Professional Documents
Culture Documents
SEMESTER VII
(2016-17)
LEGAL RESEARCH AND WRITING
SUBMITTED BY
S UBMITTED TO
GARIMA PARAKH
SANGAM
M RS. SHAKUNTALA
-1-
ROLL NO. 57
PROFESSOR (LAW)
A SST.
ACKNOWLEDGEMENT
-2-
TABLE OF CONTENTS
INTRODUCTION................................................................................................................................3
MONETARY POLICY BEFORE THE 90s.........................................................................................4
[2.1] Main Focus of the Policies.......................................................................................................4
[2.3] Instruments of Fiscal Control: Direct or Indirect.....................................................................5
INDUSTRIALISATION AND FOREIGN DIRECT INVESTMENT: THE PERIOD AFTER THE
90s........................................................................................................................................................6
[3.1] Change in the Economic Conditions........................................................................................6
[3.2] Change in the Monetary Policy................................................................................................7
[3.3] New Instruments of Fiscal Control..........................................................................................8
[3.4] Beginning of Foreign Investment: Effect of Foreign Pressure..............................................11
RECENT TRENDS AND SUGGESTIONS OF THE MONETARY POLICY COMMITTEE........11
[4.1] Changing the Focus................................................................................................................11
PROPOSED CHANGE IN THE COMPOSITION OF THE MPC: EFFECT ON MONETARY
POLICY.............................................................................................................................................12
[5.1] Formation of the Monetary Policy Committee......................................................................12
[5.2] Maintenance of Transparency through Current Composition................................................13
[5.3] Alteration of Composition: Effects of Governmental Interference........................................13
CONCLUSION..................................................................................................................................15
-3-
INTRODUCTION
Monetary policy is a regulatory policy by which the central bank or monetary authority of a country
controls the supply of money, availability of bank credit and cost of money, that is, the rate of
interest. Monetary policy/monetary management is regarded as an important tool of economic
management in India. RBI controls the supply of money and bank credit. The central bank has the
duty to see that legitimate credit requirements are met and at the same credit is not used for
unproductive and speculative purposes. RBI rightly calls its credit policy as one of controlled
expansion. For most of the period in the sixties, seventies and eighties, there was an emphasis on
the achievement of price stability. In recent years, starting from the mid- nineties, promoting
economic growth is being given greater emphasis in monetary policy of Reserve Bank of India.
This is evident from the lower cash reserve ratio (CRR) set in order to increase the liquidity and
cash flow in the market. This has led to a conducive borrowing situation with a lower interest rate,
making investments easier. Using indirect fiscal instruments such as ad-hoc treasury bills, enabled
monetization of the budget deficit of the government, which helped even more after measures such
as open market auctions of such treasury bills was initiated. Further, an appropriate devaluation of
the currency has improved foreign investment and has therefore increased the growth rate of our
economy. However, the cap on foreign direct investment was kept at 49%. This helped the economy
bear the blow of the 2008 economic crisis without much damage. In 2002, the suggestion of a
Monetary Policy Committee (MPC) by the advisory group which also had former RBI Deputy
Governor S. S. Tarapore, helped make the laying down of a monetary policy more transparent and
in line with the objectives of the government by involving the Parliament in the discussions. The
main aim at that time was to control the inflationary economy. Today, development is the main
agenda which requires a different set of policy changes and this must be done without being too
drastic.
-4-
1 Deepak Mohanty, How does the Reserve bank of India conduct its monetary policy? (IIM Lucknow,
August 12 2011) <http://www.bis.org/review/r110816a.pdf> accessed 14 October 2016.
2 Ibid.
3 Ibid.
4 TR Jain, Mukesh Trehan and Ranju Trehan, Business Environment (F K Publications, 2010).
-5-
5 Rakesh Mohan, Financial Sector Reforms and Monetary Policy: The Indian Experience (Conference on
Economic Policy in Asia, Stanford,June 2006) https://siepr.stanford.edu/?
q=system/files/shared/pubs/320_rakesh-rev.pdf accessed 15 October 2016.
