A

Presentation
on
Monetary & Credit Policy
Of
India

Presented by:
Deepak Bhavnani
Ishan Sharma
Dhara Shah
Vishal Shah
Viraj Vora
 What is monetary policy?
 Itrefers to all the actions of government or
the central bank of the country which
affect, directly or indirectly supply of
money,credit, rate of interest and the
banking system. Basically it affects the
cost and availability of credit in the
economy.

Ref. Suresh Bedi

 Objectives
 Toproviding finance for economic
development
 Promoting private investment of the economy
 Creating institutional structure for mobilization
of savings
 providing additional resources for
government investment out of created money
 Continue….

 Regulating bank credit

 Encouraging monetisation in the economy
and to coordinating different sectors of the
money market
 Achieving economic growth with stability
 Discrepancies among the
objectives…
Discrepancy between price stability
and growth of employment :

If price stability is to be maintained,

the policy of dear money has to be implemented
and if this policy is implemented, industries
cannot get necessary credit at reasonable rate.
Therefore industrial development become slow
and employment cannot be generated.
Pricestability and economic
development :

It is very difficult to attain economic

development with price stability. To maintain
price stability, concept of dear money has to be
implemented. So industrial sector cannot get
adequate credit from bank due to higher cost of
borrowing. So ultimately the growth of economy
hampered.
 Role of Monetary Policy
 An integral part of the overall economic
policy of the Government.
 It includes all those measures which affect
total volume and value of money in the
economy.
 It plays an important role in the analysis of
the problems of economic stability and
economic growth.
 Various Interest Rates
 Bank rate
 Call money rate
 Prime lending rate
 Bill rate
 Bond rate
 Deposit rates
 Repo rate
 Reverse repo rate
 Bank Rate
It is the rate of interest at which the
Central bank lends to the member
commercial banks.
It is also called discount rate.
It is fixed by the central bank.
Current Bank Rate is 6%.
 Call Rate
 It is the rate charged for short term
inter- bank financial flows.
 It is called ‘call money’ because it is
only ‘a call away’ available within hours
if need be.
 Current call rate is within 1.75%-5.50%.
 Prime Lending Rate
 Itis the rate which indicates the minimum
rate at which the entrepreneurs and the
training community will get credit from
commercial banks.
 The actual lending rate may generally
exceed the PLR by 1 or 2 percentages.
 Current PLR is within 12.25%-12.50%.
 Bill Rate
 Itis the rate of interest charged by the
commercial bank for discounting the first
class bills of exchange to the traders.
 A bill of exchange is a credit instrument.
 Current Bill Rates:
 91days:- 7.3521%
 182 days:- 7.9869%
 364 days:- 7.6985%
 Bond Rate
 The securities/bonds issued by the
government and bought or sold by the RBI
at a certain rate of interest, is called Bond
Rate.
 Current bond rate is 8.20% on 10-year
bond.
 Deposit Rates
 Commercial banks pay different interest
rates on different types of deposits.
 Short term deposit attracts lower rates
compared to the long term deposits.
 Current Deposit Rates:
Saving bank rate: 3.5%
Fixed deposit rate: 7.5%-9%
 Repo Rate
 It is the interest rate at which the banks
lend to the Central Bank of the country.so,
in India, this is the rate at which RBI
borrows money from the commercial bank.
 Through repo auction RBI absorbs excess
liquidity in the economy.
 Current repo rate is 7.75%
Implications of the Repo rate cut
On Bank rate :
A cut in repo rate will lead to cut in the bank rate.
 A cut in the bank rate will lower the interest rates
on fixed deposits.
 There could be a small reduction in the loan
rates. This would prompt companies to lower
interest rates offered on fresh retail bond offers.
ICICI retail bonds, for instance, may fetch lower
rates.
On Call rate :
 The repo rate has a direct bearing on the
overnight or the call money market.
 Repo rate typically acts as a floor rate for the call
rate. As repo acts as a floor, a cut in repo rate
will also lower call rates.
 This would depress the returns from money
market mutual funds that invest (lend) in the call
market.
 Reverse Repo Rate
 The reverse Repo rate is the return banks
earn on excess funds parked with the
central bank against Government
securities.
 When RBI intends to increase liquidity in
the economy, it engages itself in “reverse
repo”
 Current Reverse Repo Rate is 6.0%
Measures of Money Supply
A knowledge of the measures of money
stock in an economy would help us to
understand monetary policy better.

 TheRBI employs four measures of money

stock namely M1, M2, M3 and M4.
 M1 : Currency with the public + demand
deposits with
the bank + other deposits with the RBI.
 M2 : M1 + Post office savings bank
deposits
 M3 : M1 + Time deposits with the bank
 M4 : M3 + Post office saving bank
deposits.

