Monetary Policy of the Reserve Bank of India!
1. Bank Rate Policy:
The bank rate or the discount rate has been used by the R.B.I, when banks turned to it as lender of last resort. From its very inception until November 1951, the bank rate was kept unchanged at 3%.
However, since then, it has been raised from time to time. It was raised to 11% on July 3, 1991 and to 12% in October 1991, for cubing imports and reducing aggregate demand.
It was gradually reduced 6.5% in October 2001, the lowest rate since May 1973. However, the bank rate has not proved to be very effective as an instrument for controlling the amount of bank borrowing. The reason is that, just by varying the bank rate, the R.B.I, cannot alter the interest rate differential between the lending rates of banks and the cost of borrowed reserves—the factor which determines the profitability to banks from borrowing.
2. Open Market Operations:
The R.B.I. Act has empowered the Bank to buy and sell short- term commercial bills. But this provision has served very little purpose, largely due to the absence of organised bill market in the country. Moreover, the bulk of government securities in India are held by institutional investors, notably commercial banks and insurance companies. Consequently, dealings of the R.B.I, in regard to open market operations are largely confined to them.
The R.B.I, over the years has tried to raise resource for both developmental and defence purposes by selling government securities. Consequently, a fiscal bias has emerged in open market operations. In other words, the monetary aspect of O.M.Os has receded to the background. This becomes clear from the fact that over the last two decades O.M.Os. have been doing well to prevent unchecked expansion of liquidity through government borrowing. The growing volume of public debt reduced cash in the hands of the public.
3. Cash Reserve Ratio:
This method, i.e., changing cash reserve ratio (CRR) which refers to the ratio of cash holding to total liabilities of a bank has been used by the R.B.I, for the first time in 1960 when there sharp increase in commodity prices. But this instrument was used for a short period.
In 1962 the R.B.I, fixed reserve requirements at 3% for both demand and time liabilities (deposits). This technique of credit control has been very frequently used in recent years with a view to stabilising prices. It was raised to 5% in June 1970. Since this measure had failed to yield necessary results, the cash reserve ratio was raised again to 7% in September 1973. Due to huge growth of liquidity in the economy over time, the ratio was raised to 15% in July 1989. However, the Government to reduced the CRR to 5.5% in October 2001. This was supposed to increase the flow of bank credit by Rs. 8,000 crores.
4. Statutory Liquidity Ratio:
In 1960, the Reserve Bank attempted to control credit expansion by fixing up additional cash reserve requirements. But this measure was not truly effective. The main reason for this was that the commercial banks satisfied the reserve requirements by making necessary portfolio adjustments without altering their liquidity position. The banks sold the government securities to raise their cash reserve ratio and thus their capacity to create credit remained unchanged.
The policy of the commercial banks clearly revealed the limitation of the technique of variable cash reserve ratio. In 1962 the Government, therefore, made necessary amendments to the Banking Regulation Act, 1949. Originally, the commercial banks were under the legal obligation to maintain a liquidity ratio of 20% against their demand and time liabilities. It was raised to 38.5% in April 1990.
It was gradually raised from time to time for two reasons:
(i) reducing commercial banks’ ability to create credit and, through it, easing inflationary pressures and
(ii) making larger resources available to the Government for developmental purposes.
However, following the recommendations of the Narasinham Committee, SLR on increment in net demand and time liabilities has been reduced to 25% in March 2001.
5. Selective Credit Control:
The R.B I. has used this method for regulating the flow of credit to specific branches of economic activity and, thus, check- the misuse of borrowing facilities.
Commercial banks have been prohibited from extending credit for speculative hoarding of essential commodities by traders. This is the main thrust of selective credit control.
In the second half of the 1950s the Reserve Bank discovered that the commercial banks made huge advances to traders against the hoarding of essential commodities which pushed up their prices. So it imposed selective credit controls on those commodities.
In fact, S.C.C. were first introduced in early 1956 as part of the R.B.I.’s policy of ‘controlled expansion’. At present, the following commodities are covered food-grains, major “oilseeds and vegetable oils, cotton and kapas, sugar, gur and khandsari, cotton yam, man-made fibres and yarn and fabrics made out of man-made fibres (including stock-in-process).
The techniques of SCC used in India are the following:
(a) Fixation of minimum margins for lending against securities. The margins vary widely (from 20% for certain basic varieties of cotton to 85% for stocks of major vegetable oils);
(b) Fixation of maximum advances to individual borrowers against stocks of certain commodities;
(c) Fixation of minimum differential rates’ of interest prescribed for different types of loans;
(d) Total prohibition of advances for financing hoarding of sensitive commodities (i.e., commodities subject to speculative pressures); and
(e) Prohibition of the discounting of bills covering the sale of certain sensitive items.
In March 1960, in order to reduce speculative pressure in the stock market, margin requirements in respect of loans against the security of ordinary shares were fixed at 50%. For the last 30 years, the R.B.I, has extensively relied on the technique of margin requirements to check the hoarding of essential commodities for it causes artificial scarcities in the market and raises prices.
Since 1973-74 much stricter selective controls have been imposed. They now cover advance against six broad groups of commodities, viz., food-grains, oilseeds, sugar, cotton, vegetable oil and cotton textiles. The rate of interest on advances against the security of these commodities is generally kept higher than on loans against securities not covered under selective controls.
The Credit Authorisation Scheme introduced in 1965 by the Reserve bank regulates not only the volume but also the terms on which credit flows to the different large borrowers, in order that credit is directed to genuine productive purposes, that credit is in accord with the needs of the borrower and there is no unique channeling of credit to any single borrower or groups of borrowers.
The minimum limit for prior authorisation for borrowers in the private sector was originally fixed at Rs. 1 crore. Since then it has been raised several times. It was last raised to Rs. 6 crores from April 4, 1986. Since July 1987, the Credit Authorisation Scheme has been liberalised for providing greater access to credit to meet genuine demands in productive sectors without the prior sanction of the R.B.I. No doubt, CAC is a king of SCC.
Apart from the usual techniques for S.C.C., the R.B.I, has been empowered to give directions to banks in general or even some particular banks as to the purpose for which loans should not be given. At the same time, the Government takes sufficient precautions that the credit for production, movement of commodities, and exports is not denied as it may have serious repercussions on the performance of the economy.
The focus of SCC is mainly on credit to traders for financing inventories, to ensure that the R.B.I, is to see from time to time that credit for production and movement of commodities for exports is not adversely affected by such controls. For making SCC effective, the R.B.I, has made frequent changes in its SCC directives in the context of changing market conditions.
While making an overall assessment of SCC, Prof. Suraj B. Gupta writes: “No definite information is available about the degree of success or failure of the SCC. However, there is a general presumption that they do put mode-rate speculative pressures on the prices of sensitive commodities to some extent.”
However, in spite of the wide powers enjoyed by it, the R.B.I’s control over the supply of credit is limited. The main reason seems to be the structure of the economy itself, or, more specifically, the underdeveloped nature of the Indian money market. In fact, the un-organised sector, which includes indigenous banks and moneylenders as the constituents is completely outside the control of the R.B.I. Whatever success the Reserve Bank has achieved in the past is mainly on account of its strict control over the organised segment of the money market.