Monetary Policy

Challenges For India

Presented by: Group 3

Kshitij / Abhay/ Varun/ Surbhi / Kunal/ Chitresh/ Anuj

Goals of Monetary Policy in

India
Monetary policy refers to the credit
control measures adopted by the RBI
Done by varying interest rates
Objectives are:
To ensure price stability (contain inflation)
To encourage economic growth
To ensure stability of exchange rate of the
Rupee

Monetary Policy Targets

Specific value of macroeconomic variables(interest rates,
monetary aggregates, exchange rates etc)
Historically, RBI was framing monetary policy by targeting
broad money supply.
In Mar 2015, RBI and Finance Ministry agree to historic
change in policy
In Monetary Policy rejig, India moved to inflation targeting
The CPI inflation target for FY 2016-17 and all subsequent
years will be 4% with a band of +/- 2%
The RBI will put out an operating target and establish a
procedure to achieve it.
If the central bank misses the inflation target, it will send a
report to the government citing reasons and remedial
actions.

Monetary Policy Instruments

Change in Reserve Requirements of Banks (R/D)
Open Market Operations
Bank Rates
CRR (4%)
Repo Rate (7.25%)
Reverse Repo (6.25%)
Bank Rate (8.25%)

Direct Credit Control

Priority Sector Lending
SLR (21.5%)

Issues in Monetary Policy

The issue of exchange rate
management in the wake of larger
capital inflows into the country
The issue of interest rate
management arising out of heavy
government borrowing from the
market
The issue of administered interest
rates and their impact on monetary
policy transmission mechanism

Exchange Rate Management

Foreign Exchange:
Inflow>Outflow

Price of Foreign currency

falls vise-a vise
domestic currency

Rupee under pressure of

appreciation against
dollar

Options with RBI

RBI starts
buying dollars
to remove
excess supply
and stabilize
value of Rupee.

Sterilized
Intervention

No Intervention:
Market Price
Determination.

RBI starts buying

dollars to remove
excess supply and
stabilize value of
Rupee.

Sterilized Intervention

Monetary Base(MB) goes up.

Inflationary Impact.
Opportunity Cost Involved.
Interest rate differential.

Buying Dollars by simultaneously selling govt.

securities.
Monetary Base : No Change.
Alternatively, reducing money mulitpier by
raising CRR.
Stabilizes both exchange rate and prices.
Restricts equilibrium .

Rupee under
downward
pressure :
Exchange Rate
Stabilization

Rupee under
upward pressure
: Exchange Rate
& Price
Stabilization

Interest Rate Management and

Fiscal Deficit
Government
needs financing

Currently in India, government

is financing
Debt not
financed
by RBI
market
borrowings

Dilemma whether to

1)Increased interest
rates,
stabilize interest rate,
2)Inflation
rates
3)Crowding out of private
spending and exports

RBI directly
monetizes
the
deficit
through
debt via open
market
operations

1)Interest will
rise or exchange
prices
2) RBI will be
blamed

Administered Interest Rates

Many small saving schemes like PPF and Postal
Schemes in India (10% of GDP)
Interest rates on them are administered,
distorting the monetary policy transmission
mechanism
Rise of dual market interest rate structureInterest rate higher in controlled markets + Tax
Benefits
Reduction in effectiveness of monetary policy
Expansionary
Monetary Policy

Increase in
bank
reserves

Banks buy
bonds, Yield
decreases

Due to
controlled
schemes,
people
switch

Cost to
borrow out
of such
instruments
is also
higher