Impact of Monetary Policy on Indian Industry

Impact of pecuniary polity on Indian IndustryINTRODUCTION fiscal form _or_ system of government is essenti in ally a fiscal constitution is essentially a programme of action undertaken by the programme of action undertaken by the Monetary Authorities, for the to the highest point part the Monetary Authorities, globally the Central posit, to control and regulate the Central Bank, to control and regulate the planning of silver with the public and the supply of money with the public and the melt of credit with a opine to achieving flow of credit with a view to achieving pre-determined macro-stinting goals.At the time of swelling fiscal constitution seeks to buzz off aggregate spending by seeks to contract aggregate spending by tightening the money supply or raising tightening the money supply or raising the arrange of return.OBJECTIVESTo achieve legal injury stability by controlling inflation and deflation.To conjure and encourage economic suppu symmetryn in th e economic system.To understand the economic stability at bounteous employment or potential level of output.SCOPE OF MONETARY indemnityThe scope of fiscal indemnity depends on two factors1. Level of Monetization of the Economy In this all economic transactions be carried out In this all economic transactions be carried out with money as a medium of exchange. This is with money as a medium of exchange. This is through by changing the supply of and packs for done by changing the supply of and demand for money and the general worth level. It is capable money and the general price level. It is capable of affecting all economic science activities such as of affecting all economics activities such as Production, enjoyment, Savings, Investment Production, Consumption, Savings, and Investment etc.2. Level of Development of the Capital Market round instruments of Monetary Policy be work through capital grocery such as coin substitute Ratio (CRR) etc. When capital market is fairly developed then the Monetary Policy effects the developed economies.OPEN MARKET OPERATIONSThe open market operations is sale and leveraging of government securities and Treasury handbills by thecommutation situate of the country.When the commutation bank decides to pump money into circulation, it buys substantiate the government securities, bills and bonds.When it decides to reduce money in circulation it sells the government bonds and securities.The pennyimeral bank carries out its open market operations through the commercial banks.DISCOUNT RATE OR BANK RATE indemnity brush aside localize or bank estimate is the consider at which centimeral bank rediscounts the bills of exchange presented by the commercial bank.The central bank can change this rate cast up or decrease depending on whether it wants to expand or reduce the flow of credit from the commercial bank.WORKING OF THE DISCOUNT RATE POLICYA rise in the discount rate reduces the net worth of the government b onds against which commercial banks take funds from the central bank. This reduces commercial banks to borrow from the central bank.When the central bank agitates its discount rate, commercial banks raise their discount rate too. Rise in the discount rate raises the cost of bank credit which discourages parentage firms to get their bill of exchange discounted.CASH RATE RATIOThe cash reserve ratio is the fate of impart deposits which commercial banks are required to oblige in the form of cash reserve with the central bank.The objective of cash reserve is to prevent of a suddenage of cash for meeting the cash demand by the depositors.By changing the CRR, the central bank can change the money supply overnight.When economic conditions demand a contractionary monetary indemnity, the central bank raises the CRR. And when economic conditions demand monetary expansion, the central bank beds mastered the CRR.STATUTORY LIQUIDITY REQUIREMENTIn India, the RBI has im catchd an another(p renominal) reserve requirement in addition to CRR. It is called statutory liquidity requirement.The SLR is the proportion of the total deposits which commercial banks are statutorily required to maintain in the form of liquid assets in addition to cash reserve ratio.CREDIT RATIONINGWhen on that point is a shortage of institutional credit available for the business domain, the large and financially strong vault of heavens or industries tend to capture the lions share in the total institutional credit.As a result the antecedency domains and essential are of necessary funds.Below two measures are generally adoptedImposition of upper limits on the credit available to large industries and firms.Charging a higher or progressive arouse rate on the bank loans beyond a certain limit.CHANGE IN LENDING MARGINSThe banks provide loans lonesome(prenominal) up to certain percentage of the value of the mortgaged attribute.The gap between the value of the mortgaged property and amount advan ced is called Lending Margin.The central bank is empowered to increase the lending margin with a