Macro economic Policies

Macro economic Management implies aggregate demand management of the economy in order to ensure growth of employment, reduce fluctuations in the level of employment and output and containments of inflation This has been done in all economies through Monetary and fiscal policies

Monetary Policy
Money supply is one of the factors that influence the aggregate demand/expenditure of the economy

Monetary Magnitudes
M0 = Base Money Currency with the public M1 = Currency with public+ Demand deposits with banks+ Other Deposits with RBI M2 = M1+ Post Office Deposits M3 = M1+ Time Deposits with Banks M4 = M3+ Total Post Office Deposits

What is Monetary Policy?

The term monetary policy refers to actions taken by central banks to affect monetary magnitudes/regulate money supply in the economy. Monetary Policy ultimately operates through its influence on expenditure ( consumption & investment) flows in the economy Monetary Policy operates on monetary magnitudes or variables such as money supply/M0&M1, interest rates and availability of credit./M3 In other words affects liquidity and by affecting liquidity, and thus credit, it affects total demand in the economy.

Growth of M3 and Differential Contribution of Components

Credit Policy
Central Bank may directly affect the money supply to control its growth by reducing M0-base money Or it might act indirectly to affect cost and availability of credit in the economy by regulating M3. In modern times the bulk of money in developed economies consists of bank deposits rather than currencies and coins. So central banks today guide monetary developments with instruments that control over deposit creation and influence general financial conditions. Credit policy is concerned with changes in the supply of credit. Central Bank administers both the Credit and Monetary policy

Aims of Monetary policy

MP is a part of general economic policy of the govt. Thus MP contributes to the achievement of the goals of economic policy. Objective of MP may be: Full employment Stable exchange rate Healthy BoP Economic growth Reasonable Price Stability Greater equality in distribution of income & wealth Financial stability

Economic growth : Monetary policy can be framed to influence the rapid economic growth. Economic growth is defined as process generating employment in a country over a long period of time. Also it is measured by the increase in the amount of goods and services produced in a country. A growing economy produces more goods and services in each successive time period. Thus, growth occurs when an economys thus, economic growth implies raising the standard of living of the people, and reducing inequalities of income distribution.

 To control inflationary pressures, monetary policy requires the use of both quantitative and qualitative methods of credit control. The open market operations are not successful in controlling inflation in underdeveloped countries as the bill market is small and undeveloped.

 To create banking and financial institution : To create banking and financial institution One of the monetary policies in an underdeveloped country is to create and develop banking and financial institution to mobilize and channelize saving for capital formation.

 establishment of branch banking in rural areas and urban areas should be encouraged. It will help in monetizing the non-monetised sector and encourage saving and investment for capital formation.

 Debt management : Debt management It is one of the important function of monetary policy in an under developed country it aims at proper timing and issuing of government bonds, stabilizing their prices and minimizing the cost of servicing the public debt. The primary aim of debt management is to create conditions in which public borrowing can increase from year to year borrowing. This is essential in order to finance development program and to control the money supply.

Price Stability: The Dominant Objective

There is convergence of views in developed and developing economies, that price stability is the dominant objective of monetary policy. Price stability does not mean complete year-toyear price stability which is difficult to attain. Price stability refers to the long run average stability of prices. Price stability involves avoidance of both inflationary and deflationary pressures.

Contd..
Price Stability contributes improvements in the standard of living of people. It promotes saving in the economy while discouraging unproductive investment. Stable prices enable exports to compete in international markets and contribute to the strengthening of BoP. Price stability leads to interest rate stability, and exchange rate stability (via export import stability). It contributes to the overall financial stability of the economy.

struments
Discount Rate (Bank Rate)

Operation of Monetary Policy

Operating Target
Monetary Base Bank Credit Interest Rates

Reserve Ratios

Open Market Operations

Intermediate Target
Monetary Aggregates(M3) Long term interest rates

Ultimate Goals
Total Spending Price Stability Etc.

Instruments of Monetary Policy

Variations in Reserve Ratios Discount Rate (Bank Rate) (also called rediscount rate) Open Market Operations (OMOs) Other Instruments Such as selective credit control

Variations in Reserve Ratios

Banks are required to maintain a certain percentage of their deposits in the form of reserves or balances with the RBI It is called Cash Reserve Ratio or CRR Since reserves are high-powered money or base money, by varying CRR, RBI can reduce or add to the banks required reserves and thus affect banks ability to lend.

Discount Rate (Bank Rate)

Discount rate is the rate of interest charged by the central bank for providing funds or loans to the banking system. Funds are provided either through lending directly or rediscounting or buying commercial bills and treasury bills. Raising Bank Rate raises cost of borrowing by commercial banks, causing reduction in credit volume to the banks, and decline in money supply. Variation in Bank Rate has an effect on the domestic interest rate, especially the short term rates. Market regards the increase in Bank rate as the official signal for beginning of a tight money situation.

Open Market Operations (OMOs)

OMOs involve buying (outright or temporary) and selling of govt securities by the central bank, from or to the public and banks. RBI when purchases securities, pays the amount of money by crediting the reserve deposit account of the sellers bank, which in turn credits the sellers deposit account in that bank.

