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Macroeconomics Assignment:

Monetary Policy Analysis


The Reserve Bank Of India (RBI) is India's central banking institution, which controls the
monetary policy of the Indian Rupee. It is the apex bank in the Indian banking system. It is
the central bank of India. It acts as a guide, regulator, controller and promoter of the
financial system. RBI was established on 1st April 1935 in accordance with the provisions of
the Reserve Bank of India Act,1934.The Central Office of the Reserve Bank was initially
established in Calcutta but was permanently moved to Mumbai in 1937. Though originally
privately owned, RBI has been fully owned by the Government of India since nationalization
in 1949.

The Preamble of the Reserve Bank of India describes the basic functions of the Reserve
Bank as to regulate the issue of Bank Notes and keeping of reserves with a view to securing
monetary stability in India and generally to operate the currency and credit system of the
country to its advantage.

RBI plays a very important and critical role in the development strategy of India.
RBI Governers (Last 5)

Urjit Patel Raghuram Rajan D. Subbarao

Sep 2016 - Present Sep 2013-Sep 2016 Sep 2008-Sep 2013

Y.V. Reddy Bimal Jalan

Sep 2003 -Sep 2008 Nov 1997-Sep 2003
Role Of RBI

1. A Currency Authority
2. Banker to the Government
3. Advisor to the Government
4. Bankers Bank
5.Lender of the Last Resort
6.Supervision of the Banks
7.Controller of Money and Credit
8.Foreign Exchange Control and Management
9.Monetary Data Publication
10.Promotional Functions:
i) Promotion of Commercial Banks ii) Promotion of Co-Operative Banks
iii) Promotion of Agriculture and Rural Credit iv) Promotion of Industrial Finance
Monetary Policy
Monetary policy refers to the use of official instruments under the control of the central
bank to regulate the availability, cost and use of money and credit with the aim of achieving
optimum levels of output and employment,price stability, balance of payments equilibrium
or any other goals set by the state.

Monetary Policy involves "the management of a nation's money, credit and banking system by
the nation's central bank". It influences the supply, cost and availability of money and in turn
economic activities.

Legal Tender
Instruments Of Credit Control
Quantitative or General Methods

Bank Rate: The rate at which RBI discounts bills for commercial banks. This banking system
involves commercial and co-operative banks, Industrial Development Bank Of India,
IFC, EXIM Bank and other approved financial institutions. Funds are provided either
through lending directly or rediscounting or buying money market instruments like
Commercial Bills or Treasury Bills. Increases in Bank Rate increases the cost of
borrowing by commercial banks which results in the reduction of credit volume to
the banks and hence declines the money supply. Increase in Bank Rate means
tightening of RBI's monetary policy.

Repo Rate: The rate at which the Commercial Banks borrow money from RBI. Reduction in repo
rate helps the commercial banks to get money at a cheaper rate and an Increase in
repo rate discourages the commercial banks to get money as the rate increases and
becomes expensive. The increase in the repo rate will increase the cost of borrowing
and lending of the banks which will discourage the public to borrow money and
encourages them to deposit.
Cash Theportion of deposits which commercial banks have to keep with RBI in the form of
Cash Reserves. Higher the CRR with RBI, lower will be the liquidity in the system and
vice versa. The RBI is empowered to vary CRR between 3 and 15 percent.

Statutory Theportion oftotal deposits which commercial banks have to keep with RBI in the
form ofliquid assets viz. Gold, Cash or Government approved securities. The ratio of
the liquid assets to time and demand liabilities is termed as the Statutory Liquidity
Ratio Ratio.Banks have to report to the RBI every alternate Friday their SLR maintenance,
(SLR): and pay penalties for failing to maintain SLR as mandated.RBI is empowered to
increase this ratio up to 40%. An increase in SLR also restricts the bank's leverage
position to pump more money into the economy.

Reverse The rate at which theRBIborrow money fromthe Commercial Banks. An increase in
the reverse repo rate will decrease the money supply and vice-versa, other things
Repo Rate:
remaining constant. An increase in reverse repo rate means that commercial banks
will get more incentives to park their funds with the RBI, thereby decreasing the
supply of money in the market. An increase in the Repo Rate and the Reverse Repo
Rate indicates strengthening of RBI's monetary policy.
Key Indicators (As Of 8 April 2017)

Inflation 7.5%
Bank Rate 6.5%
CRR 4.000%
SLR 20.50%
Repo Rate 6.25%
Reverse Repo Rate 5.750%
Marginal Standing Facility Rate 6.5%
Qualitative or Selective Methods

Open Market An open market operation is an instrument of monetary policy which involves buying
and selling government securities from or to the public and banks. This mechanism
influences the reserve positions of the banks, yield on government securities and the
cost of bank credit. The RBI sells government securities to contract the flow of credit
and buys government securities to increase the flow of credit. Open Market
Operations makes bank rate policy effective and maintains stability in government
securities market.

