Monetary Policy Tools and Highlights of RBI’s first bi—monthly monetary policy statement, 2016—17 and its Impact on Indian Economy

The Goals of Monetary Policy

  • Primarily price stability, while keeping in mind the objective of growth.
  • In India, subsequent to the recommendations of the Dr. Urjit Patel Committee Report, the Reserve Bank has formally announced a “glide path” for disinflation that sets an objective of below 8 per cent CPI inflation by January 2015 and below 6 per cent CPI inflation by January 2016.
  • The agreement on Monetary Policy Framework between the Government and the Reserve Bank of India dated February 20, 2015 defines the price stability objective explicitly in terms of the target for inflation – as measured by the consumer price index-combined (CPI-C) – in the near to medium-term, i.e., (a) below 6 per cent by January 2016, and (b) 4 per cent (+/-) 2 per cent for the financial year 2016-17 and all subsequent years.
  • Price stability is a necessary (if not sufficient) precondition to sustainable growth and financial stability. The relative emphasis assigned to price stability and growth objectives in the conduct of monetary policy varies from time to time depending on the evolving macroeconomic environment. Financial stability is important for smooth transmission of monetary policy and, therefore, regulatory and financial market policies, including macro-prudential policies, are often announced along with monetary policy under Part-B of monetary policy statements

Instruments of Monetary Policy
There are several direct and indirect instruments that are used in the implementation of monetary policy.

Cash Reserve Ratio (CRR): The share of net demand and time liabilities (deposits) that banks must maintain as cash balance with the Reserve Bank.
Statutory Liquidity Ratio (SLR): The share of net demand and time liabilities (deposits) that banks must maintain in safe and liquid assets, such as, government securities, cash and gold. Changes in SLR often influence the availability of resources in the banking system for lending to the private sector.
Refinance facilities: Sector-specific refinance facilities aim at achieving sector specific objectives through provision of liquidity at a cost linked to the policy repo rate. The Reserve Bank has, however, been progressively de-emphasising sector specific policies as they interfere with the transmission mechanism.
Liquidity Adjustment Facility (LAF): Consists of overnight and term repo/reverse repo auctions. Progressively, the Reserve Bank has increased the proportion of liquidity injected in the LAF through term-repos.
Term Repos: Since October 2013, the Reserve Bank has introduced term repos (of different tenors, such as, 7/14/28 days), to inject liquidity over a period that is longer than overnight. The aim of term repo is to help develop inter-bank money market, which in turn can set market based benchmarks for pricing of loans and deposits, and through that improve transmission of monetary policy.
Marginal Standing Facility (MSF): A facility under which scheduled commercial banks can borrow additional amount of overnight money from the Reserve Bank by dipping into their SLR portfolio up to a limit (currently two per cent of their net demand and time liabilities deposits) at a penal rate of interest (currently 100 basis points above the repo rate). This provides a safety valve against unanticipated liquidity shocks to the banking system. MSF rate and reverse repo rate determine the corridor for the daily movement in short term money market interest rates.
Open Market Operations (OMOs): These include both, outright purchase/sale of government securities (for injection/absorption of liquidity)
Bank Rate: It is the rate at which the Reserve Bank is ready to buy or rediscount bills of exchange or other commercial papers. This rate has been aligned to the MSF rate and, therefore, changes automatically as and when the MSF rate changes alongside policy repo rate changes.
Market Stabilisation Scheme (MSS): This instrument for monetary management was introduced in 2004. Surplus liquidity of a more enduring nature arising from large capital inflows is absorbed through sale of short-dated government securities and treasury bills. The mobilised cash is held in a separate government account with the Reserve Bank. The instrument thus has features of both, SLR and CRR.

Following are the highlights of RBI’s first bi—monthly monetary policy statement, 2016—17:

Repo rate cut by 0.25% to 6.50%

Reverse repo hiked by 0.25% to 6%

Cash reserve ratio or CRR unchanged at 4%

Minimum daily cash maintenance by banks with RBI cut by 5%

MSF rate cut by 0.75% to lower banks’ borrowing cost

Policy to remain accommodative going forward

Pegs 2016—17 growth forecast at 7.6%

Expects inflation at around 5%

Cut in small savings rate, MCLR introduction to improve monetary policy transmission

Government adhering to fiscal consolidation path will help lower inflation

7th Pay Commission award to put upward pressure of up to 1.5% on inflation

Proposes custodian banks; banks focusing on wholesale and long term financing

Second bi—monthly monetary policy on June 7

Source : ET & Business Line

Impact of MONETARY POLICY: 2016-17 : RATES & RATIOS

1. Repo Rate reduced to 6.50%. This means banks will have cushion to reduce lending and deposit rates sooner or later.
2. Reverse Repo Rate is now 6%. The increase in this rate is good for banks. Because banks get higher returns on their surplus funds kept with RBI.
3. Marginal Standing Facility rate now is 7%. This rate is linked to Repo rate ( 50 bps higher than Repo rate)
4. Bank Rate is at 7%. ( Bank Rate and MSF rate are at the same rate)
5. Cash Reserve Ratio is at 4% of NDTL. This is a structural liquidity and hence, RBI does not change CRR often.
6. Statutory Liquidity Ratio ( SLR) now stands at 21.25% of NDTL. SLR reflects Government borrowings and through SLR securities banks borrow from RBI.
7. RBI has provided more liquidity to banks by reducing the minimum cash maintenance with banks.
Important to note is :
If Repo rate is 6.5 %, Reverse Repo will be 50 bps lower ( 6%); MSF will be 50 bps higher ( 7%). Bank rate and MSF will be same ( 7% each).

Source: Shri Arvind Mannur. Follow Link: Shri Arvind Mannur

WHAT ARE THE EFFECTS OF MONETARY POLICY 2016-17 ?

1. Since RBI has given more liquidity to banks, banks have cushion and may in future reduce
deposit rates. Not so good news for deposit holders.
2. After reducing deposit rates, banks will reduce MCLR ( Marginal Cost of Lending Rates). This will reduce EMI of borrowers. There will be more credit pick-up.
3. The inter-bank call money rates will move between Repo Rate ( 6.50%) & Reverse Repo Rate ( 6.00%). Call rates may not go up beyond 6.50%. Good for borrowing banks. The interest rate corridor (gap between Repo & Reverse Repo rates) is reduced to 50 bps.
4. Marginal Standing Facility (MSF) is now at 7%. Good for banks to borrow at relatively cheaper rates.
5. Bank Rate (7%) is redundant now. Hence, no impact.
6. Since inflation is falling, Government will give importance to growth. Banks will have to aggressively use RBI liquidity facility and lend more (but carefully)
7. RBI tries to provide liquidity to banks. It is the responsibility of banks to use liquidity to develop business. Here lies the efficiency of banks. Good banks are expected to expand loan book by using RBI liquidity.
8. Banks should have good Treasury department and Credit department to work together to increase business & profits,
9. Good CASA + Borrowing from RBI+ Increased Fee Business+ Better alignment of Assets & Liabilities will make banks stronger.
10. Now the Corporate Office has to guide the business growth. And branches have to bring more business. This is the challenge and difficult task.

 Source: Arvind Mannur Link:Arvind Mannur
 
 
 
 
 

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