view to decrease the bank credit.MORAL SUASIONThe moral suasion is a method of persuading and convert the commercial banks to advance credit in overall economic amuse of the country.Under this method the central bank writes letter to hold meetings with the banks on money credit matters.EXPANSIONARY POLICY / CONTRACTIONARY POLICYAn Expansionary Policy increases the total supply of money in the economy while a Contractionary Policy decreases the total money picture into the market.Expansionary policy is traditionally employ to combat a recession by lowering bets order.Lowered evoke rates means lower cost of credit which induces people to borrow and spend thereby providing travel to various industries and kick start a slowing economy.A Contractionary Policy results in increasing interest rates to combat inflation.An Economy growing in an uninhibited style leads to inflation.Hence in creasing interest rates increase the cost of credit thereby making people borrow less.Due to lesser borrowing the amount of money in the system reduces which in turn brings down the inflation.A Contractionary Policy is besides known as TIGHT POLICY as it tightens the flow of money in purchase order to ascertain Inflationary forces.INCREASE OR DECREASE THE LENDING RATESThe RBI makes an adjustment in its lending rate (Repo Rates) in order to influence the cost of credit. Thereby discouraging borrowing and indeed reduces brings reduction in the system.RBIBANKFlow of Money Leading to reduced liquidityBy increasing interest ratesWhenever the liquid in the system increases, the RBI intervenes to alter the system.The Central Bank does this by issuing fresh bonds and treasury bills in open market. This tool was extensively used at the time when dollar inflows into our economy were very high resulting in rupee appreciating. In order to stabilize the exchange rates, RBI first bought addi tional dollars thereby stabilizing the rate exchange.RBI Freshly issued Bonds/ T- Bill Open marketOpen marketCRRBy increasing the CRR, the RBI decreases the lending capacity of the bank to the achievement of the increase in the ratio increase in the ratio.E.g. of the CRR is increased from 7.5% to 8.5% the banks were deprived of lending to the extent of 75 basis points of their deposit value.MONETARY POLICY OF INDIA OVERVIEWHistorically, the Monetary Policy is announced twice a year April-September and (October-March).The Monetary Policy has become dynamic in nature as RBI reserves its right to alter it from time to time, depending on the state of the economy.The Monetary policy determines the supply of money in the economy and the rate of interest charged by banks. The policy also contains an economic overview and provides future forecasts.The curb Bank of India is responsible for formulating and implementing Monetary Policy.The Monetary Policy aims to maintain price stability, f ull employment and economic addition.Emphasis on these objectives remove been changing time to time depending on prevailing circumstances.For explanation of monetary policy, the whole peak has been divided into 4 sub periodsMonetary policy of controlled expansion (1951 to 1972)1972)Monetary Policy during Pre Reform period (1972 to 1991)to 1991)Monetary Policy in the Post-Reforms (1991 to 1996)1996)Easing of Monetary policy since Nov 1996MONETARY POLICY OF INDIAMonetary policy of controlled expansion (1951 to 1972)To regulate the expansion of money supply and bank credit to promote ripening.To restrict the excessive supply of credit to the private orbit so as to control inflationary pressures.Following steps were takenChanges in Bank Rate from 3% in 1951 to 6% in 1965 and it remained the same till 1971.Changes in SLR from 20% in 1956 to 28% in 1971Select Credit run In order to reduce the credit or bank loans against essential commodities, margin was increased.As a result of the higher up changes, the supply of money increased from 3.4% (1951 to 1956) to 9.1 (1961 to 1965).Monetary Policy during Pre Reform period (1972 to 1991) in addition known as the Tight Monetary policy Price situation worsened during 1972 to 1974. Following Monetary Policy was adopted in 70s and 80s which were mainly concerned with the task neutralizing the push of fiscal shortage and inflationary pressure.Changes in CRR to the legally maximum limit of 25%Changes in SLR also to the maximum limit to 38.5%Monetary Policy in the Post-Reforms 1991 to 1996The year 1991-1992 saw a fundamental change in the institutional manakin in setting the objective of monetary policy. It had twin objectives which were Price stability and economic ontogenesis. Following instruments were usedContinuing the same maximum CRR and SLR of 25% and 38.5%, mopped up bank deposits to the extent of 63.5%.In order to ensure profitability of banks, Monetary Reforms Committee headed by late Prof. S Chakravarty, Reforms Committee headed by late Prof. S Chakravarty, recommended raising of interest rate on authorities recommended raising of interest rate on Government Securities which activated Open Market