Margin requirements are imposed to check the credit of speculative activities.

Government Securities, Shares, Essential Commodities are more prone to
Requirements speculation. Prices of these items are influencedby indulging in speculative
purchases with the help of bank loans. Higher margin is imposed to discourage such

Consumer's Consumers durables are very often purchased with the help of bank loans. Excess as
well as insufficient demand for these items disturb the production. Excess demand
also leads to speculation and black marketing. To avoid these problems consumer
Regulation: credit is required to be regulated.
Directives: The Central Bank issues directives written or oral to the commercial banks to follow
certain line of action. Commercial banks may be asked to be rigid or liberal in
granting loans or follow any other fiscal discipline demanded by the situation. The
success of this method depends on the prestige and power of the Central Bank.

Under this method the central bank may impose a ceiling on loans and advances.
Rationing Of
Such ceilings may be on aggregate lending or specific. Restrictions also may be
Credit: imposed on discounting facilities for individual bank.

Moral It refers to the various forms of appeals of the Central Bank to the commercial banks
to follow a particular line of action. Appeals of the Central Bank may take the form of
calling meeting of the heads of the commercial banks, letters or circulars, oral
request, discussion or any other informal ways of conveying the Central Banks
desire to commercial banks to implement the credit policy more rigorously.
How Does The Monetary Policy Affect
Inflation & Other Problems

Expansionary Policy Contractionary Policy

Problem : Recession & Unemployment Problem :Inflation

Measures:RBI buys securities through open Measures:RBIsellssecurities through open
market operations which reduces CRR, which market operations whichincreasesCRR and
ultimately lowers the bank rate. SLR, whichleads to increased margin against
As a result: holding of stock of goods.
Money Supply (+) As a result:
Interest Rate (-) Money Supply (-)
Investment (-) Interest Rate (+)
Aggregate Demand (+) Investment (+)
Aggregate Output (+) Aggregate Demand (-)
Price Level (-)
Analysis Of India's Monetary Policy
FY 2010-11
September 2010 April 2011

