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RBI Monetary Policy Committee, Objectives, RBI Policy Tools

Context: Recently, the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) unveiled its latest review of the Monetary Policy.

Key Highlights of RBI’s Monetary Policy Review

Rates

  • The repo rate was unchanged at 6.5% for the fourth consecutive meeting.
  • A cumulative rate hike of 2.5% (250 bps) still working its way through the economy.
  • The Standing Deposit Facility rate remains at 6.25%.
  • The Marginal Standing Facility (MSF) rate is maintained at 6.75%.

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Growth and Inflation

  • GDP growth forecast retained at 6.5% for FY24.
  • The inflation forecast retained at 5.4% for FY24.
  • Cooling vegetable prices and LPG rate cuts seem to soften inflation. High inflation is identified as a major risk to macroeconomic stability and sustainable growth

Liquidity and Measures

  • RBI plans to undertake open market operations (OMOs) with G-secs to manage liquidity via auctions.
  • The limit of the gold loans under the Bullet Repayment Scheme for Urban Cooperative Banks (UCBs) doubled to ₹4 lakh.
  • Payments Infrastructure Development Fund scheme extended by 2 years to December 2025, now including PM Vishwakarma scheme beneficiaries.
  • RBI to introduce card-on-file tokenisation facility at issuer banks for enhanced cardholder convenience.
  • NBFCs (middle and base layers) are allowed to use credit risk mitigation tools with eligible instruments.

RBI Monetary Policy

Monetary Policy: Under the terms of the RBI Act, this monetary policy was developed in 1934. This strategy, which can be either contractionary or expansionary, differs from fiscal policy, which controls the nation’s taxes and overall spending. An expansionary policy is used when there is a sudden increase in the overall amount of money. A contractionary policy is used when there is a slower rate of growth or decline in the money supply.

The Reserve Bank of India established a system of rules called a monetary policy that regulates how all of the financial institutions in the nation operate. Bank interest rates, including additional rates like the SLR, CRR, etc., are under the jurisdiction of the RBI’s monetary policy. The RBI Monetary Policy Committee has kept the key policy repo rate unchanged at 6.5%.

Reserve Bank Of India
  • Established on April 1st, 1935, the Reserve Bank of India (RBI) arose from the recommendations of the Hilton Young Commission, enshrined in the Reserve Bank of India Act of 1934.
  • Its Central Office initially resided in Calcutta, but later it was moved to Mumbai permanently in 1937.
  • Nationalisation in 1949, under the RBI Nationalisation Act 1949, marked a significant milestone in its journey.

Need of RBI Monetary Policy

The central bank uses monetary policy, a procedure, to control the money supply in order to accomplish particular objectives including preventing inflation, preserving a fair exchange rate, generating employment, and fostering economic progress. Changing interest rates through open market operations, reserve requirements, or foreign exchange trading is part of monetary policy, whether it be directly or indirectly.

Conducting monetary policy is the responsibility of published by the RBI’s Monetary Policy Committee. The Reserve Bank of India Act, of 1934 specifically mandates this obligation. With the advent of the Monetary Policy Framework (MPF), Monetary Policy Committee (MPC), and Monetary Policy (MPP) Process, there have recently been numerous changes made to how India’s monetary policy is established.

RBI Monetary Policy Committee

The Monetary Policy Committee (MPC) was established as per the provisions of Section 45ZB of the amended RBI Act, 1934, by the central government in 2016. Its key purpose, as specified in the Act, is to decide the policy rate necessary for maintaining targeted inflation levels. Decisions made by the MPC are mandatory for the Reserve Bank of India to follow. The MPC consists of six members,

  • RBI Governor serving as the ex-officio chairperson.
  • Deputy Governor responsible for monetary policy,
  • RBI officer nominated by the Central Board, and three experts appointed by the central government.

Read about: List of RBI Governors

RBI Monetary Policy Tools or Instruments

Quantitative Tools Of Monetary Policy

  • Cash Reserve Ratio (CRR): This is the percentage of a bank’s total deposits that must be kept in the form of cash reserves with the central bank. By adjusting the CRR, the RBI can control the amount of funds available to the banks for lending.
  • Statutory Liquidity Ratio (SLR): SLR refers to the minimum percentage of deposits that a bank must maintain in the form of gold, cash, or other approved securities. Changes in SLR can influence the bank’s ability to lend.
  • Repo Rate: This is the rate at which the central bank lends short-term money to commercial banks. An increase in the repo rate makes borrowing from the central bank more expensive, thereby reducing the money supply in the economy.
  • Reverse Repo Rate: This is the rate at which the central bank borrows money from commercial banks. A higher reverse repo rate incentivizes banks to park more funds with the central bank, reducing the money supply.
  • Open Market Operations (OMOs): These involve the buying and selling of government securities in the open market by the central bank. When the central bank buys securities, it injects liquidity into the economy; selling securities does the opposite.
  • Bank Rate: This is the rate at which the central bank provides long-term finance to commercial banks. A higher bank rate results in higher lending rates by banks, thereby moderating the growth of credit in the economy.
  • Marginal Standing Facility (MSF): Under this facility, banks can borrow overnight funds from the central bank against approved government securities. This rate is usually set higher than the repo rate.