Ref. Francis Cherunilam

Instrument of Monetary Policy
A) Quantitative Credit control Measures :
 Bank rate
 Open market operations
 Variable reserve ratio
 Cash reserve requirement
 Statutory Liquidity ratio

B) Qualitative or Selective Credit Control Measures :

 Moral persuasion
 Quantitative measures…
Bank Rate :
 It is the minimum rate at which central bank
provides financial accommodation to commercial
banks.
 When inflation prevails in the market, bank rate
is raised by RBI. Rise in bank rate leads to cut in
bank credit as credit becomes costlier.
 While in case of deflation, bank rate is reduced
by RBI. Cut in bank rate leads to increase in
money supply in the market as credit becomes
cheaper.
Open Market Operation :

 Itrefers to the purchase and sale of a variety of

assets, such as foreign exchange, gold,
Government securities and even company
shares.
 Through this option, the central bank seeks to
influence the economy either by increasing the
money supply or by decreasing the money
supply.
 RBI sells securities during inflation and buys
them during depression.
 Variable Reserve Ratio
A) Cash Reserve Ratio :
 Under this policy the RBI, varies the reserve
ratio which the commercial banks have to
keep in reserve with it.
 The RBI is empowered to vary the cash
reserve ratio between 3% and 15% of the
total demand and time liabilities.
 Current CRR is 6.25%
B) Statutory Liquidity Ratio :
 It requires banks to invest a specified
percentage of their deposit liabilities in
government and other approved
securities/bonds.
 The Liquidity ratio serves two purpose :

i) A higher liquidity ratio forces commercial banks to

maintain a larger proportion of their resources in liquid
form, thereby reducing their capacity to make
advances.
ii) A higher liquidity ratio diverts bank’s funds to
investment in government securities.
 Current SLR is 25%.
 Selective credit control…
 It is to direct/distribute bank credit to certain
sectors in the economy in the way deemed fit by
the RBI.
 Under this, the RBI could stipulate differential
margin requirements for bank loans against
different products, as well as the differential
differential interest rates on different
borrowings/borrowers.
 It is a direct tool as the regulation is binding on
banks.
 Moral Persuasion
 RBI instructs the banks to go slow or fast in
credit creation to all or selected sectors.
 Since it operates through advise only, the
instrument is referred to as “moral persuasion”.
 This is surely an indirect tool as advise can
never be enforced scientifically.
 It could be used to control both quantity as well
as quality of bank credit and money supply.
 Credit Policy
Guidelines that spell out how to decide
which customers are sold on open
account, the exact payment terms, the
limits set on outstanding balances.
 Credit Creation
 Itis special and very important function of
commercial banks
 Banks can create credit through loans,
with additional with drawl or discounting of
securities.
 “Every loan creates new deposits”
 Types of Deposits
 Primary:
 Primary deposits are those that are placed
with the banks by customers.
 In it bank doesn’t play any role.
 The banks lend credit on the basis of these
deposits to other customers.
 There is no increase in the supply of money
due to these deposits.
 It merely turns currency money into deposit
money.
Derivative Deposits :

 Primary deposits are passive while derivative

deposits are active one.
 When a customer borrows loan from the bank, it
does not give money in cash but credits the
amount in the customer’s account. Thus, new
deposits are created. These can be called
derivative deposits.
Assumptions about credit creation
 Banks co-operative one another. They accept cheques
from one another for payment.
 Banks maintain liquidity to meet deposit liabilities and
cash reserve ratio to certain fixed extent.
 During all phases of the credit creation, the proportion of
cash reserve remains static.
 There is no policy of the credit restriction by the central
bank in operation.
 There is no leakages in the flow of credit and derivative
deposits.
 The business condition is normal.
 Credit creation process
Ex. There are banks like Bank of India, Bank of Baroda,
Punjab National Bank. All those banks maintain 20% cash
reserve ratio.

Bank of India

Liabilities Amt. Assets Amt.