Operations (OMO).Bank rate was raised from 10% in Apr 1991 to 12% in Oct 1991 to control the inflationary pressures.Easing of Monetary policy since Nov 1996In 1996-97, the rate of inflation acutely declined. In the later half 1996-97, industrial recession ripped the Indian economy. To encourage the economic growth and to meet the recessionary trend, the RBI growth and to tackle the recessionary trend, the RBI eased its monetary policy.Introduction of Repo rate- Repo rate increased from 3% in 1998 to 6.5% in 2005. This instrument was 3% in 1998 to 6.5% in 2005. This instrument was systematically used in the monitory policy as a result of rapid industrial growth during 2005-06. In the occurrent monetary policy, the Repo rate was cut from current monetary policy, the Repo rate was cut fro m 5.00% to 4.75%. terminate Repo rate Through RRR, the RBI mops up liquidity from the banking system. In the current monetary policy, the Repo rate was cut from 3.50% to 3.25%.Flow of credit to Agriculture The flow of credit to agriculture has increased from 34,013 (9.2% of overall credit) in 2009 (Rs. in crore).Reduction in Cash Reserve Ratio The CRR which was at 15% until 1995 gradually reduced to 5% in 2005. The CRR remained unchanged in the current monetary policy.Lowering Bank rate The Bank rate was gradually reduced from 12% in 1997 to 6% in 2003. Since then the Bank Rate from 12% in 1997 to 6% in 2003. Since then the Bank Rate has remained unchanged to 6%.Review of 2009/10 Monetary policyThe Policy Review projects GDP growth at 6% this FY due to laxation private consumption and investment demand.The RBI set its inflation projection for March 10 at 4% (currently at -1.21%). The RBI also projects the CPI to come down into the single digit zone. pledge of a non-disruptive bo rrowing in 2009-10. Recently, the Government increased the borrowing plan from Rs. 2.41 lakh crore to 2.99 Lakh crore because of robust liquidity in the market due to slow credit growth.The fiscal stimulus packages of the Government and monetary easing and regulatory action of the Reserve Bank have helped to arrest the moderation in growth and keep our financial markets functioning normally.RBIs Indicative Projections2009-2010(Actual Numbers)2010-2011(April 2010 policy targets)GDP7.28(with an upward bias)Inflation(Based on WPI for March end)9.95.5Money Supply(March end)17.317Credit(March end)1720Deposit(March end)17.118 outgrowthRBIs revised growth rate is 8% with an upward bias as the indian economy is on recovery path.Growth in industrial sector and service sector are expected to continue. The trade and import sector has also registered a strong growth.INFLATIONInflation is projected to be at 5.5% for FY 2010-11. As per RBI inflation is no longer driven by supply side factors al one.boilersuit demand pressures on inflation are also beginning to show signs, pushing RBI to increase rates even before the official policy of 2010.MONETARY MEASURESThe Bank rate has been retained at 6 %.The repo rate is now 5.25% which has 5% in 2009-2010.The reverse repo has increased from 3.5% to 3.75%.The cash reserve ratio of plan bank has increased from 5.75% to 6%.The expected outcomes of the actions areInflation lead be contained and inflationary expectations will be anchored.The recovery process will be sustained.Government borrowing requirements and the private credit demand will be met.Policy instruments will be further aligned in a manner consistent with the evolving state of the economy.IMPACT OF THE OUTCOMESGrowth with stabilityThe middling growth rate of the Indian economy over a period of 25 years since 1980-81 has been impressive at about 6.0 per cent, which is a real improvement over the previous three decennarys, when the annual growth rate was only 3.5 per cent. everywhere the last four years during 2003-07, the Indian economy has entered a high growth phase, averaging 8.6 per cent per annum. The acceleration of growth during this period has been accompanied by a moderation in volatility, oddly in pains and services sectors.An important characteristic of the high growth phase of over a quarter of snow is resilience to shocks and considerable degree of stability. We did witness one serious balance of payments crisis triggered largely by the disjunction war in the early 1990s. Credible macroeconomic, structural and stabilization programme was undertaken in the wake of the crisis. The Indian economy in later years could successfully avoid any adverse contagion advert of shocks from the East Asian crisis, the Russian crisis during 1997-98, sanction like situation in post-Pokhran scenario, and border conflict during May-June 1999. Seen in this context, this robust macroeconomic surgical operation, in the face of recent oil as well as intellectual nourishment price shocks, demonstrates the vibrancy and resilience of the Indian economy.The Reserve Bank projects a real GDP growth at around 8.5 per cent during 2007-08, barring home(prenominal) and external shocks.Poverty and unemploymentThe sustained economic growth