Monday, 13 June 2022

What are the main instruments of monetary policy in India?

The reserve bank of India implements the monetary policy for the development of the economy in India. The monetary policy is controlled by the reserve bank of India. They control the supply of money in the market through various tools of monetary policies. The instrument of monetary policy helps RBI to control inflation and deflation in the economy. In the case of deflation, the availability of money is not appropriate and it leads to a reduction in investment. On the other hand, inflation makes the poor poorer and the rich became richer this leads to a rise in the prices of commodities. In India, RBI is the sole authority that controls and implements all the monetary policies such as reserve repo rate, CRR, SLR, open market operation many more. But these instruments divide into two parts that are. Quantitative, General or indirect Qualities, selective or direct Here in this guide, we will discuss both the instrument of monetary policy in the best possible way. Quantitative methods This category includes quantity and volume of money. Quantitative methods include bank rate variations, open market operation, reserve ratios, and many more. These methods control credit money in the economy through commercial banks. These instruments are indirect. Here we will discuss one by one instrument of quantitative methods. The policy of bank rate The bank rate refers to the rate of interest at which the central bank lends money and rediscounts first-class bills of exchange and security held by the commercial banks. When the RBI finds that inflationary pressures will rise in the economy then the interest rates are also raised. Borrowing from the central bank becomes costly for commercial banks so they try to less borrow in that situation. As result, the commercial banks also raise their land rates for business communities. On the other hand, this situation became contrary, when the central banks lend their money in lower rate interest to commercial banks then the commercial bank borrow loans at a cheaper rate. The commercial banks also lend their money at a low rate to businesses then the businesses are taking more loans for development. This will maintain the cash flow in the market and the output is an increase in employment, and income, demand starts rising and the downward movement of prices is checked. Open market operation Open market operation refers to the sales and purchases of short/long term securities in the open market by the central bank. In the case of rising prices then the central bank sells its securities to control it. Commercial banks reduce their securities because they are not in a position to lend money to business communities. In this situation, the money market faces a shortage in money supply in the market. On the other situation when the RBI purchases securities from the commercial bank and other individuals in exchange for money then the commercial banks can invest that money in the business and many more places. Changes in reserve ratios This instrument was first used in USA monetary policy as a monetary device. Every commercial and noon commercial bank is required to maintain a certain percentage of the total deposit as a reserve in the bank’s vault and a certain percentage in the central bank also. These reserves are known as statutory liquidity ratio (SLR), and cash reserve ratio (CRR). Statutory liquidity reserve concludes a certain percentage of reserves that are maintained in gold and foreign reserve. In India, the SLR rate is 25-40 percent by the central bank. The cash reserve ratio (CRR) refers to a certain amount of reserve that is maintained in form of cash that is deposited in the RBI accounts. The CRR rate is between 3 to 15 percent by the regulation of India. These rates change with time and the situation of the market also. These rate changes bring many changes in the commercial bank's position also. Repo rate A Repo rate refers to the rate at which commercial banks borrow money by selling their securities to RBI for maintains liquidity. In another world when commercial banks borrow from the RBI at a certain rate of interest that is called the repo rate. Commercial banks take loans from a commercial banks to maintain cash flow in the market. at the time of inflation, the central bank increase in repo rate which means they want to prevent commercial banks from borrowing from the central banks. The central bank keeps changing the repo rate and reverses the repo rate for adjusting the liquidity in the market. Reverse repo rate The reverse repo rate refers to the interest rate at which the central bank borrows money from the commercial bank and domestic bank. This is one of the important tools of the RBI to control excess money supply in the market. If the reverse repo rate is increased that means the supply of money will fall, and vice versa as well. This happens when the central bank is assuming all the variables remain constant. The commercial banks are attracted by the raised rate of interest and they want to deposit their money to the RBI which will reduce the availability of money in the market. Qualitative methods or selective This method is used for specific purposes for example controlling export over imports, essential and non-essential credits, and many more. They usually take the form of changing margin requirements to control speculation activities within the economy. These methods are used to control particular items raised prices in the market in a short term period.

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