Qualitative Tools Of Monetary Policy

  • Rationing of Credit: The RBI may fix a credit amount to be granted to commercial banks. This involves setting limits on the amount available for each commercial bank, which helps in lowering the bank’s credit exposure to certain sectors.
  • Regulation of Consumer Credit: This involves regulating the supply of consumer credit through mechanisms like installment sale and hire purchase of consumer goods. Features like installment amount, down payment, and loan duration are fixed in advance, which helps to check the credit and inflation in the country.
  • Change in Marginal Requirement: The RBI can adjust the margin, which is a certain proportion of the loan amount not financed by the bank. By changing the margin, the RBI can influence the size of the loan, encouraging credit supply for necessary sectors and avoiding it for others.
  • Moral Suasion: This involves the RBI using persuasion, suggestions, and advice to commercial banks to undertake certain actions in the economic interests of the country. While these directives are not mandatory, they are morally binding on the banks.
Other Important Tools
  • Base rate: It is the minimum rate set by the RBI below which banks are not allowed to lend. It is decided to enhance transparency in the credit market and ensure that banks pass on the lower cost of funds to their customers.
  • Liquidity Adjustment Facility (LAF): It is a monetary policy tool used by central banks, including the Reserve Bank of India (RBI), to manage liquidity in the banking system. This facility is primarily employed to influence short-term interest rates and maintain stability in the financial markets.
    • The LAF operates through two main components Repo Rate and Reverse Repo Rate.
  • Standing Deposit Facility (SDF): It is a tool introduced by the Reserve Bank of India (RBI) for liquidity management in the banking system.
    • It allows banks to deposit their excess liquidity with the RBI without providing any collateral, and in return, banks receive interest.
    • This mechanism is unique in that it is collateral-free, unlike other liquidity absorption tools like reverse repo operations.
    • The SDF was introduced in April 2022 and serves as a significant tool for the RBI to manage the excess liquidity in the banking system efficiently

Monetary Policy Types

1. Expansionary Monetary Policy

It involves increasing the money supply in an economy, usually implemented by lowering key interest rates to boost economic activity.

  • The Reserve Bank of India (RBI) may reduce policy rates like Repo, Reverse Repo, MSF, and Bank Rate. This leads to increased bond prices, lower interest rates, and enhanced capital investment.
  • Domestic bonds become less attractive, reducing the demand for domestic currency and lowering the exchange rate.
  • This boosts exports, reduces imports, and improves the balance of trade.

2. Contractionary Monetary Policy

It aims to decrease the money supply, often by raising key interest rates, which can slow economic growth. When RBI adopts this policy, it increases policy rates.

  • This results in decreased bond prices and higher interest rates, leading to reduced capital investment.
  • Domestic bonds become more attractive, increasing the demand for domestic currency and the exchange rate.
  • Consequently, exports decrease, imports increase, and the balance of trade diminishes.

Role of RBI Monetary Policy

In order to establish a statutory and institutionalized structure for a monetary policy committee to achieve price stability while keeping growth as a goal in mind, the Reserve Bank of India Act of 1934 was changed by the Finance Act of 2016. The committee is in charge of determining the benchmark policy rate (repo rate) required to maintain inflation within the designated target level.

The main objective of monetary policy is to balance the supply and demand of money. As the economy expands, so does the demand for money. The central government increases the money supply proportionately to the increase in demand to prevent inflation.

RBI Monetary Policy Objectives

High employment rates, a stable price level, and an improvement in economic conditions are all the main objectives of the RBI Monetary Policy. There are six main goals of monetary policy, and they are listed here.

1. The Neutrality of Money

The primary proponents of the neutral money objective of monetary policy include several outstanding economists including Wick Steed and Robertson. The policy states that the government must aim to prevent money from being aligned with the economy of the nation. Economic turbulence can result from any shift in currency. They contend that altering any policy element will negatively impact the nation’s overall economic situation.

