MONETARY POLICY
A tool to manage money supply
The money……
Why demand for money?
We are the supplier of funds and we get it
against the work
RBI creates high powered money (M0)
Bank deposits, reserve ratio & repo....
M1,M2,M3,M4
Money multiplier effect: liquidity
Money
Measure What it Contains Liquidity Meaning
Currency in circulation +
Money created &
M0 Bankers’ deposits with RBI Highest
controlled directly by RBI
+ Other RBI deposits
Cash with public +
Money you can spend
M1 Demand deposits + Other Very High
immediately
deposits with RBI
M1 + Savings deposits in
M2 High M1 + small savings
Post Office
M2 + Time deposits with Broad money used for
M3 Medium
banks economic activity
M3 + Post Office time Total money in Indian
M4 Lower
deposits economy
Indian Banking and Financial System
How to fight with inflation and deflation?
▪ Supply and demand
▪ Potato vs price
Inflation
▪ Stable inflation will lead max. GDP &
employment
▪ Fight inflation – Reduce money supply
▪ Tight money policy, dear money policy or
hawkish policy
Deflation
▪ Deflation will effect GDP & employment
negatively
▪ Fight deflation – Increase money supply
▪ Easy money policy, cheap money policy or
dovish policy
Unemployment, down GDP….. recession
Neutral monetary policy
RBI is trying to control in a range
Lower tolerance 2% to upper tolerance 6%
[Link]
Monetary policy: tools
▪ Quantitative/ General/ Indirect
▪ Ratios: SLR, CRR, incremental CRR
▪ Open market operations (OMO) & Market
stabilization scheme (MSS)
▪ Rates: Bank, Marginal standing facility (MSF),
Liquidity adjustment facility (LAF), (Repo, RR)
Monetary policy: tools
LAF MSF
▪ RBI uses to manage the short-term ▪ Banks can borrow from RBI by
liquidity/money supply pledging the G-Sec at a higher rate
than REPO rate (r+1)
▪ Banks are allowed to borrow money
from central bank through REPO ▪ RRBs also allowed in 2020
▪ All clients of RBI are eligible to bid ▪ Bid can be in multiple of 1 cr.
in multiple of 5 cr.
▪ Banks are allowed the use the
▪ Bank can not sell the G-Sec to RBI securities from SLR
that is part of SLR
▪ Bank can borrow maximum upto
▪ Bank can borrow any amount of 2% of its NDTL
money as long it has G-Sec
▪ Narsimahn committee recommended ▪ MSF rate will always be higher
LAF
Monetary policy: tools
▪ Qualitative: selective/ direct
▪ Margin requirement/ Loan-to-value (LTV)
▪ Consumer credit control/ EMI
▪ Selective credit control (SCC), credit ceiling &
rationing, Priority sector lending (PSL)
▪ Moral suasion & direct action
Bank’s functioning
Time deposits Demand deposits Other
▪ FD, cash ▪ CA, savings, ▪ Interest
certificates, demand draft accrued on
cumulative/ deposit
recurring
▪ Overdue
deposits, staff ▪ Unpaid
balance in FD dividends
security deposit
▪ Unclaimed ▪ Gold
▪ 2015 onwards:
deposits borrowed..
unbreakable FD
Net demand and time liabilities (NDTL)
Liabilities Demand Time
▪ Deposit ▪ +100 ▪ +80
▪ Withdrawn ▪ -30 ▪ -20
▪ Net left ▪ +70 ▪ +60
NDTL = +130 crores
Ratios to protect against bank “runs”
NDTL = +130 crores
CRR 3% SLR 18%
▪ Need to maintain in
▪ Reserved money liquid assets
▪ Bonds, Gold, RBI
▪ Can’t lend approved securities G-
sec, T-bill, PSU
▪ No benefit to banks debentures..)
Reserve ratios:
High reserve ratio (Pre-LPG) Effect
▪ High cost of credit
▪ High reserve ratio
▪ Less business expansion
▪ Less exports
▪ About 53% ▪ Less job creation
▪ Tax collection
▪ Increase government
borrowings
▪ High current account
deficit
1991 : Narsimhan committee I
Before After (current scenario)
▪ CRR 15% ▪ CRR 3%
▪ SLR 38.5% ▪ SLR 18%
Impact of CRR
[Link]
Monetary policy: Quantitative
To take measures in
case of Inflation Deflation
▪ Policy ▪ Tight/Dear ▪ Easy/
Cheap
▪ Money ▪ Decrease ▪ Increase
supply
▪ CRR/SLR ▪ Increase ▪ Decrease
▪ OMO ▪ Sell G-Sec ▪ Buy
Incremental CRR
▪ Arrangement was done to handle excess cash in the
system due to demonetization
▪ CRR for 26 November to 10 December and asked to
maintain 100% CRR (effectively 44% … hypothetical
figure)
▪ CRR/SLR maintained @ fortnight lag
▪ Later on observed by Market stabilized scheme (MSS)
Thank You