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What is the Monetary and Credit Policy?

Aparajita Saha

The Reserve Bank of India announces the Monetary and Credit Policy twice a year. On October 22, 2001, it will announce the second half (October 2001-March 2002) of the biannual policy.

For the uninitiated, this 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 presents future forecasts.

Here are a list of terms and their definitions to guide you through the bewildering maze of terms that accompany the RBI's monetary policy:

How often is the Monetary Policy announced?

Initially, the Reserve Bank of India announced all its monetary measures twice a year in the Monetary and Credit Policy. However, 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.

What is monetary and fiscal policy?

Two important tools of macroeconomic policy are monetary policy and fiscal policy.

The monetary policy regulates the supply of money and the cost and availability of credit in the economy. It deals with both the lending and borrowing rates of interest for commercial banks.

The monetary policy aims to maintain price stability, full employment and economic growth.

Reserve Bank of India is responsible for formulating and implementing monetary policy. It can increase or decrease the supply of currency as well as interest rate, carry out open market operations, control credit and vary the reserve requirements.

Monetary policy is different from fiscal policy as the former brings about a change in the economy by changing money supply and interest rate, whereas fiscal policy is a broader tool with the government. Fiscal policy can be used to overcome recession and control inflation. It may be defined as a deliberate change in government revenue and expenditure to influence the level of national output and prices.

For instance, at the time of recession the government can increase expenditures or cut taxes in order to generate demand.

On the other hand, the government can reduce its expenditures or raise taxes during inflationary times. Fiscal policy aims at changing aggregate demand by suitable changes in government spending and taxes.

The annual Union Budget showcases the government's fiscal policy.

Here are some often-used terms in the monetary policy.

What is inflation?

Inflation refers to a persistent rise in prices. Simply put, it is a situation of too much money and too few goods. Thus, due to scarcity of goods and the presence of many buyers, the prices are pushed up. The converse of inflation, that is, deflation, is the persistent falling of prices. RBI can reduce the supply of money or increase interest rates to reduce inflation.

What is money supply?

This refers to the total volume of money circulating in the economy, and conventionally comprises currency with the public and demand deposits (current account + savings account) with the public.

RBI has adopted four concepts of measuring money supply. The first one is M1, which equals the sum of currency with the public, demand deposits with the public and other deposits with the public. Simply put M1 includes all coins and notes in circulation, and personal current accounts.

The third concept M3 or the broad money concept, as it is also known, is quite popular. M3 includes net time deposits (fixed deposits), savings deposits with post office saving banks and all the components of M1.

What is Statutory Liquidity Ratio?

Banks in India are required to maintain 25 per cent of their demand and time liabilities in government securities and certain approved securities.

These are collectively known as SLR securities. The buying and selling of these securities laid the foundations of the 1992 Harshad Mehta scam.

What is Cash Reserve Ratio?

All commercial banks are required to keep a certain amount of its deposits in cash with RBI. This percentage is called the cash reserve ratio. The current CRR requirement is 8 per cent.

What is a Repo?

A repurchase agreement or ready forward deal is a secured short-term (usually 15 days) loan by one bank to another against government securities.

Legally, the borrower sells the securities to the lending bank for cash, with the stipulation that at the end of the borrowing term, it will buy back the securities at a slightly higher price, the difference in price representing the interest.

What is the bank rate?

Bank rate is the minimum rate at which the central bank provides loans to the commercial banks. It is also called the discount rate. Usually, an increase in bank rate results in commercial banks increasing their lending rates. Changes in bank rate affect credit creation by banks through altering the cost of credit.

What are open market operations?

An important instrument of credit control, the Reserve Bank of India purchases and sells securities in open market operations. In times of inflation, RBI sells securities to mop up the excess money in the market. Similarly, to increase the supply of money, RBI purchases securities.

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