By Mohammed Asif
Published On: December 25, 2021 at 13:00 IST
Introduction
Throughout the pandemic Reserve Bank of India has pleasantly surprised the market. The monthly economic review prepared by the ministry of finance held in their report that due to rapid vaccination in India which is 55% of the population has vaccinated one dose and 29% vaccinated both the doses due to which the omicron variants impact will be less severe to the economy. It also held that the real GDP in Q2 of FY2021-2022 has extended to 8.4%.[i]
The latest monetary policy was announced on December 8, 2021. In which the Repo rate stands at 4.00%, reverse repo rate stands at 3.35%, MSF (Marginal standing facility) stands at 4.25%, CRR (Cash Reserve Ratio) stands at 4.00%, SLR (Statutory Liquidity Ratio) stands at 18.00% and Bank rate stand at 4.25%.
In a theoretical sense, Monetary Policy maintains price stability while keeping in mind the growth’s objective because price stability is a requirement for sustainable growth. The monetary policy refers to the actions taken forward by the Reserve Bank of India to control the money supply and to accomplish sustainable growth.
How does Repo Rate affect the flow of money in the market?
In India, Repo Rate is decided bi-monthly by the RBIs Monetary policy committee. In Repo rate, REPO stands for repurchasing option rate. During the times of financial crux, people take loans from the banks and pay interest for that, likewise when the financial institutions and commercial banks face financial instability or shortage of funds, they also borrow money from RBI.
And the RBI grants money to those commercial banks at an interest rate on the amount obtained from the loan. Likewise, commercial banks sell eligible securities like various bond papers, gold, etc. to the RBI, when the bank repays the loan, they can repurchase those securities from the RBI.
There are certain components of Repo Rate transaction between banks and the RBI as below:
- RBI loans money in a legal agreement for the banks that needs collection. It can be securities and bonds. RBI obstructs and ascendence against securities from banks to grant monetary benefit.
- Repo Rate loans or undertakings count as temporary borrowings. Banks get sudden or term funds while the RBI has the collateral
- Banks can recover securities on a specified date and at a pre-decided price. This price is the loan amount and the interest amount is calculated on it at the Repo Rate
- RBI is approbated to sell these securities if banks turn tax-dodger and fail to repay the cash on a pre-decided date
- Banks take money to handle with insufficiency of cash reserves. And they take money to maintain the minimum reserve balance as a statutory measure.
RBI uses the repo rate as a restraining mechanism to control inflation and stabilize the economy. When repo rates rise it helps in contracting the economy when the price is shooting up way beyond. RBI takes the responsible position in the event of a hike or down-fall of inflationary pressures.
“The greater the Repo Rate the Higher the Cost of borrowing will be”[ii] thus the connection between the repo rate paid by the bank to India’s central bank and the rate of interests paid by the borrower to the bank is relatively proportional.
Comparison of Monetary Policies rates[iii]
| Policy rates | Latest | Previous | Reference |
| Interest rate | 4.00 percent | 4.00 percent | Dec 2021 |
| Cash Reserve Ratio (CRR) | 4.00 percent | 4.00 percent | Dec 2021 |
| Inter Bank Rate (IBR) | 3.49 percent | 3.52 percent | Dec 2021 |
| Money Supply M1 | 48354.38 INR Billion | 48200.32 INR Billion | Oct 2021 |
| Money Supply M2 | 52067.42 INR Billion | 49691.54 INR Billion | Nov 2021 |
| Money Supply M3 | 198180.52 INR Billion | 199158.04 INR Billion | Dec 2021 |
| Foreign Exchange Reserves | 635830.00 USD Million | 635910.00 USD Million | Dec 2021 |
| Central Bank Balance sheet | 33791.02 INR Billion | 34836.09 INR Billion | Nov 2021 |
| Loan group | 7.30 percent | 7.00 percent | Dec 2021 |
| Reverse Repo Rare | 3.35 percent | 3.35 percent | Dec 2021 |
Quantitative tools for Credit control
To restrain inflation quantitative and qualitative tools are used by the RBI to reduce the supply of money or increase the cost of funds. These are analogous to the quantity and volume of the money. Some of them are:
- Reserve ratio
The Reserve ratio plays an important part in regulating the money supply. It is of two types:
Cash Reserve Ratio (CRR)
Before determining the base rate (minimum lending rate below which is not allowed to grant funds) CRR serves as a reference rate which is decided by the RBI. CRR is used to regulate the money supply. “The more the Cash Reserve Ratio the less is the liquidity rates with the banks”. When RBI increases the CRR, dropping the loanable stakes eligible with the banks. Thus, this process helps in the slackening of investment and lowers the supply of money in the economy. Therefore, the progress of the economy is negatively affected. This helps to bring inflation down. RBI changes the repo rate and the reverse repo rate in line with the changing macroeconomic circumstances. Whenever RBI modifies the rates, it affects each sector of the economy; but in different ways. At present CRR stands at 4.00%
Statutory Liquidity Ratio (SLR)
Statutory liquidity ratio is the minimum percentage of stakes that a commercial bank continues through gold, bonds, and other securities. Every bank has liquid assets in the form of gold, cash, bond papers, and others the ratio of these liquid assets to the demand and time liabilities is called SLR. SLR has a ceiling limitation of 40% and a threshold limitation of 23%. The current rate of SLR is 18.00%. The main objectives of the SLR are- To hike and cut the flow of bank credit and to diminish the commercial banks from over liquidating.
