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Monetary Policies in India

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Published: Mon, 12 Mar 2018

Rationale

The exit of monetary policy improves the economic performance. According to Damji (2012), India implements monetary policy in order to ensure the price stability in the country and to maintains sufficient flow of credit to the productive sectors of the economy. Other than that, the monetary policy can promote economic growth and balance of payment equilibrium. In addition, India uses monetary policy because of the reason to insure the unemployment in the economy is low and the income distribution among the employees is equal. The formulating and implementing of monetary policy is responsible by Reserve Bank India. By implementing monetary policy, the Reserve Bank of India can increase and decrease the supply of currency, the rise and fall of interest rate, carry out open market operations for purchase and sell of bonds, control credit and change the reserve requirements. Reserve bank of India implements both the expansionary monetary policy and contractionary policy throughout the last decade.

Among the objectives, the two main concern a country’s implements monetary policy is to promote a rapid economic growth and maintain price stability. But, that is a tradeoff between the 2 broad objectives which are price stability and economic growth. If a country’s implements monetary tightened, in consequence will caused the growth oppressed at the beginning.(Michaer 2010)However , the current framework of monetary policy can be indicate as augmented multiple indicators approach because the models feed into the growth and inflation projection. The monetary policy tools in India mainly involved the open market operation, statutory liquidity ratio (SLR) and cash reserve ratio (CRR).

By implements expansionary monetary policy, India can sustain economic growth. Increase in money supply will shift the money supply curve to the right lead to a lower interest rate, a lower interest rate will result in lower cost of borrowing in which increase the consumption and investment in the economic. The increase in consumption and investment will cause the aggregate demand curve shift rightward, in the end the price level and aggregate output increased. The increased in investment speed up the output; thus, decreased the unemployment rate in India.

Other than that, the reason India implements and adopts monetary policy is to insure that there would be enough credit supply to different sectors of economy. However the rising volume of credit may cause the level of inflation increasing. As a result, India thinks that the expansion of the credit might be liable in this case. But the main factor causing the high inflation is due to the supply bottlenecks. In turns, the credit expansion is useful as it can help the small scale industries and agricultures sector to help their credit situation by making an arrangement of credit supply.

Besides that, since 1997, India has a view to renaissance the investment in the country. (Palle Andersen and Ramon Moreno 2005 page164) Therefore, monetary policy in India has emphasize that there would be sufficient liquidity with low and flexible interest rate. The step is easy by cutting down the Bank rate, LAF rates and the CRR .However; they must make sure the stability of macroeconomic and financial system. By improving the operational efficacy of monetary policy, reserve bank of india can develop into a technological and institutional infrastructure. In year 2012-2013, India faces considerable stress in liquidity condition due to the large amount of government cash balances maintained with the reserve bank, increase in the demand for currency, intervention in the foreign exchange market and the discrepancy between the credit off-take and deposit mobilization. Reserve bank of India cuts SLR(Statutory liquidity ratio) by 100bps in order to improve the credit and liquidity conditions in August 2012.Between,the CRR reduce by 75 bps in September 2012.In june 2014,reserve bank India also reduce the SLR by 50bps in order to let out Rs 39000 crore of liquidity for banks.(Shetty,2014) ,The improvement in the liquidity condition in India is by the outright of open market operations. As refer to Reserve Bank India, during year 2012-2013,1.5 trillion of bonds and shares was carried out.

Besides that, monetary increased the employment in a country and reduce the inequality in income and wealth. People argue that the equal in income distribution is the role of fiscal policy but economist believes that monetary policy can serve as a supplementary role to maintaining this equality. By expansionary monetary policy, which increase the credit supply could help in creating more jobs. The reserve bank of India can demand the commercial banks with the goal to enhance credit flow to employment intensive sectors such as agriculture, micro and small enterprises, as well as for affordable housing and education loans by instruct the percentage of its loans portfolios to priority areas without restriction. (Bhattacharyya, 2012) page 8.In India, the social class are normally classify into two classes, rich and poor . Rich class is said to take and advantage of the poor class. So, it’s important for India to implements the monetary policy to reduce such inequalities.

The major concern of India is the inflation is rising, mainly of food items. As a result to ensure a financial stability is the most important consideration in the implements and adoptions of monetary policy. Price continuously rising during year 2005-2006 , the annual average rate of inflation stood at 4.4 per cent, increased to 5.5 per cent during year 2006-2007.In year 2008, the financial crisis ,the inflation rate went up to 12.6 per cent, which is very high due to the overheating of the economy.(Damji,2012) During the financial crisis, Reserve bank of India implements contractiondary monetary policy in order to maintain the price stability and to stabilize the inflation .By decreased the money supply, the interest rate moved up lead to the higher cost of borrowing would caused the consumption and investment to drop. As consumption and investment is the components of aggregate expenditure therefore will caused the aggregate demand curve to decrease, result in a decrease in the price level and lower down the inflation rate. However, Reserve Bank of India will prevent the price rise by implements monetary policy only when the price in the economy is out of control. (Damji,2012) To maintain price stability meant that to ensure that there are not too high inflation or deflation which caused by the drop in output of inefficient of the allocation of resources. It is a low or stable inflation. (Mohanty 2010)

The objective of monetary policy in India is to increase the rate of capital formation which speeds up the rate of economic growth. In order to increase the rate of capital formation, the Reserve Bank of India implements contractionary policy to encourage saving ,By implements contractionary monetary policy will lead to a rise in interest rate .The cost of borrowing is high, thus the demand of money would drop, Therefore by this policy the Reserve bank of India not only encourage people in saving as well as reduce the spending in the market which might lead to increase in price level in the economic.

With the aim to maintaining a stability of the national currency, Reserve bank of India implements contractionary monetary policy to tighten liquidity in order to support rupee which had depreciate. (PTI, 2013)In year 2013, Reserve bank of India decreased the LAF(liquidity adjustment facility) from 1 percent of the total deposits to 0.5 percent each bank. As a result, the borrowed funds from the reserve bank of India being restricted. Besides decrease the LAF, another method is the reserve bank of India has required the banks to have a high average CRR (cash reserve ratio) of 99 % which beyond the earlier of 70%. In addition, this would lead to a raised of short term interest rates and the bank are now announced to sell government securities in order to raised core from open market operations.

*Monetary policy in India endeavours to maintain a judicious balance between price stability, economic growth and financial stability.


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