Tuesday, April 7, 2015

Monetary Policy of RBI

Monetary Policy

Monetary policy is the process by which central bank, the monetary authority of a country, controls the supply of money in the economy. In India, Reserve Bank (RBI) is the sole authority to frame the monetary policy. 

As per the recommendations of Urjit Patel Committee, RBI adopted the release of monetary policy on bi-monthly basis, i.e., bi-monthly monetary policy.

Operating Target and Operating Procedure of Monetary Policy

To understand the Monetary Policy of RBI, you have to understand the following terms specified by it -

1.  Policy Rate
The fixed overnight repurchase rate (repo rate) under the Liquidity Adjustment Facility (LAF) is the single monetary policy rate.

2.  Operating Target
The Weighted Average Call-money Rate (WACR) is the operating target of monetary policy.
Note that Call money is the overnight funds that are lent by one bank to another bank.

3.  Operating Procedure
Once the policy rate is announced in the bank's statements on Monetary policy, the operating procedure aims at modulating liquidity conditions so as to achieve the operating target (meaning - anchor the call money rate around the policy rate / repo rate). This is the first leg of monetary policy transmission to the financial system and the economy.

4.  Liquidity Management
RBI uses the pro-active liquidity management mechanism to achieve the operating target. The main features of this framework, which was announced on August 22, 2014, and implemented since September 5 are as follows -

a.  Assured Liquidity Operations -
Assured access to central bank liquidity of 1 % of bank's Net Demand and Time Liabilities (NDTL) (meaning Demand deposits - Current and Savings; and Time deposits - Term and Recurring). This 1 % comprises -

  • 0.25 % of NDTL provided through overnight fixed repo auctions, conducted daily at the policy rate (repo rate), and
  • 0.75 % of NDTL provided through 14-day variable rate term repo auctions, conducted on every Tuesday and Friday.

b.  Fine-tuning Operations -
Fine-tuning operations through variable rate repo / reverse repo auctions of maturities ranging from overnight to 28 days, to even out frictional liquidity mismatches that occur in spite of assured Liquidity Operations

c.  Open Market Operations (OMO) -
Outright OMO through auctions and anonymous screen-based trading on the Negotiated Dealing System - Order Matching (NDS-OM) platform to mange enduring liquidity mismatches

d.  Special Operations -
Special Operations are also conducted on holidays to help market participants tide over pressured arising from one-off events such as tax payments, government spending, balance sheet adjustments and payment and settlement requirements.

5.  Standing Facilities

a.  Marginal Standing Facility (MSF) -
A Marginal Standing Facility (MSF) allows market participants to access central bank liquidity at the end of the day (including Saturdays), even after providing assured and fine-tuning operations.

Under MSF, up to 2 % of their (market participant's) stipulated Statutory Liquidity Ratio (SLR) holdings of government securities in addition to excess SLR as collateral at a rate set at 100 basis points (bps) above the policy rate (meaning - MSF rate = Repo rate + 1 %)

b.  Reverse Repo -
Fixed rate daily overnight - reverse repo auctions are conducted at the end of the day (including Saturdays) to allow market participants to place their surplus liquidity with the RBI at a rate set at 100 bps below the policy rate (meaning - Reverse Repo rate = Repo rate - 1 %). It operates as a de facto standing facility.

Note that the MSF rate and the fixed overnight reverse repo rate define an informal corridor for limiting intra-day variations in the call rate.

1st Monetary Policy - April 7, 2015

RBI governor Shri Raghuram Rajan has decided to keep the policy rate and cash reserve ratio unchanged. Followings are the current rates -

  • Repo rate (policy rate) - 7.5 % (rate charged by RBI to banks)
  • Reverse Repo rate = Repo rate - 1 % = 6.5 % (rate at which RBI pays interest to banks)
  • MSF rate = Repo rate + 1 % = 8.5 % (rate charged by RBI to banks)
  • Bank rate = 8.5 % (rate charged by RBI to banks)
  • Cash Reserve Ratio (CRR) - 4 % (percent amount to be stored with RBI, in terms of account balance or reserves)
  • Statutory Liquidity Ratio (SLR) - 21.5 % (percent amount to be stored with itself, in terms of golds or government securities - cannot be lent to public)

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