• Vanssh Kapoor

Monetary Policy In India- by Vanssh Kapoor

Introduction Importance of money The importance of money can be easily realised from the fact that almost all the economic, social, and other activities are carried and completed through the use of money. The importance of money is increasing day by day with the rapid changes in economic development and other overall requirements of humans.

  • Importance of money to the consumers

Money helps the consumer to spend his income in such a way so that he can get maximum satisfaction. Money has generalised purchasing power. The consumer can buy the necessary goods at reasonable rates to get maximum utility.

  • Significance of money in production

Money has made mass production possible. The large-scale production is necessary to meet the growing demand of the consumers. Mass production is possible with a division of labor that depends upon money.

  • Importance in distribution

At present the production process is not simple. The production is made through the various factors of production like land, labor, capital and organization. The raw material is purchased to make new things. But each factor does not contribute equally to the product. Therefore, the distribution of products equally among the factors of production is unjust.

  • Significance of money in trade

Money helps both local and foreign trade. Money is a means of making payments for the goods and services purchased. Money is the basis of the money market and capital market. Also in the trade, we need to hire people for promoting our business and money is required to make the payment against their services.

  • Importance in industries

The industrial progress is linked with money, which is the lifeblood of a business. Promotion of big companies, arrangement of loans to expand the business and the establishment of stock exchange markets depend upon money. All such thing enhances the importance of money more for us.

Measures of money supply

RBI presented four measures of money supply in its 1977 issues of RBI Bulletin, namely M1, M2, M3 and M4.

Measures of M1 include: (a) Currency notes and coins with the public (excluding cash in hand of all commercial banks) [C] (b) Demand deposits of all commercial and co-operative banks excluding inter-bank deposits. (DD), Where demand deposits are those deposits which can be withdrawn by the depositor at any time by means of cheque. No interest is paid on such deposits. (c) Other deposits with RBI [O.D] M1 = C + DD + OD Where, Other deposits are the deposits held by the RBI of all economic units except the government and banks. OD includes demand deposits of semi government public financial institutions (like IDBI, IFCI, etc.), foreign central banks and governments, the International Monetary Fund, the World Bank, etc.

Measures of M2: (I) M1 [C + DD + OD] (if) Post office saving deposits

Measures of M3: (I) M1

(ii) Time deposits of all commercial and co-operative banks. Where, Time deposits are the deposits that cannot be withdrawn before the expiry of the stipulated time for which deposits are made. Fixed deposit is an example of time deposit

Measures of M4: (I) M3 (ii) Total deposits with the post office saving organization (excluding national savings certificates). 3. High-powered money: High-powered money is money produced by the RBI and the government. It consists of two things: (a) currency held by the public and (b) Cash reserves with the banks.

Explain the role of commercial banks and RBI with reference to regulating credit

Reserve Bank of India also works as a central bank where commercial banks are account holders and can deposit money.

RBI maintains banking accounts of all scheduled banks. Commercial banks create credit. It is the duty of the RBI to control the credit through the CRR, bank rate and open market operations. As banker's bank, the RBI facilitates the clearing of cheques between the commercial banks and helps the inter-bank transfer of funds. It can grant financial accommodation to schedule banks. It acts as the lender of the last resort by providing emergency advances to the banks.

Introduction to RBI and its functions

The Reserve Bank of India was established on April 1, 1935 in accordance with the provisions of the Reserve Bank of India Act, 1934.

The Central Office of the Reserve Bank was initially established in Kolkata but was permanently moved to Mumbai in 1937. The Central Office is where the Governor sits and where policies are formulated.

Though originally privately owned, since nationalisation in 1949, the Reserve Bank is fully owned by the Government of India.

The Reserve Bank's affairs are governed by a central board of directors. The board is appointed by the Government of India in keeping with the Reserve Bank of India Act.

-Appointed/nominated for a period of four years

-Constitution:

Official Directors-Full-time: Governor and not more than four Deputy Governors

Non-Official Directors-Nominated by Government: ten Directors from various fields and two government Official

Functions (I) Bank of issuing or currency: Every central bank of an economy is the sole authority to issue currency. The currency issued by the central bank is backed by minimum receive of assets like gold coins, gold bullions and foreign exchange etc. kept with the central bank. The Minimum Reserve System in India represent the minimum backing of Rs 200 crores by RBI out of which Rs 115 crores worth of gold and Rs 85 crores worth of foreign exchange securities are kept under RBI, the Monetary Authority of India. The authority of sole issue of currency has certain benefits like uniformity in currency, better monitoring and control over money supply and public trust and confidence in the currency issued and circulated. (ii) Banker to the banks: The central bank acts as a banker to the commercial banks in the following manner:

  • Custodian of the cash reserves of the commercial banks (CRR).

