Introduction:The most important functions of central banks is formulation and execution of monetary policy.

In the
Indian context, the basic functions of the Reserve Bank of India as enunciated in the Preamble to the RBI
Act, 1934 are:
to regulate the issue of Bank notes and the keeping of reserves with a view to securing monetary stability
in India and generally to operate the currency and credit system of the country to its advantage.
Thus, the Reserve Banks mandate for monetary policy flows from its monetary stability objective.
Essentially, monetary policy deals with the use of various policy instruments for influencing the cost and
availability of money in the economy. As macroeconomic conditions change, a central bank may change
the choice of instruments in its monetary policy. The overall goal is to promote economic growth and
ensure price stability

Monetary Policy in India:Over time, the objectives of monetary policy in India have evolved to include maintaining price stability,
ensuring adequate flow of credit to productive sectors of the economy for supporting economic growth,
and achieving financial stability. Based on its assessment of macroeconomic and financial conditions, the
Reserve Bank takes the call on the stance of monetary policy and monetary measures. Its monetary policy
statements reflect the changing circumstances and priorities of the Reserve Bank and the thrust of policy
measures for the future. Faced with multiple tasks and a complex mandate, the Reserve Bank emphasises
clear and structured communication for effective functioning of the monetary policy. Improving
transparency in its decisions and actions is a constant endeavour at the Reserve Bank. The Governor of
the Reserve Bank announces the Monetary Policy in April every year for the financial year that ends in
the following March. This is followed by three quarterly reviews in July, October and January. However,
depending on the evolving situation, the Reserve Bank may announce monetary measures at any point of
time. The Monetary Policy in April and its Second Quarter Review in October consist of two parts:

Part A provides a review of the macroeconomic and monetary developments and sets the stance

of the monetary policy and the monetary measures.

Part B provides a synopsis of the action taken and the status of past policy announcements
together with fresh policy measures. It also deals with important topics, such as, financial
stability, financial markets, interest rates, credit delivery, regulatory norms, financial inclusion
and institutional developments.

However, the First Quarter Review in July and the Third Quarter Review in January consist of only Part
A.

MONETARY MEASURES:On the basis of the current assessment and in line with the policy stance as outlined in Section III, the
Reserve Bank announces the following policy measures:

Bank Rate

The Bank Rate has been retained at 6.0 per cent.

Repo Rate

It has been decided to:

(a) Increase the repo rate under the Liquidity Adjustment Facility (LAF) by 25basis points from 5.0
per cent to 5.25 per cent with immediate effect.

Reverse Repo Rate

It has been decided to:

(b) Increase the reverse repo rate under the LAF by 25 basis points from 3.5 percent to 3.75 per cent
with immediate effect.

Cash Reserve Ratio

It has been decided to:

(c) Increase the cash reserve ratio (CRR) of scheduled banks by 25 basis pointsfrom 5.75 per cent to
6.0 per cent of their net demand and time liabilities (NDTL)effective the fortnight beginning
April 24, 2010.
As a result of the increase in the CRR, about Rs. 12,500 crore of excess liquiditywill be absorbed from
the system.
The Reserve Bank will continue to monitor macroeconomic conditions,particularly the price situation,
closely and take further action as warranted.

MONETARY POLICY REGIMES:-

In practice, to implement any type of monetary policy the main tool used is modifying the amount of base
moneyin circulation. The monetary authority does this by buying or selling financial assets Themultiplier
effectof fractional reserve banking amplifies the effects of these actions. Constant market transactions by
the monetary authority modify the supply of currency and this impacts other market variables such as
short term interest rates and the exchange rate. The distinction between the various types of monetary
policy lies primarily with the set of instruments and target variables that are used by the monetary
authority.
Monetary Policy:
Long Term Objective:

Target Market Variable:

Inflation Targeting
a given rate of change in
the CPI Price Level Targeting
a specific CPI number

Interest rate on overnight debt

Monetary Aggregates
given rate of change in the CPI
Fixed Exchange Rate
spot price of currency