Repo Rate: 6% 6.75%

Reverse Repo Rate: 5% 5.75%
CRR: 6% 6% (-)
SLR: 24% (-) 24% (-)
Bank Rate: 6% (-) 6% (-)
Inflation: 9% 9.8%
CPI: 8.3% 9%
WPI: 9% 9.8%
GDP: 8.4% 7.8%
M3 15.4% 16%
IIP shows an increasing trend since tightening
of the monetary policy since Oct 2009.
Inflationary pressures rise as Inflation was up
to 9.8%.
Monetary Policy needs to persist with a firm
anti-inflationary stance.
IIP has moderated, GDP growth at 5 quarter
Liquidity easing off since Jun'10 till Jul'11
which is a good indicator.
FY 2011-12
September 2011 April 2012
Repo Rate: 8.50% 8%
Reverse Repo Rate: 7.25% 7%
CRR: 6% 4.75%
SLR: 24% (-) 24% (-)
Bank Rate: 6% (-) 9.50%
Inflation: 7.6% 9.6%
CPI: 9.3% 10.2%
WPI: 10.1% 7.5%
GDP: 8.5% 7.7%
M3 15.5% 15%
Liquidity conditions remained in a deficit mode throughout 2011-12. However, beginning November
2011, the liquidity deficit went beyond the comfort level of (+)/(-) one per cent of net demand and time
liabilities (NDTL) of banks.
Average net injection of liquidity under the daily liquidity adjustment facility (LAF) increased from
around `0.5 trillion during April-September 2011 to around `1.4 trillion during February 2012 and
further to `1.6 trillion during March 2012, partly reflecting a build-up in government cash balances.
Reserve Bank took steps to inject primary liquidity of a more durable nature. It conducted open market
operations (OMOs) aggregating around `1.3 trillion between November 2011 and March 2012.
Cash reserve ratio(CRR) was reduced by 125 basis points (50 basis points effective January 28, 2012 and
75 basis points effective March 10, 2012), injecting primary liquidity of about `0.8 trillion.
Inflation levels were also on a moderating trend since Feb'11 until Feb'12.
FY 2012-13
September 2012 April 2013
Repo Rate: 8% 7.5%
Reverse Repo Rate: 7% 6.5%
CRR: 4.25% 4%
SLR: 23% (-) 23% (-)
Bank Rate: 9% (-) 8.5%
Inflation: 7.5% 7.54%
CPI: 9.6% 9.4%
WPI: 7.6% 7.5%
GDP: 5.8% 4.5%
M3 14% -
In response to rising inflation pressures in the period January 2010 - October 2011, the Reserve Bank
started monetary tightening. This helped in moderating inflation from its peak of 10.9 per cent in April
2010 to an average level of 7.5 per cent over the period January-August 2012. Over this period,
however, growth slowed down and is currently below trend. This slowdown is due to a host of factors,
including monetary tightening.
Since April 2012, the monetary policy stance has sought to balance the growthinflation dynamic through
calibrated easing. The transmission of these policy impulses through the economy are done with a hope
of arresting the loss of growth momentum over the next few months. If inflation eases further, there
will be an opportunity for monetary policy to act in conjunction with fiscal and other measures to
mitigate the growth risks and take the economy to a sustained higher growth trajectory.
FY 2013-14
September 2013 April 2014
Repo Rate: 7.75% 8%(-)
Reverse Repo Rate: 6.75% 7%
CRR: 4%(-) 4% (-)
SLR: 23% 23% (-)
Bank Rate: 10.25% 9% (-)
Inflation: 6.74% 4.78%
CPI: 9.84% 8.1%
WPI: 6.46% 4.7%
GDP: 5% 5.8%
M3 - -
With output expansion of only 4.5 per cent in Q3 of 2012-13, the lowest in 15 quarters, cumulative
GDP growth for the period April-December 2012 declined to 5.0 per cent from 6.6 per cent a year ago. This
was mainly due to the protracted weakness in industrial activity aggravated by domestic supply
bottlenecks, and slowdown in the services sector reflecting weak external demand.
On the demand side, the persisting decline in capital goods production during April 2012 February 2013
reflects depressed investment conditions. The moderation in corporate sales and weakening
consumer confidence suggest that the slowdown could be spreading to consumption spending.
Liquidity remained under pressure throughout the year because of persistently high government cash
balances with the Reserve Bank and elevated incremental credit to deposit ratio for much of the year.
FY 2014-15
September 2014 April 2015
Repo Rate: 8% 7.50%
Reverse Repo Rate: 7% 6.5%
CRR: 4% 4%
SLR: 22% 21.50%
Bank Rate: 9% 8.50%
Inflation: 8% -
CPI: 5.2% 5.0%
WPI: 2.6% 2.4%
GDP: 7.4% 6.7%
M3 - -
Hailstorms in March affected 17% of the rabi crop
sown area which in turn impacted Food Inflation
which ultimately leads to rise in CPI Inflation.
Lower Indian interest rates helped stop the rupee
from strengthening further against other
currencies whose central banks are cutting
interest rates.
Indias consumer inflation edged up in February for
the third straight month, mainly driven by food
prices, underscoring the risk of a rebound in
inflationary pressures from rising commodity
FY 2015-16
September 2015 April 2016
Repo Rate: 6.75% 6.75%
Reverse Repo Rate: 6.4% 6.25%
CRR: 4% 4%
SLR: 21.50% 21.50%
Bank Rate: 8.25% 7.75%
Inflation: 3.7% 5%
CPI: 4.2% 5.4%
WPI: 5.0% 0.79%
GDP: 8.4% 7.6%
M3 - -
Japan escaped recession in Q4 of 2015, a
combination of weak consumer spending, business
investment and exports has slowed the economy in
Q1 of 2016. In China, sluggish industrial
production, contracting exports, capital outflows
and substantial excess capacity in factories and the
property market remain formidable headwinds,
not withstanding significant monetary and fiscal
policy stimulus.
Liquidity conditions, which had tightened since mid-December, were stretched further by the
larger-than-usual accumulation of cash balances by the Government, unusually heightened and
persistent demand for currency, a pick-up in bank credit and flatter deposit mobilization at this time
relative to past years. The Reserve Bank undertook liquidity operations to quell these pressures and
supplemented normal operations with large amounts of liquidity injected through fine-tuning
variable rate repo auctions in tenors ranging between overnight and 56 days.

