Monetary Policy of India, Objectives & Role

Monetary Policy of India: Monetary policy helps shape the economic landscape of a country by influencing key factors such as inflation, economic growth and employment. The objective of the Reserve Bank of India is to maintain price stability and ensure that inflation remains at a sustainable level through instruments such as interest rate regulation and money supply management. By controlling interest rates, central banks also influence borrowing costs, consumer spending and corporate investment. Effective monetary policy promotes economic stability and fosters an environment conducive to sustainable growth.

Monetary Policy of India

Monetary Policy Updates

• All six members of the RBI's Monetary Policy Committee (MPC) unanimously decided to keep India's repo rate at 6.5 percent, marking the fourth consecutive meeting without changes.
• The MPC was last revised in February 2023 when India's repo rate was raised to 6.50% from 6.25%.
• The RBI maintained its FY24 real GDP growth forecast at 6.5% and inflation forecast for the same period at 5.4%, with factors such as vegetable prices and lower LPG prices expected to moderate inflationary pressures.
• RBI identifies high inflation as a major risk to macroeconomic stability and sustainable growth. RBI plans to conduct open market operations (OMO) through auctions of G-secs to manage liquidity.
• In 2015, the Reserve Bank of India and the Government of India signed a framework agreement on monetary policy. This arrangement, recommended by RBI Deputy Governor Urjit Patel, will set measurable targets for India's monetary policy.
• The main objective of this framework is to ensure price stability, taking into account the objective of economic growth.
• Under this arrangement, the RBI sets interest rates to keep inflation within a permissible range of +/-2 percent at 4 percent.

Monetary Policy Committee

1. Governor of the Reserve Bank of India – Chairperson, ex officio ;
2. Deputy Governor of the Reserve Bank of India, in charge of Monetary Policy – Member, ex officio ;
3. One officer of the Reserve Bank of India to be nominated by the Central Board – Member, ex officio ;
4. Shashanka Bhide, Senior advisor at National Council for Applied Economic Research (NCAER) – Member;
5. Ashima Goyal, Professor at the Indira Gandhi Institute of Development Research in Mumbai – Member; and
6. Jayanth Varma, Professor, Indian Institute of Management, Ahmedabad – Member.

Instruments of Monetary Policy in India

1. Open Market Operation: An open market operation is an instrument that involves the purchase/sale of securities such as government bonds from the public and banks. RBI sells government securities to control the flow of credit and buys government securities to increase the flow of credit.
2. Cash Reserve Ratio (CRR): The cash Reserve Ratio is a specific amount of bank deposits that banks must maintain with the RBI in the form of reserves or balances. The higher the CRR for RBI, the lower the liquidity of the system and vice versa.
3. Statutory Liquidity Ratio (SLR): All financial institutions must keep a certain amount of liquid assets with them at all times against their time and demand of liabilities. This is called the required liquidity ratio. Assets are held without cash, such as precious metals, bonds, etc.
4. Bank Rate Policy: Also known as discount rate, bank rate is the interest rate paid by the RBI for funds and loans in the banking system. An increase in the bank interest rate increases the cost of borrowing from commercial banks, which leads to a decrease in bank lending volumes and thus a decrease in the money supply. Bank rate is a symbol of RBI's tight monetary policy.
5. Credit Ceiling: Through this instrument, RBI gives an advance notice or direction that commercial banks will receive credit up to a certain limit. In this case, the commercial bank is strict in deferring loans to the public. They refer to loans to limited sectors. Some examples of loan ceilings are advances in the agricultural sector and loans in the primary sector.
6. Open Market Operations (OMO): These include the direct purchase and sale of government securities, as well as the addition and absorption of permanent liquidity.
7. Market Stabilization Scheme (MSS): This money management tool was launched in 2004. More sustainable excess liquidity from large capital flows will absorb the sale of short-term government securities and sovereign debt obligations. The cash thus used is kept in a separate account of the Government in the Reserve Bank.

Types of Monetary Policy

1. Expansionary monetary policy: Expansionary monetary policy is used when the central bank aims to stimulate economic activity. This means lowering interest rates to make borrowing more affordable, which encourages consumption and investment. Increased money supply due to lower interest rates is expected to boost consumer demand and business growth, which will boost economic growth.
2. Contractionary monetary policy: In contractionary monetary policy, central banks raise interest rates to increase borrowing, which reduces spending and investment. The goal is to slow down economic activity and avoid excessive inflation.

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