Monetary policy
Monetary policy refers to the policy of the central bank with regard to the use of monetary instruments under its control to achieve the goals specified in the Act.
The Reserve Bank of India (RBI) is vested with the responsibility of conducting monetary policy. This responsibility is explicitly mandated under the Reserve Bank of India Act, 1934.
The goal(s) of monetary policy
The primary objective of monetary policy is to maintain price stability while keeping in mind the objective of growth. Price stability is a necessary precondition to sustainable growth.
In May 2016, the Reserve Bank of India (RBI) Act, 1934 was amended to provide a statutory basis for the implementation of the flexible inflation targeting framework.
The amended RBI Act also provides for the inflation target to be set by the Government of India, in consultation with the Reserve Bank, once in every five years. Accordingly, the Central Government has notified in the Official Gazette 4 per cent Consumer Price Index (CPI) inflation as the target for the period from August 5, 2016 to March 31, 2021 with the upper tolerance limit of 6 per cent and the lower tolerance limit of 2 per cent.
The Monetary Policy Process
Section 45ZB of the amended RBI Act, 1934 also provides for an empowered six-member monetary policy committee (MPC) to be constituted by the Central Government by notification in the Official Gazette.
The MPC determines the policy interest rate required to achieve the inflation target. The Reserve Bank’s Monetary Policy Department (MPD) assists the MPC in formulating the monetary policy. Views of key stakeholders in the economy, and analytical work of the Reserve Bank contribute to the process for arriving at the decision on the policy repo rate.
Instruments of Monetary Policy
There are several direct and indirect instruments that are used for implementing monetary policy.
Repo Rate: The (fixed) interest rate at which the Reserve Bank provides liquidity to banks up to 90 days against the collateral of government and other approved securities under the liquidity adjustment facility (LAF) but limited up to .5% of NDTL . Bank can not use SLR Securities as collateral.
Reverse Repo Rate: The (fixed) interest rate at which the Reserve Bank absorbs liquidity from banks against the collateral of eligible government securities under the LAF.
Liquidity Adjustment Facility (LAF): The LAF consists of overnight as well as term repo auctions. LAF enables liquidity management on a day to day basis. All clients of RBI are eligible to bid and Bank cannot sell Government security to RBI from its SLR quota.
Marginal Standing Facility (MSF): A facility under which scheduled commercial banks can borrow amount For a period up to 1 day,24 hours, overnight from the Reserve Bank of India. Here, banks BANK can use SLR securities.
Bank Rate: It is the rate at which the Reserve Bank is ready to buy or rediscount bills of exchange or other commercial papers. RBI use BANK RATE as a penal rate in case BANKS are not able to maintain their CRR and SLR.
Cash Reserve Ratio (CRR): The average daily balance that a bank is required to maintain with the Reserve Bank as a share of such per cent of its Net demand and time liabilities (NDTL) that the Reserve Bank may notify from time to time in the Gazette of India.
Statutory Liquidity Ratio (SLR): The share of NDTL that a bank is required to maintain in safe and liquid assets, such as, unencumbered government securities, cash and gold. Changes in SLR often influence the availability of resources in the banking system for lending to the MARKET.
Open Market Operations (OMOs): These include both, outright purchase and sale of government securities, for injection and absorption of durable liquidity, respectively.
Market Stabilisation Scheme (MSS): This instrument for monetary management was introduced in 2004. Surplus liquidity of a more enduring nature arising from large capital inflows is absorbed through sale of short-dated government securities and treasury bills. The cash so mobilised is held in a separate government account with the Reserve Bank OF India.