They further contend that rigorous adherence to the neutral monetary policy will minimise cyclical variations and prevent trade cycles, inflation, and deflation in the nation’s economy. The authorities in this place maintain a stable currency. The primary goal of this Monetary Policy objective is to maintain absolute stability in the money supply.

2. Exchange Stability

The conventional goal of monetary policy authority is exchange stability. One of the key goals of the Gold Standard for various nations was this. These movements served to automatically adjust any imbalances or changes to the amount of money. Unpredictability in the conversation rates will result in gold withdrawals or inflows, upsetting the undesirable payment balance.

As a result, stable currency rates are crucial for international trade. Therefore, the main goal of monetary policy is to stabilize and manage the external changes that are occurring in a nation. Avoiding factors that could lead to exchange rate instability is crucial.

  • It may have a sharp volatility, which can increase market speculation.
  • More volatility can result in significant losses, undermine domestic confidence, and create difficulties for international investors. This will have a negative influence on capital outflow, which is essential for capital formation and growth.
  • More exchange rate fluctuations may also result in higher prices and higher levels of prices.

3. Price Stability

One of the main goals of monetary policy, it has received significant attention in the twenty-first century. The most reliable and significant goal of monetary policy is price stability.

Prices that remain steady boost public trust and eliminate cyclical volatility. Thus, it promotes economic equality and helps people appreciate the importance of business activity. As a result, the community experiences an overall wave of welfare and wealth that is beneficial to everyone.

Additionally, price stability promotes the improvement of the nation’s economic situation. Additionally, the growth in good output benefits both the nation and its citizens. Additionally, it raises imports while lowering exports. Following the introduction of the monetary policy, certain slight price increases also aid the successful operation of the nation’s economy.

4. Full Employment

People who were working were fired as a result of the unexpected rise in unemployment during the Great Depression, which led to widespread unemployment throughout society. It is acknowledged to be both economically wasteful and socially hazardous. As a result, it was also stated as the primary goal of monetary policy. Currently, it is also referred to as full employment, which could have a direct impact on the stability of the exchange rate and pricing. If both of these things operate together, everything will run more smoothly.

According to the economist, having a balance between saving and investment at the full employment level is the essential factor in achieving full employment. According to classical economists, full employment is a typical aspect of the economy, but in the current environment, it cannot be fully utilized; as a result, full employment is necessary for better improvement of the nation’s economic status.

They also consider those who worked for a period of time before losing their position to be employed. Following the completion of the goal of full employment, monetary policy must work toward price balancing. Some of the ways the policy can be applied are listed below:

  • Given that disguised unemployment is on the rise in countries like India, monetary policy is more appropriate for nations like ours.
  • The policy can address the genuine unemployment issue, which will fuel the nation’s brisk economic expansion.
  • It is one of the most practical tools for promoting the community’s economic and social welfare.

5. Economic Growth

In recent years, economic development has gained significant attention from politicians and economists all across the world. Utilizing human, natural, and other resources is also necessary if we want to raise the per capita income of the nation. The majority of the time, a nation’s economy is determined by its per capita income. Another important goal of monetary policy is to enhance per capita income, which is necessary if we wish to boost the nation’s economy.

6. Stability in the Balance of Payments

Another goal of monetary policy is the balance of payments. It was first made available after the war. This monetary policy objective’s primary goal stems from the problem with global trade’s lack of international liquidity. It was believed that the increase in the payment balance deficit decreased. Many less developed nations reduce their imports, which negatively impacts the economy and development of the nation. Consequently, this goal brings about a balance in the payments.

Read More: Fiscal Policy

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RBI Monetary Policy Committee FAQs

What are the 3 monetary policies?

The Fed has traditionally used three tools to conduct monetary policy: reserve requirements, the discount rate, and open market operations.

What are the 4 monetary policies?

Central banks have four main monetary policy tools: the reserve requirement, open market operations, the discount rate, and interest on reserves. 1 Most central banks also have a lot more tools at their disposal.

What is monetary policy example?

Monetary policy refers to the steps taken by a country's central bank to control the money supply for economic stability. For example, policymakers manipulate money circulation for increasing employment, GDP, price stability by using tools such as interest rates, reserves, bonds, etc.

What is monetary policy and why is it important?

Monetary policy influences interest rates in the economy – like interest rates for housing loans, business loans and interest rates on savings accounts. Changes in interest rates influence people's decisions to invest or consume, which ultimately affects economic growth, employment and inflation.

What are the 2 types of monetary policy?

There are two main kinds of monetary policy: contractionary and expansionary.

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