Primary deposit Rs.10,000 Cash Rs.10,000
CRR Rs.2000
Additional Rs.8000
Reserve
 Bank of India
Liabilities Amt Assets Amt
Primary Rs.10,000 Cash Rs.10,000
Deposit
Derivative Rs.8,000 Loan Rs.8,000
Deposit

Bank of Baroda
Liabilities Amt Assets Amt
Primary Deposit Rs.8,000 Cash Rs.8,000
Cash Rs.1,600
reserve
Additional Rs.6,400
Reserve
 Bank of Baroda

Liabilities Amt Assets Amt

Primary Rs.8,000 Cash Rs.8,000
Deposit
Derivative Rs.6,400 Loan Rs.6,400
Deposit
 Equation for the credit creation

Total credit creation = Primary Deposit * 100

(total demand deposits) Cash Reserve Ratio

= Rs.10,000 * 100
20
= Rs.50,000
The process of credit creation can be presented as
follows:

Bank Total Required Derivative

Deposits Reserves Deposits
Bank of India Rs.10,000 Rs.2,000 Rs.8,000

Bank of Rs.8,000 Rs.1,600 Rs.6,400

Baroda
Punjab Rs.6,400 Rs.1,280 Rs.5,120
National
Bank
Dena Bank Rs.5,120 Rs.1,024 Rs.4,096

Rs.50,000 Rs.10,000 Rs.40,000

 Limitations of monetary policy
 Dominance of unorganized sector
 Huge proportion of black money
 The seller’s market
 Lack of co-operation of fiscal policy
 Anti-production
 Limitation of the bank rate
 Limitation of qualitative means
 Lack of change in prices, labor rates etc.
 Recommendations by Prof.
Sukhmoy chakravatri To made
policy success in India
 It is necessary to make money market
integrated.
 The rates of interest should not be lowered
so much that they discourage savings.
 It is necessary to develop entrepreneurial
capacity with suitable monetary policy.
 It is necessary to maintain fiscal discipline.
 Black money need to be curbed.
Name Current Yr.
GDP 8.5
Repo Rate 7.5
Bank Rate 6
Call Rate 6.5 to 20
Inflation 5.3 Projected
CRR 6.25
SLR 25
PLR 12.25 TO 12.5
Savings Bank 3.5
Deposit Rate 7.5 to 9
Sensex 13607.04
Nifty 3984.95
 How does the Monetary policy
impact on the banking?
 Reduction in interest rate would force
banks to lower their lending rate &
borrowing rates.
 Since the financial sector reforms
commenced, banks are free to decide on
interest rates on term deposits and loans.
 RBI would have a say and determine
direction on interest rates as it is an
important tool to control inflation.
 What impact does a cut in CRR
have on interest rates?

• From time to time, RBI prescribes a CRR or

the minimum amount of cash that banks
have to maintain with it. The CRR is fixed
as a percentage of total deposits. As more
money chases the same number of
borrowers, interest rates come down.
 Does a change in SLR and gilts
products impact interest rates?
 As part of the reforms process, the government has
begun borrowing at market-related rates. Therefore,
banks get better interest rates compared to earlier for
their statutory investments in government securities.
 Banks are still the main source of funds for the
government.
 This means that despite a lower SLR requirement,
banks' investment in government securities will go up as
government borrowing rises. As a result, bank
investment in gilts continues to be high despite the RBI
bringing down the minimum SLR
 As government borrowing increases, interest rates, too,
rise.
How does the Monetary Policy affect the
domestic industry and exporters in
particular?
 Exporters look forward to the monetary policy
since the central bank always makes an
announcement on export refinance, or the rate
at which the RBI will lend to banks which have
advanced pre-shipment credit to exporters.

A lowering of these rates would mean lower

borrowing costs for the exporter.
 The stock markets and money move
similarly, in some ways. Why?

 Most people attribute the link between the amount of

money in the economy and movements in stock markets to
the amount of liquidity in the system. This is not entirely
true.
 The factor connecting money and stocks is interest rates.
People save to get returns on their savings. In true market
conditions, this made bank deposits or bonds (whose
returns are linked to interest rates) and stocks (whose
returns are linked to capital gains), competitors for people's
savings.
 A hike in interest rates would tend to suck money out of
shares into bonds or deposits; a fall would have the
opposite effect. This argument has survived econometric
tests and practical experience.
Is the money supply related to jobs,
wages and output?
 An increase in the money supply - currency with the
public, demand deposits and time deposits -
increases prices all round because there is more
currency moving towards the same goods and
services.
 RBI follows a least-inflation policy, which means
that its money market operations as well as
changes in the bank rate are generally designed to
minimise the inflationary impact of money supply
changes. Since most people can generally see
through this strategy, it limits the impact of the RBI's
monetary moves to affect jobs or production.
 Continue……
 Jobs, wages and output are affected over the
long run, if the trend of high inflation or low
liquidity persist for very long period
 If wages move slower than other prices, higher
inflation will drive real wages lower and
encourage employers to hire more people. This
in turn ramps up production and employment.
 When inflation fell unemployment increased.
 If wages move slower than other prices…