Interest rate on overnight debt

The growth in money supply

the spot price of the currency

Gold Standard
by thegold price

the

the spot price of goldLow inflation as measured

Mixed Policy Usually interest rates

CPIchange

usually unemployment +

Monetary Policy transmission Mechanism:Monetary Policy thus has an effect on the interests rates the general public face and thereby also on the
total demand and total supply in the economy. The channels that mean that marker interest rates affect
supply and demand can be divided into the interest rate channel, the credit channel and the exchange rate
channel. You can read more about these channels below:(a) Monetary base:Monetary policy can be implemented by changing the size of the monetary base. This directly changes the
total amount of money circulating in the economy. A central bank can use open market operations to
change the monetary base. The central bank would buy/sell bonds in exchange for hard currency. When

the central bank disburses/collects this hard currency payment, it alters the amount of currency in the
economy, thus altering the monetary base.
(b) Reserve requirements:The monetary authority exerts regulatory control over banks. Monetary policy can be implemented by
changing the proportion of total assets that banks must hold in reserve with the central bank. Banks only
maintain a small portion of their assets as cash available for immediate withdrawal; the rest is invested in
illiquid assets like mortgages and loans. By changing the proportion of total assets to be held as liquid
cash, the Federal Reserve changes the availability of loanable funds. This acts as a change in the money
supply. Central banks typically do not change the reserve requirements often because it creates very
volatile changes in the money supply due to the lending multiplier.
(c) Discount window lending:Many central banks or finance ministries have the authority to lend funds to financial institutions within
their country. By calling in existing loans or extending new loans, the monetary authority can directly
change the size of the money supply.
(d) Credit Channel :The credit channels describes the way in which monetary policy affects demand via banks and others
financial institutions. If the interest rate rises, banks choose to decrease their lending and instead buy
bonds. This means that households and companies find it more difficult to borrow money. Companies that
are either unable or unwilling to borrow must cut back their activities, postpone investment and so on, and
this dampens activity in the economy.
(e) Interest rate Channel:The contraction of the monetary supply can be achieved indirectly byincreasing the nominal interest rates.
Monetary authorities in differentnations have differing levels of control of economy-wide interest rates. In
the United States, the Federal Reserve can set the discount rate, as well as achieve the desired Federal
funds rate by open market operations. This ratehas significant effect on other market interest rates, but
there is no perfectrelationship. In the United
States open market operations are a relativelysmall part of the total volume in the bond market. One
cannot setindependent targets for both the monetary base and the interest rate becausethey are both
modified by a single tool open market operations; one mustchoose which one to control.In other nations,

the monetary authority may be able to mandate specificinterest rates on loans, savings accounts or other
financial assets. By raising the interest rate(s) under its control, a monetary authority can contract
themoney supply, because higher interest rates encourage savings anddiscourage borrowing. Both of these
effects reduce the size of the money supply.
(f) Currency board:A Currencyboard is a monetary arrangement that pegs the monetary baseof one country to another, the
anchor nation.
As such, it essentially operatesas a hard fixed exchange rate, whereby local currency in circulation
isbacked by foreign currency from the anchor nation at a fixed rate. Thus, to grow the local monetary base
an equivalent amount of foreign currency mustbe held in reserves with the currency board. This limits the
possibility for the 25 local monetary authorities to inflate or pursue other objectives. The
principalrationales behind a currency board are three-fold:
1. To import monetary credibility of the anchor nation
2. To maintain a fixed exchange rate with the anchor nation
3. To establish credibility with the exchange rate (the currency boardarrangement is the hardest form of
fixed exchange rates outside of dollarization)

RBI ANNUAL MONETARY POLICY: 2010-11

RBI came out with its annual monetary policy for 2010-11 which was in line withmarket expectations.
RBI hiked repo, reverse repo and CRR by 25 bps each. Thepolicy rate hikes will be done with immediate
effect while the CRR hike will beeffective from April24. The increase in CRR is expected to absorb about
Rs12500cr from the system.In the wake of the global economic crisis, the RBI pursued an
accommodativemonetary policy beginning mid-September 2008However, strong signs of recovery in the
economy and rising inflation, bothconsumer as well as asset price inflation, the RBI embarked on the first
phase of exit from the expansionary monetary policy by restoring the statutory liquidityratio (SLR) of
scheduled commercial banks to its pre-crisis level in the SecondQuarter Review of October 2009. The
process was carried forward by the secondphase of exit when the RBI announced a 75 bps increase in the
CRR in the ThirdQuarter Review of January 2010. As inflation continued to increase and exceeded the
RBIs baseline projection of 8.5% for March 2010, RBI respondedexpeditiously with a mid-cycle increase
of 25 bps each in the repo rate and thereverse repo rate on March 19, 2010.

MONETARY MEASURES:

Bank Rate changed at 9.0%.

Repo Rate Hiked from 8%.
Reverse Repo Rate Hiked from 7 %.
Cash Reserve Ratio Hiked from 4.50%.
Statutory Liquidity Ratio Unchanged at 23%.