  • Lender of the last resort in the sense that if commercial banks fail to generate enough cash from its own sources it approaches the central bank as a last resort. The central bank in turn may grant loans and advances to the needy banks.

  • The central bank also acts as central clearing house for the commercial banks.

(iii) Banker to the government: As a banker to the government the central bank carries out all banking businesses on behalf of both the central government and the state governments. It maintains current account of the government for keeping cash balances and also making and receiving payments on behalf of the government. It provides loans and advances to the government. It also acts as financial advisor to the government. (iv) Custodian of the foreign exchange reserves of the nation: This function helps in maintaining stability in exchange rate as fixed by the government and also enforcing exchange control and other regulations for a favorable balance of payments for the economy. (v) Controller of credit and money supply: Credit control and control of money supply is probably the most important function of a central bank. Through various methods/instruments of credit control the central bank aims. (vi)Lender of last resort: The central bank acts as a lender of last resort by providing money to its member banks in times of cash crunch. It performs this function by providing loans against securities, treasury bills and also by rediscounting bills.

This is regarded as one of the most crucial functions of the central bank wherein it helps in protecting the financial structure of the economy from collapsing.

(vii)Clearing house for transfer and settlement: Central bank acts as a clearing house of the commercial banks and helps in settling of mutual indebtedness of the commercial banks. In a clearing house, the representatives of different banks meet and settle the inter-bank payments.

Commercial banks and their functions

The commercial bank is a financial institution which is primarily concerned with accepting deposits from public and lending to the public besides others. These banks operate both under the public as well private sectors.

Some public sector banks include the State Bank of India, Punjab National Bank and Bank of India among others. The private sector commercial banks may include the banks namely HDFC bank, ICICI bank and HSBC bank among others. Functions (I) Acceptance of deposits: Every commercial bank accepts deposits from different sections of society including the general public, business entities and other institutions. Commercial banks accept following types of deposit:

  • Current Account Deposits or Demand Deposits: This type of account is generally maintained by the business entities and money under these deposits are payable on demand of the depositor. The depositors are free to deposit or withdraw money from their account any number of times without any restrictions.

  • Savings Account Deposits: This type of account is generally maintained by the households or individuals. The depositor can deposit or withdraw money deposited under this account only for a limited number of times. This account also attracts a nominal rate of interest payable to the account holder.

  • Fixed Deposit or Time Deposit or Term Deposit: Under this account money is deposited for a fixed period and the rate of interest is relatively higher than other accounts depending on the tenure of the fixed deposit.

(ii) Extending Loans and Advances: This is another important function of a commercial bank. This is also the main source of income of any commercial bank. Banks grant loans and advances out of the surplus money after keeping certain percentage of their total deposit called as reserves. Some important forms of loans and advances are ordinary loans, overdraft facility and discounting of bills of exchange. (iii) Creation of Credit: This function is derived from the earlier two functions of the commercial banks. This unique function has direct impact on the supply of money in an economy. (iv) Transfer of Funds: The banks provide the facility of fund transfer to its customers through the instruments of cheque, demand draft or electronic transfer from one place to another or one person to another. (v) Agency Functions: Banks receive and collect different types of payments on behalf of their clients through the instruments of cheques, drafts, bills and promissory notes etc. Banks also buy and sell gold, silver and other securities on behalf of their customers.

(vii) General Utility Services: In modern days the banks also perform some very useful functions for the benefit of its customers and the economy like collection and publication of data, advisory functions, issue of lockers and underwriting of loans, shares and debentures issued by the government.

Discuss about the role of RBI with respect to the latest Monetary policy

The RBI is the central bank of India. It was established in 1935 under a special act of the parliament. The RBI is the main authority for the monetary policy of the country. The main functions of the RBI are to maintain financial stability and the required level of liquidity in the economy.

The RBI also controls and regulates the currency system of our economy. It is the sole issuer of currency notes in India. The RBI is the central banks that control all the other commercial banks, financial institutes, finance firms etc. It supervises the entire financial sector of the country.

Monetary policy is a way for the RBI to control the supply of money in the economy. So, these credit policies help control the inflation and in turn help with the economic growth and development of the country.

Positive impact on economy

  • It can promote low inflation rates. One of the biggest perks of monetary policy is that it can help promote stable prices, which are very helpful in ensuring inflation rates will stay low throughout the country and even the world. As inflation essentially makes an impact on the way we spend money and how much money is worth, a low inflation rate would allow us to make the best financial decisions in life without worrying about prices to drastically rise unexpectedly.

