Monetary Policy in India

Topics: Monetary policy, Central bank, Federal Reserve System Pages: 142 (39406 words) Published: March 5, 2013
This chapter deals with two sections such as ‗Instruments of Monetary Policy in India‘ and ‗Money, Prices and Output in India‘. The former examines the first objective of the study, i.e. to understand the changing role and importance of monetary tools in India and the latter deals with the second and third objectives of the research work. Our second objective is to find out how much monetary policy ensures financial stability and third objective is to analyze its role in facilitating growth. SECTION-1

Being the first part of this analysis chapter, we are going to take a cautious step to enter into the area of ‗instruments of monetary policy in India‘. Generally, there are two sub-divisions among the monetary policy techniques, such as quantitative and qualitative methods and they are popularly known as general and selective credit controlling measures.

Among the various techniques and methods, we have taken into account the most important and selected monetary instruments such as Bank rate, CRR, SLR, OMO, and Repo and Reverse Repo rates; the new members of monetary management, along with selective credit control measures.

6.1.1. BANK RATE
The dictionary meaning of Bank Rate is the discount rate of a central bank. Now it is known as the base rate and it is also called as the Minimum Lending Rate (MLR). It is the rate at which the central bank lent to the other banks. According to M. Spalding, the bank rate is ―the minimum rate charged by the central bank for discounting approved bills of exchange.‖ Hence, being the ‗lender of 269

last resort‘, the central bank helps the commercial banks by rediscounting the first class bills, i.e. by advancing loans against approved securities. The Reserve Bank of India Act defines Bank Rate as ―the standard rate on which it is prepared to buy or rediscounts bills of exchange or other commercial papers eligible for purchase under this Act‖. That is why Bank Rate is known as the ‗Rediscount Rate‘.

In India, the Bill market is not so well developed and the RBI makes advances to banks mainly in other forms such as against Government securities and as refinance. Hence, the bank rate is not the key lending rate, though it does form the basis for multiplicity of the RBI‘s lending rates charged for various types of advances. However, the efficiency of this as a tool of credit control has often been questioned. Bank Rate is usually, more sticky than other rates. Changes in it are always discontinuous. Since bank rate changes have ‗announcement effect‘, i.e. effects or market reactions produced by the mere announcement of a change in the bank rate, central banks avoid making frequent changes in the bank rate, even though changing conditions may warrant such variations.

Generally, Bank rate policy aims at influencing the level of economic activity, the cost and availability of credit to the commercial banks, and the interest rates and money supply in the economy. There is a direct relationship between the bank rate and the market interest rates. A change in the bank rate leads to change in other interest rates prevailing in the market, although there is a clear cut distinction between the two. In this sense, bank rate can be considered as an effective rate in the market. Changes in the bank rate influence the entire interest rate structure, i.e. short-term as well as long term interest rates. A rise in the bank rate leads to a rise in the other market interest rates, which implies a clear money policy increasing the cost of borrowing. Similarly, a fall in the bank rate results in a fall in the other market rates, which implies a cheap money policy reducing the cost of borrowing. According to Hawtrey, the bank rate policy alters the short-term interest rates in the market, which influence the level of economic activity...
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