RBI Annual Policy Statement for 2006-07: April 18, 2006

Highlights
Focus on credit quality and financial market conditions for maintaining macroeconomic, in particular, financial stability. Monetary and interest rate environment enabling growth momentum consistent with price stability. Bank Rate, Reverse Repo Rate, Repo Rate and Cash Reserve Ratio kept unchanged. GDP growth projection for 2006-07 at 7.5-8.0 per cent. Inflation to be contained within 5.0-5.5 per cent during 200607. M3 projected to expand by around 15.0 per cent for 2006-07. In normal circumstances, the policy preference would be for maintaining a lower order of money supply growth in 2006-07. Deposits projected to grow by around Rs.3,30,000 crore for 2006-07.

 Adjusted non-food credit projected to increase by around 20 per cent, implying a calibrated deceleration from a growth of around 30 per. Appropriate liquidity to be maintained to meet legitimate credit requirements, consistent with price and financial stability. Primary Dealers to be permitted to diversify their activities. Barring the emergence of any adverse and unexpected developments in various sectors of the economy and keeping in view the current assessment of the economy including the outlook for inflation, the overall stance of monetary policy at this juncture will be: to ensure a monetary and interest rate environment that enables continuation of the growth momentum consistent with price stability while being in readiness to act in a timely and prompt manner on any signs of evolving circumstances impinging on inflation expectations. to focus on credit quality and financial market conditions to support export and investment demand in the economy for maintaining macroeconomic, in particular, financial stability. to respond swiftly to evolving global developments.

Annual Policy Statement 2006-07

The Statement consists of two parts: Part I. Annual Statement on Monetary Policy for the Year 2006-07; and Part II. Annual Statement on Developmental and Regulatory Policies for the Year 2006-07.

PART I Domestic Developments

The upward revision of real GDP growth to 7.5-8.0 per cent in the Third Quarter Review of January 24, 2006 turned out to be in alignment with the advance estimate of the Central Statistical Organisation at 8.1 per cent for 2005-06, up from 7.5 per cent in the previous year. Inflation, measured by variations in the wholesale price index (WPI) on a year-onyear basis, was 4.0 per cent at end-March 2006 and 3.5 per cent as on April 1, 2006 after receding from a peak of 6.0 per cent on April 23, 2005. The average price of the Indian basket of international crude oil ruled at around US $ 60.1 per barrel in January-March, 2006 higher by 30.2 per cent than a year ago. The year-on-year M3 growth was 16.2 per cent (Rs.3,77,238 crore) in 2005-06 (March 31, 2006 over April 1, 2005) as compared with 12.1 per cent (Rs.2,42,260 crore), net of conversion, in the previous year.

Excluding the end-March effect, the year-on-year increase in aggregate deposits during 2005-06 (March 31, 2006 over April 1, 2005) was 16.9 per cent (Rs.3,02,534 crore) as against an increase of 12.8 per cent (Rs.1,92,269 crore), net of conversion, in the previous year. Excluding the end-March build-up, the year-on-year increase in non-food bank credit during 2005-06 (over April 1, 2005) was 30.8 per cent (Rs.3,42,493 crore) on top of 27.5 per cent (Rs.2,21,602 crore), net of conversion, a year ago. Financial markets remained generally stable during 2005-06 although interest rates firmed up in all segments and the uncollateralised overnight call market experienced persistent tightness during the last quarter of the year. A noteworthy and desirable development during the year was the substantial migration of money market activity from the uncollateralised call money segment to the collateralised market repo and collateralised borrowing and lending obligations (CBLO) markets. The total overhang of liquidity as reflected in outstandings under the Liquidity Adjustment Facility (LAF), the Market Stabilisation Scheme (MSS) and surplus cash balances of the Central Government taken together declined from an average of Rs.1,14,192 crore in March 2005 to Rs.74,334 crore in March 2006. For the first time since 1969, investment by SCBs in Government and other approved securities declined by Rs.11,576 crore in 2005-06 in contrast to an increase of Rs.49,373 crore, net of conversion, in 2004-05. During 2005-06, the Central Governments net market borrowings at Rs.95,370 crore were 86.5 per cent of the budgeted amount of Rs.1,10,291 crore and gross market borrowings of Rs.1,58,000 crore were 88.5 per cent of the budgeted amount of Rs.1,78,487 crore.

Overall Assessment
Macroeconomic and financial conditions have evolved as stronger than expected. Inflation has been contained well within the projected range as reflected in the relative stability of long-term interest rates. There are indications of improvement in the fiscal situation and the return to the path of correction set by the Fiscal Responsibility and Budget Management Rules. Global growth has also exhibited considerable resilience. Downside risks to the economic outlook internationally continue in the form high and volatile oil prices, geo-political tensions and supply shocks, elevated asset prices, global imbalances and tightening of monetary policy globally. In the domestic economy, non-food credit growth, deposit growth and money supply growth were higher than the projections. Asset prices have registered a substantial increase. Ensuring credit quality and increasing the pace of investment in infrastructure is important.

Monetary Measures
As on 18th April 2006: Bank Rate kept unchanged at 6.0 per cent. Reverse Repo Rate and Repo Rate kept unchanged at 5.5 per cent and 6.5 per cent, respectively. Cash reserve ratio (CRR) kept unchanged at 5.0 per cent. As on 15th Oct 2006: Policy Rates Bank Rate: 6% Repo Rate: 7% Reverse Repo Rate: 6% Reserve Ratios CRR: 5% SLR: 25%