Various tools / instruments of monetary policy
The Reserve Bank of India (RBI) uses the monetary policy to manage liquidity or money supply in a manner that balances inflation and at the same time aids growth.
- Repo and Reverse Repo Rate
Repo is a transaction wherein securities are sold by the RBI and simultaneously repurchased at a fixed price. This fixed price is determined in context to an interest rate called the repo rate. The transaction is relevant for banks; when they need funds from the RBI, the central bank repurchases the securities.
The higher the repo rate, more costly are the funds for banks and hence, higher will be the rate that banks pass on to customers. A high rate signals that access to money is expensive for banks; lesser credit will flow into the system and that helps bring down liquidity in the economy. The reverse is the reverse repo rate, which banks use to park excess money with RBI. At present, repo rate is 6.75% and reverse repo is 6.25%.
- Cash Reserve Ratio (CRR)
This is the percentage of a bank’s total deposit that need to be kept as cash with the RBI. The central bank can change the ratio to a limit. A high percentage means banks have less to lend, which curbs liquidity; a low CRR does the opposite. The RBI can reduce or raise CRR to tighten or ease liquidity as the situation demands.
- Open Market Operations
This refers to buying and selling of government securities by RBI to regulate short-term money supply. If RBI wants to induce liquidity or more funds into the system, it will buy government securities and inject funds, and if it wants to curb the amount of money out there, it will sell these to banks, thereby reducing the amount of cash that banks have. RBI uses this tool actively even outside of its monetary policy review to manage liquidity on a regular basis.
- Statutory Liquidity Ratio
This is the percentage of banks’ total deposits that they are needed to invest in government approved securities. The lesser the amount of SLR, the more banks have to lend outside.
- Bank Rate
This is the re-discounting rate that RBI extends to banks against securities such as bills of exchange, commercial papers and any other approved securities. In recent years, it has been the repo rather than the bank rate that has acted as a guideline for banks to set their interest rates. It is currently at 8.25%. Directionally, bank rate follows repo.
In addition to these measures, RBI also uses many qualitative tools to regulate credit flow and cost of credit to the economy and specific sectors within it.
Quantitative Instruments of Monetary Policy
The Quantitative Instruments are also known as the General Tools of monetary policy. These tools are related to the Quantity or Volume of the money. The Quantitative Tools of credit control are also called as General Tools for credit control. They are designed to regulate or control the total volume of bank credit in the economy. These tools are indirect in nature and are employed for influencing the quantity of credit in the country. The general tool of credit control comprises of following instruments.
Monetary Policy Stance
Monetary policy stance is based upon the assessment of the macroeconomic and financial conditions and monetary measures taken on the basis of those conditions. The overall objective while taking such instance is to speed up the economic development of the nation and raise the national income and standard of living of the people
Monetary policy consists of the actions of the central bank, currency board or other regulatory committee that determine the size and rate of growth of the money supply, which in turn affects interest rates. Monetary policy is maintained through actions such as modifying the interest rate, buying or selling government bonds, and changing the amount of money banks are required to keep in the vault (bank reserves).