since the early 1990s has also been associated with noticeable reduction in poverty. The proportion of people living below the poverty line (establish on uniform recall period) declined from 36 per cent in 1993-94 to 27.8 per cent in 2004-05. There is also some evidence of pick-up in employment growth from 1.57 per cent per annum (1993-94 to 1999-2000) to 2.48 per cent (1999-2000 to 2004-05).Consumption and investment demandIndias growth in recent years has been mainly driven by domestic consumption, contributing on an clean to almost two-thirds of the overall demand, while investment and export demand are also accelerating. Almost one-half of the incremental growth in real GDP during 2006-07 was on work out of final consumption demand, while around 42 per cent was on discover of the rise in real gross fixed capital formation. The investment boom has come from the creation of fixed assets and this phenomenon has been most pronounced in the private corporate sector, although fixed investment in the public sector also picked up in this period. According to an estimate by the Prime Ministers Economic Advisory Council, the investment rate (provisional) crossed 35 per cent in 2006-07 from 33.8 per cent in 2005-06.A reasonable degree of price stabilityHigh growth in the last four years has been accompanied by a moderation of inflation. The headline inflation rate, in terms of the wholesale price index, has declined from an average of 11.0 per cent during 1990-95 to 5.3 per cent during 1995-2000 and to 4.9 per cent during 2003-07. The trending down of inflation has been associated with a significant reduction in inflation volatility which is indicative of well-anchored inflation expectations, despite the shocks of varied nature. Although, inflation based on the wholesale price index (WPI) initially rose to above 6.0 per cent in early April 2007 it eased to 3.79 per cent by alarming 25, 2007. Pre-emptive monetary measures since mid-2004, accompanied by fiscal and supply-side measures, have helped in containing inflation in India.The policy preference for the period ahead is strongly in favour of price stability and well-anchored inflation expectations with the endeavour being to contain inflation close to 5.0 per cent in 2007-08 and in the range of 4.0-4.5 per cent over the medium-term. Monetary policy in India would continue to be vigilant and pro-active in the context of any accentuation of global uncertainties that pose threats to growth and stability in the domestic economy.Improved fiscal performanceYet another ordained outcome of developments in recent years is the marked improvement in the health of Government finances. The fiscal management in the country has significantly improved consistent with targeted reduction in fiscal deficit indicators after the adoption of the Fiscal Responsibility and Budget Management (FRBM) Act, 2003 by the Central Government. The finances of the commonwealth Governments have also exhibited significant improvement since 2003-04 guided by the Fiscal Responsibility Legislations (FRLs).With gross fiscal deficit of the Central Government budgeted at 3.3 per cent of GDP in 2007-08, the FRBM target of 3.0 per cent by 2008-09 appears feasible. The revenue deficit is budgeted at 1.5 per cent of GDP for 2007-08 the FRBM path envisages elimination of revenue deficit in 2008-09.External sectorIndias linkages with the global economy are getting stronger, underpinned by the growing openness of the economy and the two way movement in financial flows. Merchandise exports have been growing at an average rate of around 25 per cent during the last four years, with a steady increase in global market share, reflec ting the competitiveness of the Indian industry. Structural shifts in services exports, led by package and other business services, and remittances have imparted stability and strength to Indias balance of payments. The net invisible surplus has graduation exercise a significant part of the expanding trade deficit and helped to contain the current account deficit to an average of one per cent of GDP since the early 1990s. Gross current receipts (merchandise exports and invisible receipts) and gross current payments (merchandise imports and invisible payments) taken together, at present, constitute more than one half of GDP, highlighting the significant degree of integrating of the Indian economy with the global economy.Greater integration into the global economy has enabled the Indian corporates to admittance high-quality imports from abroad and also to expand their overseas assets, dynamically. The liberalised external payments regime is facilitating the process of acquisition of contrary companies by Indian corporates, both in the manufacturing and services sectors, with the objectives of reaping economies of scale and capturing offshore markets to better face the global competition. withal higher outflows, there has been a significant increase in capital inflows (net) to almost five per cent of GDP in 2006-07 from an average of two per cent of