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Group 4 Section B
Anup Nair 14P072
DevangNahar 14P075
DikshaMahajan 14P077
K. Mohana 14P087
PrashantGhabak 14P093
Varun Dave 14P118
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Table of Contents
Contents
INTRODUCTION........................................................................................................... 3
China Monetary System : A brief overview........................................................4
Monetary Policy Instruments in China........................................................................6
Internationalisation of Renminbi...............................................................................12
Monetary Policy of India: An Overview.............................................................14
References............................................................................................................... 18
INTRODUCTION
China and India, over the past decade have followed completely different
growth trajectories. Indias growth was fuelled by rising domestic
consumption whereas China relied heavily on exports and foreign
investments. The Indian economy has slowed down since 2008 whereas
China up till now has registered above 8% growth rate though it is showing
signs of slowing down. Each economy has its own unique sets of problems
due to structure, government policies and maturity of financial institutions
and markets. This results in different monetary policies objectives and
mechanisms by which a central bank can influence the economy. China and
India are no different in this regard.
Indias growth is supply side constrained. Internal consumption has risen
steadily over the years but supply is restricted due to insufficient capacity.
This is generally attributed to lack of investments and lack of agility in policy
making. Thus rising demand and limited supply has pushed up the prices
resulting in persistent inflation. Dependence on imports for key raw materials
like oil also pushes up the prices of derived goods. Rigid policies also played
a part in reducing foreign investments which could have been used to bridge
the gap between savings and investments.
China on the other hand is a demand constrained economy. Massive
investment has created excess capacity. However there is a decline in
private consumption which has forced the Chinese enterprise to turn to the
rest of the world for generating demand. This increases the current account
surplus and leads to widening of the monetary base, which coupled with
cheap credit, have been known to generate bubbles. The USD/CNY peg also
leads to massive forex inflows, increasing the monetary base.
The monetary policy, in response to the above issue, varies a lot between
the two countries. In this report we will try to examine the key instruments
affecting monetary policy and how they differ in India and China.
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The Peoples bank of Chinas website states that the objective of its
monetary policy is to maintain the stability of the value of the
currency and thereby promote economic growth.
The following are monetary policy instruments used by the Peoples bank of
China:
Window Guidance
Capital controls
2) Wage controls
Historically, in 1978, Chinas wage regime was characterized by a centrally
regulated salary system that, among other things, determined the wages
according to regions, occupations, industries and sectors. The heart of the
system was a classification scheme with more than 300 standardized
occupational classifications used for the salary formation. After 1978, the
wage regime had undergone three sets of reforms in 1985, 1992 and 1994
1995, respectively. The two reforms in1985 and 1992 incorporated an
indexation of wages to the development of the consumer price index.
Thus, high inflation had an impact on the wage level setting and higher
wages, in turn, triggered higher inflation rates. This constituted circles that
easily led to an inflationary spiral through ever increasing inflationary
expectations.
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Internationalisation of Renminbi
During the era of the command economy, the value of the Renminbi was set
to unrealistic values in exchange with western currency and severe currency
exchange rules were put in place. With the opening of the mainland Chinese
economy in 1978, a dual-track currency system was instituted, with
Renminbi usable only domestically, and with foreigners forced to use foreign
exchange certificates. The unrealistic levels at which exchange
rates were pegged led to a strong black market in currency transactions.
In the late 1980s and early 1990s, China worked to make the RMB more
convertible. Through the use of swap centers, the exchange rate was
brought to realistic levels and the dual track currency system was abolished.
As of 2014, the Renminbi is convertible on current accounts but not capital
accounts. The ultimate goal has been to make the RMB fully convertible.
There is difference between how RNB is handled in mainland China and how
it is handled outside it.
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and fiscal measures followed the oil price plus agricultural supply shock over
1973-75. In both the cases there was an unnecessary loss of output. An
emphasis on expanding supply would have been more useful. After the 197980 oil shock, a cut in public investment and acute monetary tightening was
avoided. Recovery was fast, however, deficits and supply side inefficiency
continued.
The similarly closed, import substitution and public investment driven model
of development followed, allowed macro-policy to be driven towards
domestic requirements. Commercial banks ability to multiply the reserve
base and create broad money was countered through strict compulsory
reserve and statutory liquidity requirements through some extent. This,
together with administered prices, controlled inflation too politicallyacceptable levels. Thus, political business cycles in India largely took the
form of a decrease in long-term development expenditures and interpositions
that skewed allocative efficiency, not of increased creation of money.
Since the seventies, major development ideas changed to increase
openness. In India also the bad effects of controls were becoming prevalent.
Some liberalization started in the mid-eighties, but a dominant thrust for
external openness came from the mid 1991 balance of payment crisis when
foreign exchange reserves were down to 11days of imports. The crisis
brought home the lesson that many interest controls and credit rationing
were destructive to growth and stability. It made possible the implementation
of the series of pending committee reports. Current account and partial
capital account liberalization, and a slow move to more flexible exchange
rates followed. While controls continued on domestic portfolios and debt and
equity inflows were liberalized. Equity shares risks, while short-term debt
flows create a big repayment burden in unfortunate times. On foreign debt,
the sequence of relaxation favored commercial credit and longer term debt.
Major reforms were taken towards development of equity, forex money and
government securities markets.
Although low by developing country standards, Indian inflation was more
than world rates. Cumulating of large public debt made the fiscal-monetary
combination followed in the past unsustainable. The automatic monetization
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of the government deficit was stopped and auction based market borrowing
adopted for meeting the fiscal deficits. The repressed financial regime was
disassembled, interest rates became more market determined and the
government began to borrow at market rates. All administered interest rates
were deregulated except the savings bank deposit rate. RBI initiated a
delivery versus payment mechanism for settlement of trades in government
securities was, leading to establishment of the CCIL (Clearing Corporation of
India),a central counterparty to undertake guaranteed settlement for
government securities, repos in G-secs and forex market trades.
The basic objectives of monetary policy remained price stability and
development, butin line with the recommendations of the Chakravarty
Committee (RBI, 1985), the operating procedures had shifted from credit
controls towards flexible monetary targeting with feedback from the mid1980s till 1997-98. However, deregulation of the financial markets combined
with the increasing openness of the economy in 1990s made money demand
more unstable, and money supply more remote. The RBI itself noted
monetary policy based on demand function of money, in these cases, was
expected to lack meticulousness.
% of their respective NDTL at 100 basis points above the repo rate to
provide a safety valve against unanticipated liquidity shocks
Bank Rate: It is the rate at which the Reserve Bank is ready to buy or
rediscount bills of exchange or other commercial papers. It also signals
the medium-term stance of monetary policy.
Market Stabilization Scheme (MSS): This instrument for monetary
management was introduced in 2004. Liquidity of a more enduring
nature arising from large capital flows is absorbed through sale of
short-dated government securities and treasury bills. The mobilized
cash is held in a separate government account with the Reserve Bank.
The Reserve Bank looks at both short term and longer term issues related to
liquidity management. In the longer term, it monitors the developments in
global financial markets, capital flows, the governments fiscal position and
inflationary pressures, with an eye toward encouraging strong and
sustainable economic growth.
References
1. https://www.imf.org/external/np/vc/2007/070507.htm
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2. http://www.thechinaguide.com/index.php?
action=preparation/moneyCurrency
3. http://www.economonitor.com/blog/2013/12/china-monetarypolicy-under-financial-repression/
4. http://www.wsj.com/articles/china-central-bank-pboc-cutsinterest-rates-1416567408
5. http://www.pbc.gov.cn/publish/english/963/index.html
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