Credit Policy:Credit Control is an important tool used by Reserve Bank of India, a major weapon of the monetary
policy used to control the demand and supply of money (liquidity) in the economy. Central Bank
administers control over the credit that the commercial banks grant. Such a method is used by RBI to
bring Economic Development with Stability. It means that banks will not only control inflationary
trends in the economy but also boost economic growth which would ultimately lead to increase in
real national income with stability. In view of its functions such as issuing notes and custodian of cash
reserves, credit not being controlled by RBI would lead to Social and Economic instability in the country.
The Reserve Bank of India will meet for its quarterly monetary policy on Tuesday. Governor D Subbarao
shocked markets by refusing to cut interest rates. Hardly anyone in the market sees a high probability of a
rate cut specially after the RBI made its priorities and concerns clear in the mid quarter review. Since
then, little has changed on the macro-economic front to allow room for a rate cut because of 5 main
reason:-

(1) FISCAL DISAPPOINTMENT:The biggest disappointment for the RBI will continue to be the lack of fiscal action. Despite the RBI's
clear message, that further monetary policy action will be linked to signs of credible fiscal consolidation,
the government has done nothing. All they have done was to give one political excuse after another for
keeping measures on hold. And so, we still await that diesel price hike. The fuel subsidy burden could rise
to Rs. 1, 80,000crore at $ 105 per barrel oil for the rest of 2012-13. A Rs. 5 per litre increase in diesel
prices would reduce that by Rs. 25,000 crore, according to Kotak Securities estimates.
(2) INFLATION RISKS:-

Inflation risks have remained high. The last print on the wholesale price index or WPI and consumer price
index or CPI was lower than expected but still remains well above the RBI's comfort level. There has also
been a trend of upward revisions in the WPI data, so it would tough to take comfort in the 7.25 per cent
read on WPI in June. CPI too remains in double digits. With food prices rising due to a poor monsoon,
CPI will likely remain uncomfortable in the months to come. Core inflation is the relatively comfortable
indicator. However, RBI has made it clear that they are looking at all indicators of inflation and that one
can't call for a rate cut based on the steady core inflation numbers.
(3) SLUGGISHGROWTH:The growth scenario remains unchanged. Private investment remains on hold. The government has started
to make some efforts to revive sector like coal and power but these are measures which will play out in
the medium term rather than the short term. This means the investment side of the economy remains
weak. The consumption side is where there is still hope. Despite fears of a crack in the domestic
consumption, we are yet to see any indicators to show that consumption demand is falling off a cliff. It
has moderated, yes. But that was the intention of the RBI so they are unlikely to be fazed by it.
(4) GLOBAL FEARS:The fourth variable remains global growth. Here, there has been a worsening of conditions. In response,
most central banks, including Asian central banks, have cut rates to support growth. However for India,
the domestic macro-economic conditions will and should remain the prime focus. And so, while the RBI
may take note of global conditions, it seems difficult to justify a rate cut based on global conditions.

(5) LIQUIDITYEASES:It is the amount of money supply in the market. Central banks absorb or inject money into the market by
buying or selling government securities from banks. These are called open market operations or OMOs.
They also use cash reserve ratio or CRR to manage liquidity. CRR is the percentage deposits banks have
to maintain with RBI. Liquidity has eased in the past 6 weeks and now is well within the RBI's comfort
zone. It is indeed possible, that liquidity pressures will resurface due to the structural sluggishness in the
deposit growth. A need to inject money into the system occurs if the credit demand is higher than the
deposit growth. But the RBI may not want to pre-empt that with a cut in Cash Reserve Ratio. If liquidity

pressures were to re-emerge, they can just as easily restart open market operations or OMOs or cut CRR
if and when required later.

Conclusion:RBI has powers to supervise and control commercial and co-operative banks with a view to developing
an adequate and a sound banking system in the country. The RBI has powers to issue licenses to new
banks and branches, prescribe minimum requirements regarding paid up capital and reserve, maintenance
of cash and other reserves and inspect the working of banks in India and abroad. The RBI has also powers
to conduct ad-hoc investigations from time to time into complaints, irregularities and frauds in banks. The
functions of RBI include issue of currency notes, banker to the government, bankers banks, and
exchange control authority audit control and agriculture finance. The monetary policy of RBI is
regulatory policy whereby the central bank maintains its control over the supply of money for the
realization of general economic goal.

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monetary-policy
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