- Open market operations
It is a monetary tool in which central banks buy and sell bonds to regulate the money supply in the economy. The United States uses open market operations through the federal reserve bank.
The objective of the federal reserve bank is to limit inflation during periods of healthy economic growth by reducing the economic supply of funds the bank puts breaks on the economy if it is expanding too quickly and when the economy is more sluggish its objectives may change.[iv] The federal bank regulates the money supply by purchasing bonds and other securities from the banks which increases the funds and banks can use them to lend loans to individuals and other businesses.
More cash in the banks results in more short-term interest rates and when borrowing costs are low economic activity tends to rise. By this, we can say that securities trading is one of the quickest and most effective ways to control economic activity.
Qualitative tools for Credit Control
These instruments aid or restrict the flow of credit to specific areas of economic activity. Some of them are:
- Margin requirements:
It refers to the part of the loan amount which cannot be borrowed from the bank. The difference between the value of securities offered for loans by the individuals and the value of loans granted for them. To reduce the money supply, the margin requirements are hiked by RBI and vice versa.
- Selective credit control:
It is a qualitative mechanism of credit control by the RBI. This mechanism aims far from general or quantitative methods, at the direction of credit taken for a particular purpose or any economic activity.
- Moral suasion:
It is a step taken by the RBI for assuring and guiding the commercial banks to stick to the policies and act correctly through general interaction.
- Rationing of credit:
It refers to the credit ceiling (that can be granted by the SCBs) being controlled by the RBI.
Pandemic effect on Monetary policy
The financial situation in recent months is turning highly tense as a consequence due to the Omicron variant. The retrieval of aggregate demand depends on the private investment which is still lingering due to the Covid-19 and the monetary policy committee has said that focusing the attention on headwinds emerging from the global developments is the main problem to the domestic aspect which is now marginally disordered due to the newly emerging variant Omicron and this variant has also added the difficulty when several other countries economics are battling with the Omicron due to the restrictions on travel from and to the other countries there is substantially high uncertainty on how the growth-inflation advancement will be planned and managed in the coming recent months.
Conclusion
India is a country where the macroeconomic implications will be on both the formal and informal sectors. This country has already taken two severe shocks and still recovering them: Demonetization in November 2016 and the introduction of the unplanned goods and services tax (GST) in 2017.
Though India was hit by demonetization which was indeed a very big monetary shock to everyone it did not cardinally disturb demand and supply mechanisms for too long. But due to the current pandemic covid situation, there is not only one question of finding employment but there are also numerous unanswered questions about demand and supply which is zero. Hence it directly affected the lack of underlying revenues.
India which has a vast number of firms in the informal sectors was forced to be shut down, which indirectly affects the large micro-finance sector, which layout support to countless micro-enterprises throughout the country.
But in recent times we have seen a rapid growth in vaccination in India where 51.5Cr of the population has been fully vaccinated with both doses. The considerable pick-up in the covid vaccinations gave immense confidence to open up and start economic activity all over again. Over this period RBI has taken charge and principally responded to the groundbreaking crisis. Based on an evaluation of the developing macroeconomic and financial status the Monetary policy committee decided to maintain the status quo in the Repo Rate policy and to continue the accommodative policy by a majority of 5 to 1. Therefore, the Bank rate and MSF (Marginal Standing Facility) remain unchanged at 4.25%, and the reverse repo rate also continued unchanged at 3.35%.[v]
As Mahatma Gandhi said “To lose patience is to lose the battle” is indeed an unerring piece of confidence which an egalitarian country like India need to always hope and have faith in.
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ABOUT THE AUTHOR
Mohammed Asif is a Third year Law student pursuing B.A.LLB(Hons) from ICFAI law school, Hyderabad. He is a future lawyer and Lifelong humanitarian who believes in consistency and hard work rather than talent.
Edited by: Aashima Kakkar, Associate Editor, Law Insider
References
[i] Reserve Bank of India – Publications (rbi.org.in)