Monetary policy is the process by which the monetary authority of a country controls the supply of money for the

purpose of promoting economic growth and stability.

The official goals usually include relatively stable prices and low unemployment.

Growth with stability and equity Stability general price stability Policy statement through which RBI seeks to ensure price stability in the economy
Money supply (M3) level of legal currency in the economy Interest rates inflation

Concerned with the management of supply of money in a growing economy.

Earlier announced twice a year
a slack-season policy (AprilSeptember) a busy-season policy (OctoberMarch) in accordance with agricultural cycles.

Now become dynamic in nature as RBI reserves its right to alter it from time to time, depending on the state of the economy.

Maintain price stability Ensure adequate flow of credit to the productive sectors of the economy Stability of national currency Growth in employment and income

Quantum channel: money supply and credit (affects real output and price level through changes in reserves money, money supply, and credit aggregates). Interest-rate channel. Exchange-rate channel (linked to the currency) Asset price.

Rapid Economic Growth: By encouraging investment Price Stability: By altering Repo Rate Exchange Rate Stability: By altering foreign exchange reserves Full Employment Equal Income Distribution: By providing cheap credit to the weaker sections.

CRR - Cash Reserve Ratio - a portion of the deposit (as cash) which banks have to keep/ maintain with the RBI.
SLR - Statutory Liquidity Ratio - banks are required to invest a portion of their deposit in government securities.
Ensures a portion of bank deposits is totally risk free RBIs control over liquidity and thus inflation

Bank Rate / Discount Rate Rate at which central bank provides loans to commercial banks affect credit creation Inflation too many buyers and too few goods Money Supply (M3) - broad money concept total volume of money circulating in the economy
Currency with the public Demand deposits with the public M1 = coins and notes in circulation and personal current accounts M2 = M1 + personal deposit accounts, govt. deposits and deposits in currencies other than rupee M3 = net time deposit (FD) + savings deposits with post office saving banks + M1

Open market Operations OMO RBI buys and sells securities sells during times of inflation and purchases to increase the supply of money Repo Repurchase Agreement or Ready Forward Deal secured short term loan given by one bank to another against govt. securities

Borrower sells securities to the lender for cash, and at the end of borrowing period buys back all securities at a slightly higher price

Liquidity Adjustment Facility - allows banks to borrow money through repurchase agreements. This arrangement allows banks to respond to liquidity pressures and is used by governments to assure basic stability in the financial markets.

Impact of cut in CRR on interest rates Impact of change in SLR and Gilt Products on interest rates
CRR decreases, interest rates come down

Impact on domestic industry and exporters

Govt. borrows at market related rates banks get better interest rates compared to what they used to get earlier Banks are still the main source of funds for govt. despite a lower SLR, banks investment in govt. securities will go up Govt. borrowing increases, interest rates increase Export refinance rate at which RBI will lend to banks which have advanced pre - shipment credit to exporters Interest rates Hike in interest rates suck money out of shares into bonds or deposits

Impact on stock markets and money supply

Impact of money supply on jobs, wages and output

Effect over the long run Increase in money supply lowering of interest rates increases prices all around because there is more currency moving towards the same goods and services Least inflation policy money market operations and changes in bank rate are designed to minimize inflation

Interest Rate OMO RBI buys or sells govt. bonds in the secondary market injects money CRR amount of free cash that the banks can lend Primary placement of govt. debt direct intervention in the market directly buying new bonds from the govt. at lower than market prices limit hike in interest rates due to higher govt. borrowings

The policy is trying to enhance the flow of bank credit in adequate quantity to industry, agriculture and trade to meet the requirement, and also to provide special assistance for neglected sectors and weaker sections of the community. It is also trying to maintain internal price stability by controlling the flow of credit to the optimum level.

Determination of state income and expenditure policy tax revenue, public expenditures, loans, transfers, debt management, budgetary deficit, and so on.

1. To mobilize adequate resources for financing various programmes and projects adopted for economic development;
2. To raise the rate of savings and investment for increasing the rate of capital formation; 3. To promote necessary development in the private sector through fiscal incentive;

4. To arrange an optimum utilization of resources; 5. To control the inflationary pressures in economy in order to attain economic stability; 6. To remove poverty and unemployment; 7. To attain the growth of public sector for attaining the objective of socialistic pattern of society; 8. To reduce regional disparities; 9. To reduce the degree of inequality in the distribution of income and wealth.

Taxation Policy Public Expenditure Policy Public Debt Policy Deficit Financing Policy

Source of revenue Direct taxes are progressive by nature and indirect taxes are regressive by nature Objectives:
Mobilization of resources for financing economic development Formation of capital by promoting savings and investment Attainment of quality in the distribution of income Attainment of price stability by adopting anti inflationary policy

Govt. expenditure mostly related to developmental activities Features:

Development of infrastructure Development of Public Enterprises heavy and basic industries Support to Private Sector support for establishment of industry Social Welfare and Employment Programmes e.g NREGS

Financing developmental plans Loan taken by govt. from RBI in the form of issuing fresh currency. creates problem of inflation

Internal Debt amount of loan raised by the govt. within the country External Debt loan from external sources in the form of foreign capital technical know how and capital goods; borrowing from international agencies such as IMF etc.

Capital Formation Mobilization of Resources through taxation, public debt Incentives to Savings tax concessions etc. Inducement to Private Sector Tax concessions, tax exemptions etc. Reduction of Inequality Progressive Taxes, subsidies, grants etc. Export Promotion concessions, subsidies etc. Alleviation of Poverty and Unemployment JRY (Jawahar Rozgar Yojna), NREGS (National Rural Employment Guarantee Scheme)

Instability growing volume of deficit financing has created inflationary trend;

Defective Tax Structure tax structure failed to raise the productivity of direct taxes and country relies more on indirect taxes Inflation demand pull inflation due to increasing volume of public expenditure; cost push inflation due to rise in indirect taxes Negative Return of the Public Sector negative return on capital invested in PSUs Growing Inequality unequal distribution of wealth and income; tax evasion
disequilibrium in Balance of Payments also affects stability