Waiver Scheme, Sixth Pay Commission, and fiscal stimulus measures led to an increase in government final consumption's share from 9.8% of GDP in the previous year to over 11.1% of GDP in 2008-09 through payments made. Considering a potential shortfall in monsoon rainfall, the agricultural sector's outlook for 2009-10 needs careful evaluation.

The Indian agriculture sector heavily depends on rain, with approximately 60% of agricultural land relying on it. The performance of the South-West monsoon has a significant impact on this industry. Despite observing positive growth and signs of recovery in the first quarter of 2009-10, there is a mixed outlook for industrial sector growth. In order to assess industry developments considering global economic and financial changes, the Reserve Bank established an Industry Monitoring Group in April 2009. This group comprises members from external agencies and relevant departments within the Bank.

Managing subsidies has been an ongoing policy challenge. In 2008-09, high prices of fertilizers in global commodity markets and increased minimum support price for wheat and rice resulted in substantial increases in fertilizer and food subsidies compared to budget estimates. During that period, fertilizer subsidies rose by Rs. 44,863 crore while food subsidies increased by Rs. 10,960 crore.

* The global economic recession has caused an increase in unemployment, leading to the implementation of large stimulus packages worldwide. In India,

specific data on the unemployment situation resulting from slowed growth is not available at the macro level; however, unemployment remains a concern and certain sectors have experienced an increase in joblessness. The Union Budget for 2009-10 in India was presented with the understanding that the global economy was uncertain and its effects were impacting the country's economy. The government aimed to maintain a high growth trajectory by stimulating demand through increased public spending in identified sectors. The projected General Fiscal Deficit (GFD) for 2009-10 was 6%.

In 2008-09 (RE), the percentage of GDP was 6.5%, but in the provisional accounts for the same period, it decreased to 6.2%. However, there was an increase to 8% of the GDP when compared. The moderation in economic activities has hindered fiscal correction and consolidation at the State Government level. The projected deficit for the State Governments' consolidated revenue account is expected to be 0.

The GFD is projected to be higher at 3.4% of GDP in comparison to the 2008-09 surplus of 6% of GDP.