PRESENTATION

ON CENTRAL BANKING POLICY

CENTRAL BANK
A central bank, reserve bank, or monetary authority is a public institution that manages a state's currency, money supply, and interest rates. Central banks also usually oversee the commercial banking system of their respective countries. In contrast to a commercial bank, a central bank possesses a monopoly on increasing the nation's monetary base, and usually also prints the national currency, which usually serves as the nation's legal tender.

FUNCTIONS OF A CENTRAL BANK MAY INCLUDE :

Bank

of Issue Monetary authority Managerial of exchange control Issuer of currency Banker of Banks

MONETARY POLICY

Monetary policy is the process by which the

central bank, or monetary authority of a country controls

(i)

the supply of money,

(ii)
(iii)

availability of money, and

cost of money or rate of interest

to attain a set of objectives oriented towards the

growth and stability of the economy.

Monetary theory provides insight into how to craft optimal monetary policy.

Monetary policy rests on the relationship between the rates of interest in an economy, that is the price at which money can be borrowed, and the total supply of money. Monetary policy uses a variety of tools to control one or both of these, to influence outcomes like economic growth, inflation, exchange rates with other currencies and unemployment. Where currency is under a monopoly of issuance, or where there is a regulated system of issuing currency through banks which are tied to a central bank, the monetary authority has the ability to alter the money supply and thus influence the interest rate (to achieve policy goals).

GOALS OF MONETARY POLICY

High employment Price stability Economic growth Interest rate stability Financial market stability Foreign exchange market stability

POLICY TOOLS
The main monetary policy instruments available to central bank are open market operation bank reserve requirement interest rate policy re-lending and re-discount (including using the term repurchase market), and credit policy

1. OPEN MARKET OPERATIONS

Through open market operations, a central bank influences the money supply in an economy directly. Each time it buys securities, exchanging money for the security, it raises the money supply. Conversely, selling of securities lowers the money supply. Buying of securities thus amounts to printing new money while lowering supply of the specific security.

THE MAIN OPEN MARKET OPERATIONS ARE:

Temporary lending of money for collateral securities ("Reverse Operations" or "repurchase operations", otherwise known as the "repo" market). These operations are carried out on a regular basis, where fixed maturity loans (of one week and one month for the ECB) are auctioned off. Buying or selling securities ("direct operations") on ad-hoc basis. Foreign exchange operations such as forex swaps.

2. BANK RATE OF INTEREST

It is the interest rate which is fixed by the RBI to control the lending capacity of Commercial banks. During Inflation , RBI increases the bank rate of interest due to which borrowing power of commercial banks reduces which thereby reduces the supply of money or credit in the economy. When Money supply Reduces it reduces the purchasing power and thereby curtailing Consumption and lowering Prices. Bank Rate = 9% (Current)

3. CASH RESERVE RATIO

CRR, or cash reserve ratio, refers to a portion of deposits (as cash) which banks have to keep/maintain with the RBI. During Inflation RBI increases the CRR due to which commercial banks have to keep a greater portion of their deposits with the RBI . This serves two purposes. 1. It ensures that a portion of bank deposits is totally risk-free and 2. Secondly it enables that RBI control liquidity in the system, and thereby, inflation. CRR = 4.75% (Current)

4. STATUTORY LIQUIDITY RATIO

Apart from the CRR, banks are required to maintain liquid assets in the form of gold, cash and approved securities. Higher liquidity ratio forces commercial banks to maintain a larger proportion of their resources in liquid form and thus reduces their capacity to grant loans and advances, thus it is an anti-inflationary impact. A higher liquidity ratio diverts the bank funds from loans and advances to investment in government and approved securities. If SLR increases, the lending capacity of commercial banks decreases thereby regulating the supply of money in the economy. SLR = 23% (Current)

5. EXCHANGE REQUIREMENTS
To influence the money supply, central bank may require that some or all foreign exchange receipts (generally from exports) be exchanged for the local currency. The rate that is used to purchase local currency may be market-based or arbitrarily set by the bank. In this method, money supply is increased by the central bank when it purchases the foreign currency by issuing (selling) the local currency. The central bank may subsequently reduce the money supply by various means, including selling bonds or foreign exchange interventions.

