Impact of RBI?s Monetary Policy for the Last Two Decades and Medium Te

We are indebted to Prof.Bala V Balachandran, Prof.Lakshmi Kumar. The views expressed herein are those of the author and not necessarily those of the Great Lakes Institute of Management.

© 2004 by Kaushik.P All rights reserved. Short sections of text, not to exceed two paragraphs, may be quoted without explicit permission provided that full credit, including © notice, is given to the source.

"Impact of RBI’s Monetary Policy for the Last Two Decades and Medium Term Strategy for Managing Foreign Exchange Reserves."

--Macro Economics

Kaushik.P

Srinagar Colony, Off Raj Bhavan Road,

24, South Mada Street,

Chennai - 600015, India

Preamble:

The Monetary Policy, traditionally announced twice a year, regulates the supply of money and the cost and availability of credit in the economy. It deals with both the lending and borrowing rates of interest for commercial banks. The Monetary Policy aims to maintain price stability, full employment and economic growth. The Reserve Bank of India is responsible for formulating and implementing Monetary Policy. It can increase or decrease the supply of currency as well as interest rate, carry out open market operations, control credit and vary the reserve requirements.

Objectives:

The objective of price stability has, however, gained further importance following the opening-up of the economy and the deregulation of financial markets in India in recent times.

There are four main 'channels' which the RBI looks at:

· Quantum channel: money supply and credit (affects real output and price level through changes in reserves money, money supply and credit aggregates).

· Interest rate channel.

· Exchange rate channel (linked to the currency).

· Asset price.

Monetary Policy:

Pre-Reform (Prior 1992)

In the pre-reform era, the financial market in India was highly segmented and regulated. The money market lacked depth, with only the overnight interbank market in place. The interest rates in the government securities market and the credit market were tightly regulated. The dispensation of credit to the Government took place via a statutory liquidity ratio (SLR) process whereby the commercial banks were made to set aside substantial portions of their liabilities for investment in government securities at below market interest rates. Furthermore, credit to the commercial sector was regulated, with prescriptions of multiple lending rates and a prevalence of directed credit at highly subsidised interest rates. Monetary policy had to address itself to the task of neutralising the inflationary impact of the growing deficit. The Reserve Bank had to resort to direct instruments of monetary control, in particular the cash reserve ratio.