GDP during 2000-01 to 2002-03. Capital inflows (net) have remained substantially above the current account deficit and have implications for the dribble of monetary policy and macroeconomic and financial stability.With the significant strengthening of the current and capital accounts, the foreign exchange reserves have more than doubled from US$ 76 billion at the end of March 2003 to US $ 228.8 billion as on August 31, 2007.Financial stabilityThe Indian record on financial stability is noteworthy as the decade of the 1990s has been otherwise turbulent for the financial sector in more EMEs. The approach towards the financial sector in India has been to consistently upgrade it by adapting the foreign best practices through a consultative process. The Reserve Bank has endeavoured to establish an enabling regulatory framework with prompt and effective supervision, and development of legal, technological and institutional infrastructure. The regulatory norms with respect to capital adequacy, income recognition, asset classification and provisioning have progressively moved towards convergence with the international best practices. The Basel II capital adequacy framework is being implemented in a phased manner with effect from March 2008.We have observed that the Indian banks balance sheets have strengthened considerably, financial markets have deepened and widened and, with the introduction of the real time gross settlements (RTGS) system, the payment system has also become robust. Currently, all scheduled commercial banks are compliant with the minimum capital adequacy ratio (CRAR) of 9 per cent. The overall CRAR for all scheduled commercial banks stood at 12.4 per cent at end-March 2006. The gross non-performing assets of scheduled commercial banks has declined from 8.8 per cent of advances at end March 2003 to 3.3 per cent at end March 2006, while the net non-performing assets have declined from 4.0 per cent to 1.2 per cent during the same period.Financial marketsDevelopment of financial markets received a strong impetus from financial sector reforms since the early 1990s. The Reserve Bank has been engaged in developing, widening and deepening of money, government securities and foreign exchange markets combined with a robust payments and settlement system. A wide range of regulatory and institutional reforms were introduced in a planned manner over a period to improve the efficiency of these financial markets. These included development of market micro structure, removal of structural bottlenecks, introduction/ diversification of new players/instruments, dislodge pricing of financial assets, relaxation of quantitative restrictions, better regulatory systems, introduction of new technology, improvement in trading infrastructure, clearing and settlement practices and greater transparency. Prudential norms were introduced early in the reform phase, followed by interest rate deregulation. These policies were supplemented by strengthening of institutions, encouraging good market practices, rationalised tax structures and enabling legislative and accounting system framework.A review of monetary policy challengesThe conduct of monetary policy has become more thought-provoking in recent years for a variety of reasons. Many of the challenges the central banks are facing are almost similar which could be summarized as followsChallenges with globalisationFirst, globalisation has brought in its train considerable softness in reading underlying macroeconomic and financial developments, obscuring signals from financial prices and clouding the monetary authoritys gauge of the performance of the real economy. The growing importance of assets and asset prices in a globally integrated economy complicates the conduct of monetary policy when it is reduceed on and equipped to address price stability issues.Second, with the growing integration of financial markets domestically and internationally, there is greater activism in liquidity management with a special focus on the short-end of the market spectrum. There is also a greater sophistication in the conduct of monetary policy and central banks are consistently engaged in refining their technical and managerial skills to view with the complexities of financial markets. As liquidity management acquires overriding importance, the evolving solvency conditions of financial intermediaries may, on occasions, get obscured in the short run. No doubt, with increasing globalization, there is greater coordination between central banks, fiscal authorities and regulatory bodies governing financi al markets.Third, there is considerable difficulty faced by monetary authorities across the knowledge domain in detecting and measuring inflation, especially inflation expectations. Recent experience in regard to impact of increases in oil prices, and more recently elevated food prices shows that ignoring the structural or permanent elements of what is traditionally treated as shocks may slow down appropriate monetary policy response especially if the