-6-
6 Ibid.
7 Deepak Mohanty, How does the Reserve bank of India conduct its monetary policy? (IIM Lucknow,
August 12 2011) <http://www.bis.org/review/r110816a.pdf> accessed 15 October 2016.
-7-
productive assets such as gold, jewellery, real estate etc. 8 An expert committee on monetary reforms
headed by Late Prof. S. Chakravarty suggested 4 per cent rate of inflation as a reasonable rate of
inflation and recommended that monetary policy by RBI should be so formulated that ensures that
rate of inflation does not exceed 4 per cent per annum. Emphasising the importance of price
stability from the viewpoint of Indias balance of payments, Prof. Rangarajan said9
The increasing openness of the economy, the need to service external debt and the necessity to
improve the share of our exports in a highly competitive external environment require that the
domestic price level not be allowed to rise unduly, particularly since our major trading partners
have had notable success in recent years in achieving price stability.
[3.2] Change in the Monetary Policy
1.
Reduced Reserve Requirements : During 1990s both the Cash Reserve Ratio (CRR) and
the Statutory Liquidity Ratio (SLR) were reduced to considerable extent. The CRR was at its
highest 15% plus and additional CRR of 10% was levied, however it is now reduced by 4%. The
SLR is reduced form 38.5% to a minimum of 25%.10
2.
Increased Micro Finance : In order to strengthen the rural finance the RBI has focused
more on the Self Help Group (SHG). It comprises small and marginal farmers, agriculture and
non-agriculture labour, artisans and rural sections of the society. However still only 30% of the
target population has been benefited.11
8 Rakesh Mohan, Financial Sector Reforms and Monetary Policy: The Indian Experience (Conference on
Economic Policy in Asia, Stanford,June 2006) https://siepr.stanford.edu/?
q=system/files/shared/pubs/320_rakesh-rev.pdf accessed 15 October 2016.
9 Supriya Guru, The Meaning and Objective of Monetary Policy (Ypur Article Library, 20 April 2014)
<http://www.yourarticlelibrary.com/economics/the-meaning-and-objectives-of-monetary-policy/37889/>
accessed 15 October 2016.
10 Gaurav Akrani, Monetary Policy in India: 1990 reforms and its evaluation (Kalyan City Life, 13
September 2010) <http://kalyan-city.blogspot.in/2010/09/monetary-policy-in-india-1900-reforms.html>
accessed 16 October 2016.
11 Ibid.
-8-
3.
Fiscal Monetary Separation : In 1994, the Government and the RBI signed an agreement
through which the RBI has stopped financing the deficit in the government budget. Thus it has
seperated the Monetary policy from the fiscal policy.
4.
Changed Interest Rate Structure : During the 1990s, the interest rate structure was
changed from its earlier administrated rates to the market oriented or liberal rate of interest.
Interest rate slabs are now reduced up to two and minimum lending rates are abolished. Similarly,
lending rates above Rs. 2 lakh are freed.12
5.
Changes in Accordance to the External Reforms : During the 1990, the external sector
has undergone major changes. It comprises lifting various controls on imports, reduced tariffs,
etc. The Monetary policy has shown the impact of liberal inflow of the foreign capital and its
implication on domestic money supply.13
6.
Higher Market Orientation for Banking : The banking sector got more autonomy and
operational flexibility. More freedom to banks for methods of assessing working funds and other
functioning has empowered and assured market orientation.14
were progressively lowered, as a part of financial sector reforms. As a result, more bank funds were
available for loan purposes which led to growth in the economy. Liquidity Adjustment Facility
(LAF) which allows banks to borrow money through repurchase agreement was introduced by the
RBI in June 2000, in phases. The funds under LAF are used by banks to meet day-to-day
mismatches in liquidity. With globalisation there was large influx of foreign capital in the country.
