RBI Monetary Policy Review: Basic Knowledge

In everyday, in newspapers or in TV nowadays, we see, reporters asking about monetary policy of RBI. We see, sometime columnist, urge for rate hike or to keep it at same position. Nowadays, we also see, Government is mulling to have monetary policy powers with itself from RBI. So, sometimes, people think, what is monetary policy. So let me explain in basic terms. 

Monetary Policy:

Actually, monetary policy is a way in which RBI controls flow of money in market. Now we think, actually what is needed to control the flow of money in market. We need to control the flow of money in order to check inflation. Let me explain, if there is more money in the market, then people will have more demand, but corresponding to this demand, if there is not enough supply, then prices of commodities will rise. So, it is very necessary to control the supply of money in the market. If there is high inflation, purchasing power of the country will decrease and growth will be lost and people will lose their job and then this vicious circle will continue. So we get to know flow of money is needed to be controlled to check inflation.

Role of RBI:

RBI is the sole issuer of currency in India. RBI also oversee monetary policy of India. Presently, RBI has a monetary policy committee which decides monetary policy of India. But RBI governor, presently, Raghuram Rajan has final authority on Monetary policy. RBI according to Urjit Patel committee recommendations, adopted Consumer Price Index of Inflation as benchmark for Monetary policy. RBI has fixed a target of under 6% inflation for January 2016. Then RBI will form this policy, to keep CPI in between 2-6%. 

Components of Monetary Policy:

Monetary policy of RBI consists of bank rate, repo rate, reverse repo rate, statutory liquid ratio, cash reserve ratio, marginal standing facility. 

Bank rate: This is the rate at which RBI gives loans to banks at long terms without any collateral. But this is not main monetary policy rate nowadays. 

Repo Rate: It is the interest  rate at which Banks borrow loan from RBI for short terms with collateral with maintaining statutory liquidity requirements.This is presently 7.25 %

Reverse Repo Rate: This is the interest rate at which RBI accepts bank deposits apart from Cash Reserve Ratio. This is always 1% less or 100 basis point less than Repo Rate. So it is 6.25 %.

Marginal Standing Facility: This is the rate at which banks can borrow money from RBI by pledging their Statutory Securities. This is always  1% higher than Repo Rate.

Cash Reserve Ratio: This is the ratio of total net time and demand deposits of Bank which it has to keep with RBI. This is currently 4%. At this RBI does not give any interest. So it is dead asset of banks. 

Statutory Liquidity Ratio: This is the total ratio of total net demand and time deposits of which banks has to invest in Govt. Securities or in RBI approved securities. In this way, govt. generate capital for its schemes at less rates of interest. This is also known as financial repression. This is currently 21.5%. 

These are few ways by which RBI tries to control money flow in the market. By these ways, RBI controls, lending powers of banks, so loans becomes costlier, and money supply is controlled. 

Monetary policy always tries to create balance between growth and inflation. 

Hope you got to know basics of monetary policy. Please let me know and comment.