RBIS POLICY WITH PRICE RISE -POLICY & IMPLICATIONS

RBI
The Reserve Bank of India was established on April 1, 1935 in accordance with the provisions of the Reserve Bank of India Act,1934. Though originally privately owned, since nationalisation in 1949, the Reserve Bank is fully owned by the Government of India.

Management and Structure

Main Activities of the RBI:

1- Monetary Authority 2- Issuer of Currency 3- Banker and Debt Manager to Government 4- Banker to Banks 5- Regulator of the Banking System 6- Manager of Foreign Exchange

7- Regulator and Supervisor of the Payment and Settlement Systems

8-Developmental Role

Monetary Authority
Monetary policy refers to the use of instruments under the control of the central bank to regulate the availability, cost and use of money and credit.

The main objectives of monetary policy in India are: 1-Maintaining price stability 2- Ensuring adequate flow of credit to the productive 3-sectors of the economy to support economic growth 4- Financial stability

Direct Instruments
Cash Reserve Ratio (CRR) Statutory Liquidity Ratio (SLR) Refinance facilities

Indirect Instruments
Liquidity Adjustment Facility (LAF) Open Market Operations (OMO) Market Stabilisation Scheme (MSS) Repo/reverse repo rate Bank rate

 Cash Reserve Ratio (CRR): The share of net demand

and time liabilities that banks must maintain as cash balance with the Reserve Bank. Statutory Liquidity Ratio (SLR): The share of net demand and time liabilities that banks must maintain in safe and liquid assets, such as, government securities, cash and gold. Refinance facilities: Sector-specific refinance facilities (e.g., against lending to export sector)provided to banks.

 Liquidity Adjustment Facility (LAF): Consists of

daily infusion or absorption of liquidity on a repurchase basis, through repo (liquidity injection)and reverse repo (liquidity absorption) auction operations, using government securities as collateral. Open Market Operations (OMO): Outright sales/purchases of government securities, in addition to LAF, as a tool to determine the level of liquidity over the medium term.

 Market Stabilisation Scheme (MSS): This

instrument for monetary management was introduced in 2004. Liquidity of a more enduring nature arising from large capital flows is absorbed through sale of short-dated government securities and treasury bills. The mobilised cash is held in a separate government account with the Reserve Bank. Repo/reverse repo rate: These rates under the Liquidity Adjustment Facility (LAF) determine the corridor for short-term money market interest rates. In turn, this is expected to trigger movement in other segments of the financial market and the real economy.

HOW DOES BANK RATE WORKS

HOW CRR WORKS..

For eg. Say.the CRR is pegged by RBI at 10%. If a

bank recieves Rs 100 as deposit ,then they can lend Rs.90 as a loan & will have to keep the balance Rs 10 in the customers deposit A/c. Now,the borrower who has received Rs.90 as a loan will deposit the same in his bank. The borrowers bank will now lend out Rs.81 (Rs 90 X 90% ) & keep Rs 9 in his deposit A/c. As this process continues the banking system can expand the initial deposits of Rs 100 into a maximum of Rs 1000 (Rs. 100+Rs. 90+Rs 81=Rs 1000)

HOW CRR WORKS (CONTD.)

So
The higher the cash reserve (CRR) required, the lower

the money available for lending. Every time the borrowed money comes into a deposit A/c of a customer , the bank has to compulsorily keep a part of it reserves. This reduces credit expansion by controlling the amt. of money that goes out by the way of loans. This directly effects money creation process & in turn affects the economic activity.

HOW OMO WORKS.

LATEST RATES..
1. CRR 6 %
2. SLR 25 % 3. REPO RATE 6.25 %

4. REVERSE REPO RATE- 5.25 %

5. BANK RATE 6.0 %

PRICE SITUATION

PRICE SITUATION(contd.)
During August-September 2010,international

commodity prices increased again on account of the supply disruptions in many commodities.
Commodity prices earlier recorded some decline

during May-June 2010, as concerns over euro area recovery and sustainability of high growth in demand in emerging economies spilled over to commodity markets.

 Policy rates in advanced economies continue to remain

near zero/very low Price Situation levels as the concerns on sustainability of recovery became more prominent in the second quarter of 2010-11.

As the pace of recovery was slowing, the Bank of Japan

decided to reduce the policy rate. Israel and Canada, on the other hand, increased their policy rates in Q2 of 2010-11, recognising the inflation risks going forward.

(contd.)
Among the emerging economies, China and Thailand

raised their policy rates during Q2 of 2010-11 while South Africa reduced it.

Inflation Conditions in India

Inflation Conditions in India

WPI inflation increased at a faster pace since

November 2009 to reach 11.0 per cent (year-on-year) by April 2010 and remained elevated in the first quarter of 2010-11.
During May-August 2010, however, some moderation

in inflation was visible, indicating that inflation might have peaked off (8.6 percent provisional in September 2010 as per the new series of WPI with base ( 200405=100).

 With the persistence of deficit liquidity conditions, the

Reserve Bank extended the liquidity-easing measures introduced in May 2010.

In view of the evolving inflationary scenario, the repo

and the reverse repo rates were raised by 50 basis points and 75 basis points, respectively, in two stages in July 2010 .

RBIS LIQUIDITY MGT. (CONTD.)

Despite surplus government balance and currency

with the public operating as the major drains on liquidity during the second quarter of 2010-11, when compared with the situation prevailing at the end of the first quarter, variations in both currency and government surplus had a positive contribution to autonomous liquidity in the system.

SLR MAINTAINED BY BANKS..

There has been a significant reduction in the holdings

of government securities by SCBs not only because of the higher growth of non-food credit, but also because banks tapped the repo window under the LAF for their liquidity needs, leading to gradual decline in SLR maintenance (Chart IV.2). The excess SLR investments of SCBs amounted to `1,86,097 crore in early October 2010.

Conclusion
From various monetary, fiscal and other

measures it becomes clear that to control inflation government should adopt all measures simultaneously. That the success of the fiscal measures to control inflation needs a matching demand-supply equation is vindicated by Indias failure to check price rise in 2010. RBI has hiked policy rates repeatedly during the last two years, but prices, especially food prices, have gone on increasing unchecked as demand has continued to outpace supply.