focus is on core inflation. Accounting for house rents/prices in inflation measurement has also gained anxiety in some countries. The central banks are often concerned with the stability/variability of inflation sort of than the level of prices. Inflation processes have become highly unclear and central banks are faced with the posit to recognise the importance of inflation perceptions and inflation expectations, as distinct from inflation indicators. In this context, credible dialogue and creative engagement with the market and e conomic agents have emerged as a critical channel of monetary transmission.Challenges for acclivitous market economiesIt is essential to recognize that the international financial markets have differing ways of judging macroeconomic developments in industrial and emerging market economies. Hence, the challenges and policy responses do differ.First, the EMEs are facing the dilemma of move with the inherently volatile increasing capital flows relative to domestic absorptive capacity. Consequently, often the impossible triplet of fixed or managed exchange rates, open capital accounts and discretion in monetary policy has to be managed in what could be termed as fuzzy manner rather than satisfactorily resolved a fuss that gets exacerbated due to huge uncertainties in global financial markets and possible consequences in the real sector.Second, in the emerging scenario of large and uncertain capital flows, the choice of the instruments for sterilization and other policy responses ha ve been constrained by a number of factors such as the openness of the economy, the depth of the domestic bond market, the health of the financial sector, the health of the public finances, the countrys inflationary track record and the perception about the credibility and consistency in macroeconomic policies pursued by the country. Further deepening of financial markets may help in absorption of large capital inflows in the medium term, but it may not give immediate rest period at the current stage of financial sector development in many EMEs, extraly when make haste and magnitude of flows are very high. Some of the EMEs are also subject to adverse current account shocks in view of elevated commodity prices. Going forward, global uncertainties in financial markets are likely to dominate the concerns of all monetary authorities, but, for the EMEs, the consequences of such macro or financial disturbances could be more serious.Third, the banking sector has been strengthened and non-banking intermediation expanded providing both stability and efficiency to the financial sector in many EMEs. Yet, sometimes, aligning the operations of large financial conglomerates and foreign institutions with local public policy priorities remains a challenge for domestic financial regulators in many EMEs. Further, reaping full benefits of competition in financial sector is somewhat limited in many EMEs. Large players in developed economies compete with each other intensely, while it is possible that a few of them dominate in each of the EMEs financial markets. A few of the financial intermediaries could thus wield dominant position in the financial markets of these countries, increasing the concentration risk. duration it is extremely difficult to envision how the current disturbances in financial markets will resolve, the focus of many EMEs will be on considering various scenarios and being in readiness with appropriate policy strategies and contingency plans. Among the fa ctors that are carefully monitored, currency markets, liquidity conditions, globally dominant financial intermediaries, impact on real sector through credit channel and asset prices are significant, but the list is certainly not exhaustive.Monetary policy framework in IndiaObjectivesThe basic objectives of monetary policy, namely price stability and ensuring credit flow to support growth, have remained unchanged in India, but the underlying operating framework for monetary policy has undergone a significant transformation during the past two decades. The relative emphasis placed on price stability and economic growth is modulated according to the circumstances prevailing at a particular point in time and is clearly spelt out, from time to time, in the policy statements of the Reserve Bank. Of late, considerations of macroeconomic and financial stability have assumed an added importance in view of increasing openness of the Indian economy.FrameworkIn India, the broad money (M3) emerg ed as the nominal anchor from the mid-1980s based on the infix of a stable relationship between money, output and prices. In the late 1990s, in view of ongoing financial openness and increasing evidence of changes in underlying transmission mechanism with interest rates and exchange rates gaining in importance vis--vis quantity variables, it was felt that monetary policy exclusively based on the demand function for money could lack precision. The Reserve Bank, therefore, formally adopted a sevenfold indicator approach in April 1998 where