Therefore to provide stability in financial markets, RBI uses sterilization and LAF to absorb the
excess liquidity that comes in with huge inflow of foreign capital. Other reforms included
deregulation of administered interest rate system by allowing commercial banks to determine
lending rates based on market forces and delinking of monetary policy from budget deficit by
phasing out the use of ad hoc Treasury Bills which were used by government to borrow from RBI to
finance fiscal deficit. This meant that RBI would no longer finance the governments fiscal deficit.
Another important change that occurred was linking of the banking system with Self Help Groups
(SHGs). RBI introduced the scheme of micro finance for rural poor along with NABARD, and is
now promoting various other microfinance institutions.
1. Open Market Operations
An open market operation is an instrument of monetary policy which involves buying or
selling of government securities from or to the public and banks. This mechanism influences
the reserve position of the banks, yield on government securities and cost of bank credit.
The RBI sells government securities to control the flow of credit and buys government
securities to increase credit flow. Open market operation makes bank rate policy effective
and maintains stability in government securities market.
2. Cash Reserve Ratio
Cash Reserve Ratio is a certain percentage of bank deposits which banks are required to
keep with RBI in the form of reserves or balances. Higher the CRR with the RBI lower will
be the liquidity in the system and vice versa. RBI is empowered to vary CRR between 15
percent and 3 percent. But as per the suggestion by the Narsimham committee Report the
CRR was reduced from 15% in the 1990 to 5 percent in 2002. As of September 2015, the
CRR is 4.00 percent.
3. Statutory Liquidity Ratio
Every financial institution has to maintain a certain quantity of liquid assets with themselves
at any point of time of their total time and demand liabilities. These assets have to be kept in
-10-
non-cash form such as precious metals, approved securities like bonds etc. The ratio of the
liquid assets to time and demand liabilities is termed as the Statutory liquidity ratio. There
was a reduction of SLR from 38.5% to 25% because of the suggestion by Narshiman
Committee. The current SLR is 21.5%.
4. Bank Rate Policy
The bank rate, also known as the discount rate, is the rate of interest charged by the RBI for
providing funds or loans to the banking system. This banking system involves commercial
and co-operative banks, Industrial Development Bank of India, IFC, EXIM Bank, and other
approved financial institutes. Funds are provided either through lending directly or
rediscounting or buying money market instruments like commercial bills and treasury bills.
Increase in Bank Rate increases the cost of borrowing by commercial banks which results
into the reduction in credit volume to the banks and hence declines the supply of money.
Increase in the bank rate is the symbol of tightening of RBI monetary policy. As of 3
February 2015, the bank rate is 8.75%.8.50% in 4 March 2015.8.25% in 2 June 2015
5. Change in Margin Requirements on Loans
Margin is the difference between loan value and market value of security and is fixed by
RBI. For different types of loans the margin requirement differs. If the margin percentage is
high then less loan will be given for a certain value of security and vice versa. For example,
if the margin requirement is 0% then bank will give at max 80% of market value of security
as loan. For priority sector (where more loans are preferred), where credit is to be expanded,
the margin requirement is reduced.
6. Moral Suasion
Moral Suasion is just as a request by the RBI to the commercial banks to take so and so
action and measures in so and so trend of the economy. RBI may request commercial banks
not to give loans for unproductive purpose which does not add to economic growth but
increases inflation. From time to time the RBI holds meetings wih the member banks
seeking their cooperation in effectively controlling the monetary policy of the country. It
advices them to extend more credit to priority sectors i.e. agriculture and small industries
and invest more in government securities.
7. Repo Rate and Reverse Repo Rate
-11-
Repo rate is the rate at which RBI lends to commercial banks generally against government
securities. Reduction in Repo rate helps the commercial banks to get money at a cheaper
rate and increase in Repo rate discourages the commercial banks to get money as the rate
increases and becomes expensive. Reverse Repo rate is the rate at which RBI borrows
money from the commercial banks. The increase in the Repo rate will increase the cost of
borrowing and lending of the banks which will discourage the public to borrow money and
will encourage them to deposit. As the rates are high the availability of credit and demand
decreases resulting to decrease in inflation. This increase in Repo Rate and Reverse Repo
Rate is a symbol of tightening of the policy.
