This article has been written by Sayansh Saxena a 2nd year student of Institute of Law Nirma University Ahmedabad.
Abstract
Inflation is a thing that scares the people a lot and specially in India because most of the Indian people are middle class that try to save each and every penny from their pocket for savings and when the price increases there is a lot of distress among them. Hence to control this the Reserve Bank of India which is the head of banks in India have monetary policy in their hands through this policy Reserve Bank of India tries to control inflation and this monetary policy includes many tools like Repo rate , Reverse Repo Rate , Cash reserve Ratio , open market operations etc. In a country like India which has such a large population and most of the people are middle or lower middle class the policy has to applied appropriately otherwise there could be a ruckus in the country. Through this article I would try to explain that what are the various measures and how they are applied by the Reserve Bank of India to control inflation.
Introduction
The monetary policy is issued by Reserve Bank of India as per the RBI Act 1934 and it is given by a committee named monetary policy committee this is a 6-member committee and includes three people from Reserve Bank of India and three external members and at least four meetings have to be held during a year and they basically focus on emphasising that there should be economic growth and also the inflation should be kept under control.
Understanding Inflation
Before delving deep into the monetary policy tools, we first need to understand the factors which lead to inflation. Inflation can occur when there is large demand of goods but the supply is short hence the price increases similarly inflation can also rise due to increase in the basic things that are required to make the goods like electricity, labour, increase in the prices of raw material due to which the price of the main goods leads to a rise.
Concept of various tools
Repo Rate
There are various tools that the RBI has in it gambit it includes the repo rate it is the rate at which the reserve bank of India lends money to the banks if they increase the interest rate this discourages the bank from taking the loans and they give away loans to customer at high prices so due to the high prices the customers stop spending a large amount of money due to which the demand decreases and the supply increases as a result the prices of the goods come down this helps to reduce inflation and similarly if the rbi reduces interest rate this encourages banks to take more loans and the banks provide money to the people at low interest rate so people take loans and spend the money this leads to an increase in the cash flow and hence through this process development takes place at a faster rate because the government is also able to earn revenue
Reverse Repo Rate
Reverse repo rate is another tool which is frequently used by the RBI this is exactly the opposite of repo rate in this the bank request funds from the government and when the increase the interest rate this forces the bank to park funds with the Rbi and through this RBI decreases the money flow and hence the inflation comes under control similarly when the RBI reduces reverse repo rate this forces the banks to not park funds and hence there is more money for the people so they can easily take loans and this leads to a increase in the overall money flow of the economy.
Open Market Operation
This refers to the buying and the selling of the government securities when RBI sells securities it absorbs the liquidity from the market similarly when the RBI buys the security this leads to increase of liquidity in the market. Hence the selling of securities takes place when the RBI wishes to decrease the money flow in the economy this is done to curb inflation similarly when there is any economic slowdown in the economy RBI buys the securities so that there is more money flow in the economy and the situation of the market will improve because due to more cash flow people will be determined to buy more goods and hence the situation of the market will improve.
Cash Reserve Ratio (CRR)
The CRR is the percentage of total deposits of the bank that they are required to keep with the RBI in cash. Through this process rbi influences the lending capacity of the banks. When there is inflation RBI increases the CRR so the banks are required to give more percentage of deposit of cash to the RBI this decreases the lending capacity of the banks and if there is inflation it tends to come down similarly when there is economic slowdown RBI decreases CRR so banks are required to keep low cash with the banks and this increases the lending capacity of the banks.
Statutory Liquidity Ratio (SLR)
Similar to CRR SLR refers to the percentage of bank’s deposit that the banks are required to maintain in the form of cash, gold, government securities with themselves and this tool is also used for controlling the money flow in the economy. When there is inflation, the RBI increases the SLR due to which banks are required to maintain more money with themselves due to which their lending capacity decreases similarly when there is economic slowdown the RBI decreases the SLR due to which their lending capacity increases and they are able to give more money to their customers and this helps in increasing the pace of the market and helps the market to recover from economic slowdown.