  • It allows for the imposition of quantitative easing by the Central Bank. The Federal Reserve can make use of a monetary policy to create or print more money, allowing them to purchase government bonds from banks and resulting to increased monetary base and cash reserves in banks. This also means lower interest rates and, eventually, more money for financial institutions to lend its borrowers.

  • It can lead to lower rates of mortgage payments. As monetary policy would lower interest rates, it would also mean lower payments home owners would be required for the mortgage of their houses, leaving homeowners more money to spend on other important things. It would also mean that consumers will be able to settle their monthly payments regularly—a win-win situation for creditors, merchandisers and property investors as well!

Negative impact on economy

  • It does not guarantee economy recovery. Economists who criticize the Federal Reserve on imposing monetary policy argue that, during recessions, not all consumers would have the confidence to spend and take advantage of low interest rates, making it a disadvantage.

  • It is not that useful during global recessions. Proponents of expansionary monetary policy state that even if banks lower interest rates for consumers to spend more money during a global recession, the export sector would suffer. If this is the case, export losses would be more than what commercial organizations could earn from their sales.

  • Its ability to cut interest rates is not a guarantee. Though a monetary policy is said to allow banks to enjoy lower interest rates from the Central Bank when they borrow money, some of them might have the funds, which means that there would be insufficient funds that people can borrow from them.

What were the objectives behind the recent Monetary Policy by the RBI

Price stability or control of inflation

Achieving price stability has remained the dominant objective of monetary policy of Reserve Bank of India. It may however be noted that price stability does not mean absolutely no change in price at all. In a developing economy like ours where structural changes take place during the process of economic growth some changes in relative prices do occur that generally put upward pressure on prices.

Therefore, some changes in price level or, in other words, a certain rate of inflation is inevitable in a developing economy. Thus, price stability means reasonable rate of inflation. A high degree of inflation has adverse effects on the economy. First, inflation raises the cost of living of the people and hurts the poor most. Therefore, inflation has been described as enemy No. 1 of the poor.

Inflation sends many people below the poverty line. Secondly, inflation makes exports costlier and, therefore, discourages them. On the other hand, due to higher prices at home people are induced to import goods to a large extent. Thus, inflation has an adverse effect on the balance of payments.

Thirdly, when due to a higher rate of inflation value of money is rapidly falling, people do not have much incentives to save. This lowers the rate of saving on which investment and economic growth depend. Fourthly, a high rate of inflation encourages people to invest in the unproductive assets such as gold, jewelry, real estate etc.

Economic growth

Promoting economic growth is another important objective of the monetary policy. In the past Reserve Bank has often been criticized that it pursued the objective of controlling inflation and achieving price stability and neglected the objective of promoting economic growth. Monetary policy can promote economic growth through ensuring adequate availability of credit and lower cost of credit.

There are two types of credit requirements of businesses. First, they have to finance their requirements of working capital and for importing needed raw materials and machines from abroad. Secondly, they need credit for financing investment in projects for building fixed capital. Easy availability of credit at low interest rate stimulates investment and thereby quickens economic growth.

Exchange rate stability

The changes in capital inflows and capital outflows and changes in demand for and supply of foreign exchange, particularly US dollar, arising from the imports and exports cause great fluctuations in the foreign exchange rate of rupee. In order to prevent large depreciation and appreciation of foreign exchange rate Reserve Bank has to take suitable monetary measures to ensure foreign exchange rate stability.

Owing to the fixed exchange rate system prior to 1991 the concern about foreign exchange rate had not played a significant role in the formulation of monetary policy.

Today, the exchange rate of rupee is determined by demand for and supply of foreign exchange (say, US dollar). When there is mismatch between demand for and supply of foreign exchange, external value of rupee changes.

Since export earnings and capital inflows which determine the supply of dollars had not risen adequately, mismatch between dollars and supply of dollars had arisen causing the depreciation of rupee as against the US dollar.

This is too high current account deficit which is putting downward pressure on the exchange rate of rupee. The depreciation of rupee raises the costs of imports which adds to the inflationary pressures in the Indian economy. Therefore, reducing current account deficit (CAD) to the comfortable level is not only essential for exchange rate stability but also for controlling inflation and achieving price stability.

Conclusion

Money and banking are two basic pillars of any country's economy. Without these two assessments we cannot run any economy. Money: Money is the main substance for price paying nowadays. We use coins and notes as traditional money and we use different digital currencies like cryptocurrency, Bitcoins as the modern money. Money is any item or verifiable record that is generally accepted as payment for goods and services and repayment of debts, such as taxes, in a particular country or socio-economic context. The main functions of money are distinguished as: a medium of exchange, a unit of account, a store of value and sometimes, a standard of deferred payment. Any item or verifiable record that fulfils these functions can be considered as money.

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