[3.4] Beginning of Foreign Investment: Effect of Foreign Pressure
Until 1991, India followed fixed exchange rate system and only occasionally devalued the rupee
with the permission of IMF. The policies of floating exchange rate and increasing openness and
globalisation of the Indian economy, adopted since 1991 have made the exchange rate of rupee
quite volatile. 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.
-12-
2006 (Chairman: Shri S.S. Tarapore) recommended that there should be a formal Monetary Policy
Committee. It also recommended that at some appropriate stage, a summary of the minutes of the
Monetary Policy Committee should be put in the public domain with a suitable lag. The Committee
on Financial Sector Reforms, 2009 (Chairman: Dr. Raghuram G. Rajan) recommended that a
Monetary Policy Committee should take a more active role in guiding monetary policy actions. It
should meet more regularly; its recommendations and policy judgments should be made public with
minimal delays. The Committee on Financial Sector Assessment, 2009 (Chairman: Dr. Rakesh
Mohan) counseled on the need for strengthening the role of the TACMP and recommended that
practices/ procedures towards this goal be considered as it gains more experience. 17 Globally,
central banks follow different models. While some have government-appointed members on these
committees, the appointments are done in a manner to avoid any political interference. The Bank of
Englands monetary policy committee is made up of nine members. This includes the governor,
three deputy governors and the chief economist of the central bank. The remaining four members
are appointed by UKs Chancellor. The four members are independent and do not represent any
interest group. They are appointed for fixed terms. Each member of the committee has one vote.
While a member of the treasury is allowed to sit in on the meetings and debate along with the
monetary policy committee, this person doesnt get a vote.18
[5.2] Maintenance of Transparency through Current Composition
In India, although guided by internal inputs and of those received by the Committee of the Central
Board of Directors of the RBI, monetary policy decisions are made by the Governor alone, and the
quarterly (and now bi-monthly) policy statements are issued in his name. However, over time, the
process of monetary policy decision making has become more consultative and participative, and
relies even more on external inputs. A Technical Advisory Committee (TAC) on Monetary Policy
was established in 2005, but its role is purely advisory in nature. 19 Communicating the rationale of
monetary policy actions is central to both the credibility of the central bank and to enable the
incidence targets of the policy to adjusting behaviour appropriately. Heightened public interest and
17 URP Committee Report (21 January 2014) https://rbi.org.in/scripts/PublicationReportDetails.aspx?
UrlPage=&ID=747 accessed 16 October 2016.
18 Ira Dugal, How different will the proposed monetary policy be (Live Mint, 24 July 2015)
<http://www.livemint.com/Politics/hv0Q0axSRddH2Xfq9azT3O/How-different-will-be-the-proposedmonetary-policy-committee.html> accessed 15 October 2016.
-14-
scrutiny of MP decisions and outcomes has propelled a worldwide movement towards a committee
based approach to decision making with a view to bringing in greater transparency and
accountability in India.20 However, the function of the present committee is merely consultative and
suggestive. The final decision maker is the Governor and deciding the monetary policy of the
country is an enormous power to be vested in a single individual.
[5.3] Alteration of Composition: Effects of Governmental Interference
The RBIs internal panel, the Urjit Patel committee 21, had recommended a five-member committee
where three members would be from the RBI and two external members (all members having 3 yesr
terms) would be appointed by the RBI governor and the deputy governor in-charge. It was also
suggested that the governor would have a casting vote in case of a tie. In contrast, the latest draft of
the code22 envisages a wider monetary policy committee with seven members. Three members
would be from the RBI, including the governor, an executive board member and an RBI employee.