6. DISCOUNT WINDOW LENDING

Discount window lending is where the commercial banks, and other depository institutions, are able to borrow reserves from the Central Bank at a discount rate. This rate is usually set below short term market rates (T-bills). This enables the institutions to vary credit conditions (i.e., the amount of money they have to loan out), thereby affecting the money supply.

RBI'S ANNUAL MONETARY POLICY 2012-13

In Annual Monetary Policy 2012-13, RBI surprised markets by easing Repo rate by 50 bps(basis point) to 8%. The consensus market expectations were for a cautious 25 bps cut. Policy Rate changes Repo rate lowered by 50 bps to 8% Reverse Repo rate and Marginal Standing Facility (MSF) Rate automatically lowered by 50 bps at 7% and 9% respectively. Further, RBI increased borrowing under MSF from 1% of NDTL to 2% of NDTL. Banks with excess SLR can also borrow under MSF. CRR remains unchanged at 4.75% of NDTL (Net Demand & Time Liability).

Economic Projections RBI pegged the growth forecast for 2012-13 at 7.3% vs.7.0% projection for 2011-12 Inflation projection lower at 6.5% in Mar-13 lower than7% in Mar-12 Money supply growth for 2012-13 pegged at 15% slightly lower than 15.5% for 2011-12 Credit growth increased to 17% for 2012-13 compared to 16% for 2011-12

Forward guidance statement RBI indicates that space is limited for further reduction in policy rates given growth- inflation dynamics. Administered prices of petroleum products should be increased to reflect their true cost of production. Liquidity conditions are expected to be stable and move to RBIs comfort zone of 1% of NDTL. The increase in MSF limits will also help banks. In case the situation changes, appropriate steps will be taken.

FISCAL POLICY
In economics and political science, fiscal policy is the use of government revenue collection (taxation) and expenditure (spending) to influence the economy. The two main instruments of fiscal policy are government taxation and expenditure. Fiscal policy refers to the use of the government budget to influence economic activity.

STANCES OF FISCAL POLICY

The three main stances of fiscal policy are: 1. Neutral fiscal policy is usually undertaken when an economy is in equilibrium. Government spending is fully funded by tax revenue and overall the budget outcome has a neutral effect on the level of economic activity. 2. Expansionary fiscal policy involves government spending exceeding tax revenue, and is usually undertaken during recessions. 3. Contractionary fiscal policy occurs when government spending is lower than tax revenue, and is usually undertaken to pay down government debt.

DIFFERENCES
MONETARY POLICY

FISCAL POLICY

Monetary Policy is being implemented by the central bank i.e. the RBI A monetary policy is expected to improve the economy's rate of growth of output (which is measured by GDP). Tight or restrictive monetary policy is designed to slow the economy in the future to offset inflationary pressures

Fiscal policy decisions are set by the National Govt. Fiscal policies, tax cuts, and spending increases are normally expected to stimulate economic growth in the short run, while tax increases and spending cuts tend to slow the rate of future economic expansion.

MONETRY POLICY

FISCAL POLICY

Monetary Policy is a process which controls the demand and supply of money. Monetary Policy is been referred to as expansionary or Contractionary policy.

Whereas Fiscal policy deals in govt. spending and revenue collection by the way of tax. For fiscal policy there are three possible positions: 1. Neutral Position 2. Expansionary Position 3. Contractionary Position

MSF
MSF is the rate at which banks can borrow overnight from RBI. This was introduced in the monetary policy of RBI for the year 2011-2012. The MSF is pegged 100bps or a % above the repo rate. Banks can borrow funds through MSF when there is a considerable shortfall of liquidity. This measure has been introduced by RBI to regulate short-term asset liability mismatches more effectively