Retail inflation measured by the consumer price index (CPI) dropped sharply in February after rising
for six consecutive months. This favorable development was due to a larger than anticipated decline
in vegetable prices, helped by prices of pulses starting to come off the surge that began in August,
and effective supply management that helped limit cereal price increases. Accordingly, food
inflation eased for the first time in the second half of 2015-16. Notably, this occurred on a decline in
prices rather than favorable base effects, which were at work in the first half of the year. Inflation in
the fuel group moderated across electricity, kerosene, cooking gas and firewood, the latter easing
pressures on rural inflation. Three months ahead household inflation expectations declined to a
single digit for the second consecutive round of the survey in response to these dynamics.
FY 2016-17
September 2016 April 2017
Repo Rate: 6.5% 6.25%
Reverse Repo Rate: 6% 6%
CRR: 4% 4%
SLR: 23% (-) 23% (-)
Bank Rate: 7% (-) 6.5%
Inflation: - 3.65%
CPI: 4.4% 3.6%
WPI: 3.57% 6.55%
GDP: 7.47% 7.0%
M3 - -
Demonetization Effects
The effects of demonetisation turning out to be short-lived and modest relative to
some doomsday expectations, the outlook for 2017-18 has been brightened
considerably by a number of factors.

First, with the accelerated pace of remonetisation, discretionary consumer spending

held back by demonetisation is expected to have picked up from Q4:2016-17 and will
gather momentum over several quarters ahead. The recovery will also likely be aided
by the reduction in banks lending rates due to large inflows of current and savings
accounts (CASA) deposits, although the fuller transmission impact might be impeded
by stressed balance sheets of banks and the tepid demand for bank credit.

Second, various proposals in the Union Budget 2017-18 are expected to be growth
stimulating: stepping up of capital expenditure; boosting the rural economy and
affordable housing; the planned roll-out of the GST; and steps to attract higher foreign
direct investment (FDI) through initiatives like abolishing the Foreign
Investment Promotion Board (FIPB).
Third, global trade and output are expected to expand at a stronger pace in 2017 and
2018 than in recent years, easing the external demand constraint on domestic growth
prospects. However, the recent increase in the global commodity prices, if sustained,
could have a negative impact on our net commodity importing domestic economy.

Finally, the pace of economic activity would critically hinge upon the outturn of the south-
west monsoon, especially in view of the rising probability being assigned to an el nio
event in July-August, 2017.

Considering the baseline assumptions, the fast pace of remonetisation, survey

indicators and updated model forecasts, RBI staffs baseline scenario projects that
real GVA growth will improve from 6.6 per cent in Q3:2016-17 and 6.5 per cent in Q4 to
7.0 per cent in Q1:2017-18 and 7.4-7.6 per cent in the remaining three quarters of 2017-
It was the large shock delivered by demonetisation and the associated wage shock that
explained much of the overall change in the inflation trajectory in the second
half of 2016-17. Past monetary policy tightening continued to have visceral effects in
containing inflation.

Prices of perishables played the most decisive role, even during the three months
preceding demonetisation. In the months immediately following demonetisation,
perishables became even more prominent, with vegetable price movements
becoming pivotal after a decline of 21 per cent during November 2016 to February 2017.
Transactions in fruits and vegetables have always been cash intensive.
Anecdotal evidence points to distress sales by farmers, given their perishable nature.
Vegetable prices usually do exhibit a seasonal moderation during November-
February every year; during the 2016-17 season, however, the decline in vegetable
prices was more pronounced than in previous years

The spatial and temporal dynamics of food prices post-demonetisation show that
within the food group, the decline in vegetable prices was particularly large and seen
across states and across wholesale and retail markets.
Domestic financial markets were impacted by twin shocks demonetisation and the US
presidential election results. The Union Budget announcements, the shift in the
monetary policy stance of the Reserve Bank and new data releases relating to
inflation and economic activity also influenced market movements.

Demonetisation drove a wall of liquidity into the money market. War-time liquidity
management by the Reserve Bank, however, limited the extent of softening of
money market rates relative to the policy repo rate within the liquidity adjustment
facility (LAF) corridor. G-sec yields moved in either direction, driven by
different factors.

The rupee displayed two-way movements up to mid-January, but since then, it has
appreciated on resumption of portfolio inflows in both the debt and equity segments.
Surplus liquidity conditions impelled and lubricated the transmission of monetary
impulses to deposit and lending rates.

However, credit growth, particularly to industry, remained sluggish on risk aversion

by banks due to high levels of stressed assets and weak demand in view
of the depressed investment cycle and the presence of spare capacity in
Made By:
Parang Mehta
Girish Khatri
Shresth Gupta
Mohommad Rehman
Uddeshya Ahuja
Ayush Mittal