The remaining four members would be appointed by the government for a four-year term. The
government will have the right to remove these members mid-term under certain conditions. Each
of these members would have voting rights. A government nominee would also sit in on the
meetings, but would not have voting powers. Decisions will be taken by a majority vote, says the
code. In the event of a tie, the RBI governor would have a second and casting vote, it adds, while
removing the provision giving the RBI governor veto power of the committee's decisions.
Under the present system, the Governor is appointed by the government, but controls monetary
policy and has veto power over the existing advisory committee of RBI members and outside
appointees that sets rates. The revised draft of the Indian Financial Code (IFC) as released by the
Finance Ministry last month had suggested doing away with this veto power adding that the seven19 Saugata Bhattacharya, Why a Monetary Policy Committee is the best decision making structure
(Huffington Post, 12 August 2015) <http://www.huffingtonpost.in/saugata-bhattacharya/a-monetary-policycommitt_b_7963844.html> accessed 16 October 2016.
20 URP Committee Report (RBI, 21 January 2014) https://rbi.org.in/scripts/PublicationReportDetails.aspx?
UrlPage=&ID=747 accessed 16 October 2016.
21 Ibid.
22
-15-
member MPC to take decisions by a majority vote. 23 Of the seven members, four would be
government nominees and the rest from RBI. The government and RBI are finalising the structure
of the Monetary Policy Committee (MPC) and Governor Rangarajans comment that the
government can do away with the veto power of Governor but the majority of members in the
Monetary Policy Committee should be from the apex bank,24 conveys only half the problem the
economy would have to face in case governmental majority is retained in the MPC. Setting of the
monetary policy has traditionally been the domain of the central bank and must remain so in order
to preserve transparency and ensure accountability, as has been done so for the past so many years
with the help of the reforms that have been introduced in the functioning of the MPC. An alteration
in the present composition may result in unwarranted governmental interference, especially in the
light of the corruption scandals that tainted the previous government. Monetary policy is a sensitive
area and a crucial cog in the wheel of fiscal policy, affecting the economy, and politicizing of the
control exercised over the monetary policy will only cause economic anarchy in the country. In
other words, we cannot always trust the government to act in the best interests of the country.
Therefore, the present composition of the committee should be retained or atleast, a majority of the
RBI should be retained. Further, the committee should be the decision making body of the RBI and
the Governors power should be reduced to ensure that the pressure on a single individual is
reduced while at the same time also ensuring continuity in policy when any single member of the
committee changes.
CONCLUSION
The RBI is now more able and more responsible for controlling the overall growth of money and
credit in a manner best suited for moderating inflation, while meeting the genuine credit needs of
the economy. Price stability remains the key objective of monetary policy and there is virtually a
national consensus that high inflation is not good. Inflation expectations and inflation tolerance
have come down. It even affects the spending decisions and saving pattern of the people. Even in an
23 Rangarajan favours RBI majority in Monetary Policy Committee (Time of India, 9 August 2015)
<http://timesofindia.indiatimes.com/business/india-business/Rangarajan-favours-RBI-majority-in-MonetaryPolicy-Committee/articleshow/48410456.cms> accessed 16 October 2016.
24 Ibid.
-16-
environment of price stability, the 1990s witnessed episodes of financial instability. The
presumption that price stability ensures financial stability is thus not true, at least in the short-run.
While the basic objectives of monetary policy, namely price stability and ensuring credit flow to
support growth, have remained unchanged, the underlying operating environment for monetary
policy has undergone a significant transformation. The key development that has enabled a more
independent monetary policy environment was the discontinuation of automatic monetization of the
Government's fiscal deficit through an agreement between the Government and the Reserve Bank in
1997. In order to meet challenges thrown by financial liberalization and the growing complexities
of monetary management, the Reserve Bank switched from a monetary targeting framework to a
multiple indicator approach.
monetary authorities are now required to pay greater attention to external developments. Swings in
trade flows and especially capital flows are quite common and these impart a high degree of
volatility to exchange rates.
Moreover, the existing composition of the MPC should be altered with caution and a larger role
must be retained with the RBI.
-17-