India’s Monetary Policy
Monetary policy refers to the use of instruments under the control of the central bank to regulate the availability, cost and use of money and credit.
Goals of Monetary Policy
1. Price Stability along with growth
2. The agreement on Monetary Policy Framework between the Government and the Reserve Bank of India in 2015 defines the price stability objective explicitly in terms of the target for i.e.,
(a) below 6 per cent by January 2016
(b) 4 per cent (+/-) 2 per cent for the financial year 2016-17 and all subsequent years.
Instruments of Monetary Policy
1. Cash Reserve Ratio (CRR)
The share of net demand and time liabilities (deposits) that banks must maintain as cash balance with the Reserve Bank.
2. Statutory Liquidity Ratio (SLR)
The share of net demand and time liabilities (deposits) that banks must maintain in safe and liquid assets, such as, government securities, cash and gold. Changes in SLR often influence the availability of resources in the banking system for lending to the private sector.
Sector-specific refinance facilities aim at achieving sector specific objectives through provision of liquidity at a cost linked to the policy repo rate. The Reserve Bank has, however, been progressively de-emphasising sector specific policies as they interfere with the transmission mechanism.
3. Liquidity Adjustment Facility (LAF)
Consists of overnight and term repo/reverse repo auctions. Progressively, the Reserve Bank has increased the proportion of liquidity injected in the LAF through term-repos.
4. Term Repos
Since October 2013, the Reserve Bank has introduced term repos, to inject liquidity over a period that is longer than overnight. The aim of term repo is to help develop inter-bank money market, which in turn can set market based benchmarks for pricing of loans and deposits, and through that improve transmission of monetary policy.
5. Marginal Standing Facility (MSF)
A facility under which scheduled commercial banks can borrow additional amount of overnight money from the Reserve Bank by dipping into their SLR portfolio up to a limit (currently two per cent of their net demand and time liabilities deposits) at a penal rate of interest (currently 100 basis points above the repo rate). This provides a safety valve against unanticipated liquidity shocks to the banking system. MSF rate and reverse repo rate determine the corridor for the daily movement in short term money market interest rates.
6. Open Market Operations (OMOs)
These include both, outright purchase/sale of government securities (for injection/absorption of liquidity)
7. Bank Rate
It is the rate at which the Reserve Bank is ready to buy or rediscount bills of exchange or other commercial papers. This rate has been aligned to the MSF rate and, therefore, changes automatically as and when the MSF rate changes alongside policy repo rate changes.
8. Market Stabilisation Scheme (MSS)
This instrument for monetary management was introduced in 2004. Surplus liquidity of a more enduring nature arising from large capital inflows is absorbed through sale of short-dated government securities and treasury bills. The mobilised cash is held in a separate government account with the Reserve Bank. The instrument thus has features of both, SLR and CRR.