Monetary policy is the policy announced by the central bank (RBI in India) of the country to control the money supply, inflation, and interest rates within the economy. In India, Reserve Bank of India announces its monetary policy every two months.
There is a monetary policy committee within the RBI headed by the governor of the bank which decides about the policy rates. The Monetary policy committee is comprised of six members, three from the RBI and three members are nominated by the central government for a time period of four years (cannot be reappointed). The Structure of the monetary policy committee is shown in the diagram.
Tools of Monetary Policy
As we need steering, brakes, and accelerator to control the direction and speed of our vehicles while driving, in the similar way to control the money supply, inflation, deflation, growth and interest rates etc RBI also has some tools within the monetary policy. These tools may be broadly divided into quantitative and qualitative tools. These are shown in the chart below:
We will take a brief look at these tool one by one:
The CRR stands for Cash Reserve Ratio. This is a quantitative tool which gives power to RBI under the RBI Act 1934 to prescribe what percentage of the Net Demand and Time Liabilities (NDTL) banks have to keep with themselves in the cash form to protect the bank against bank runs etc. Currently, the CRR rate is set at 4 per cent which used to be very high before the economic reforms of 1991. Bank doesn’t get any interest on CRR money now, while during the period of 2000 to 2007 RBI used to provide interest to bank on CRR because of the slowdown in the banking sector at that time.
It stands for Statutory Liquidity Ratio. This is also a quantitative tool which gives power to RBI under the Banking Regulation Act of 1949 to prescribe what percentage of NDTL banks have to keep with themselves in the liquid form i.e. either in the form of cash, gold, or in the form of government securities approved by the RBI. Currently, the SLR is set at 19.5 per cent.
Also called the Repurchase Option. It is the rate at which RBI gives a short-term loan to its clients with government securities as collateral. Repo rate is also called the policy rate because the rates like Reverse Repo Rate and Marginal Standing Facility Rate are aligned to it. Currently, the Repo rate is 6.5 per cent while the reverse repo and MSF are set at 6.25 and 6.75 respectively. The Repo rate along with reverse repo and MSF rate forms the policy corridor.
Open Market Operation
Under the OMO, RBI purchases and sells government securities using its E-Kuber platform ( CBS of RBI) to manage the short-term requirements of the central government and also to manage the liquidity in the system. RBI fulfils ways and means advances of the government through this open market operation.
Marginal Standing Facility
This is somewhat like the Repo but not exactly. By using this MSF facility all the scheduled commercial banks expect RRBs are eligible to borrow a maximum of 1 per cent of NDTL by putting the SLR quota securities as the collateral. Keep in mind while borrowing from RBI under Repo rate banks can’t put their SLR quota securities as collateral.
Current monetary policy rates
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