Marginal Standing Facility: It is the rate at which the banks can borrow money from the RBI on overnight basis and it is placed at 25 points below the reop rate . if this is kept at a low interest rate then the bank can easily give loan to customers this increases the money flow in the economy. Similarly when there is inflation the MSF rate increases this decrease the money flow and helps to stabilise the economy.
These were some of the quantitative measures there are also qualitative measures that are followed by rbi to improve economic growth and stability some of the tools are:
Margin Requirement
The commercial banks’ function to grant loan rests upon the value of security being mortgaged. So, the banks keep a margin, which is the difference between the market value of security and the loan value. For example, a commercial bank grants loan of Rs.80,000 against security of Rs.1,00,000. So, the margin is calculated as 1,00,000 − 80,000 = 20,000. Hence when the government wants to restrict the flow of money then margin requirement of the loan is raised this discourages the customers to get the loan because they would not be able to get much of the loan against their margin similarly when they want people to take more loans, they decrease the margin requirement so that people are able to take more money against their current asset.
Selective Credit Control
In this the RBI requests the commercial banks to not give money to specific sectors in which there is a lot of inflation and asks the banks to give loans to those sectors which are facing economic slowdown and are unable to progress.
Moral Suasion
This is a kind of persuasive technique that is used by the RBI to pressurise the commercial banks to follow the monetary policy that has been made by the RBI. This involves meetings seminars speeches discussion in which RBI tries to explain to the banks the current situation and wants that the commercial banks to adopt to whatever changes that are required in the economy. In other words, this is an unofficial monetary policy that exercises the power of talk.
Hence these are the basic tools but there are certain conditions that are needed to be followed so that the monetary policy is enforced effectively they are
- Transmission Mechanism: The efficiency with which changes in policy rates translate into real economic activity and inflation outcomes.
- External factor: Global economic conditions, commodity price fluctuations and other tools can also influence the monetary policy.
In order to counter these challenges, the RBI is also taking certain important measures such as
- Transmission Mechanism: The efficiency with which changes in policy rates translate into real economic activity and inflation outcomes.
- Enhancing communication: The RBI is also consistently trying to improve and facilitate better communication of monetary policy this helps to manage market expectations and also helps to contribute towards price stability.
Conclusion
The Reserve Bank of India through various of its monetary policy measures helps to play a very vital role for the economic growth of the county as well as helping to control inflation in the country. Through various of its measures the Reserve Bank of India helps the Indian economy to prosper and keeps the citizens happy. but while implementing these policies also the RBI has to face many challenges that is trying to slow down inflation while at the same time seeing that the economy grows at a faster rate though this tends to seem a little difficult but this is the main problem that the Reserve Bank of India has to face and it also has to keep a constant check that whether its policies are followed and if they are not followed then the bank not complying with the guidelines should be punished strictly and also the method of transmission by RBI should also increase so that the commercial banks and even the people can get to know more about the policies and also according to me Rbi should try to include the study of its monetary system in school so that the children can also lean about it As there is continuous changes in the economic landscape the RBI is also continuously trying to evolve itself to new challenges and it is making sure that the Indian economy is ready to face all the challenges and ready to grow as fast as it can .
References:
- The articles were originally written by Byjus company and published on byju’s website the link for the same is https://byjus.com/free-ias-prep/monetary-policy-committee/
- The articles were originally written by Byjus company and published on byju’s website the link for the same is https://byjus.com/question-answer/what-are-the-instruments-of-monetary-policy-of-rbi/
- The articles was originally written by Reserve Bank of India and published on RBI’S website the link for the same is https://rbi.org.in/scripts/FS_Overview.aspx?fn=2752
- The articles was originally written by Rahul Ranjan and published on Times of India website the link for the same is https://timesofindia.indiatimes.com/blogs/blackslate-corner/overview-of-monetary-policy-objectives-instruments-channels-of-transmission-and-challenges/
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- The articles was originally written by Lisa Pallavi Barbora and published on mint website the link for the same is https://www.livemint.com/Money/BFvKL47eat3BzCy2RYVO7O/Monetary-policy-tools-that-RBI-uses.html
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