Central bank is the apex body of the banking structure. Each and every country has the central bank but their name differs from country to country. In India the central bank is called RBI and the functions are as follows: Issuer of currency: •Under section22 RBI has right to issue the currency note. •RBI has separate department for the issue of the currency note. •Issues and exchanges or destroys currency and coins not fit for circulation. •Objective: to give the public adequate quantity of supplies of currency notes and coins and in good quality.
•RBI is required to maintain the foreign reserve exchange of 200 crores out of which 150 crore should be in the form of gold. Banker to Government: •RBI acts as a government banker, agent and advisor to both central government and state government. •RBI keeps the cash balance, free of interest and also receives and make payments in the behalf of government and carry out other banking operations. •It provides loans to both union and state government and also helps them to clear the public debt. •It gives advice to the government on all matters relating to monetary and banking.
Bankers Bank and Lender of Last Resort: •According to banking companies’ act of 1949, every schedule bank has to maintain the cash balance of 5% demand liabilities, and 2% time liabilities. •In 1962 the system was abolished and it was said that 3% of the cash reserve will be saved on aggregate deposit liabilities. •The schedule bank can borrow the money from the RBI on the basis of securities. •RBI being the apex body has to give his helping hands to all the commercial banks in the case of banking crisis, so it is called as Lender of Last Resort. Control of Credit:
•RBI has the power to influence the volume of credit created by banks in India and it could be done by increasing the bank rates and open market operations. •According to banking regulation act of 1949 RBI can ask any particular bank not to lend to a particular person on the basis of securities. •Every bank has to take licence from the RBI and this licensed can be cancelled if the bank fails to work properly. •Each and every bank has to seek order from RBI before opening any new branch. •Every bank must send weekly return to RBI to show its assets and liabilities.
•RBI has power to inspect the accounts of any commercial banks. Custodian of Foreign Exchange Reserve: •RBI is called a reservoir of gold and foreign currencies. It has the power to sell gold at fix prices to other countries. It also buys and sells foreign currencies at international price. •Manages the Foreign Exchange Management Act, 1999. •It fixes the exchange rate. •It supplies the foreign currency to importers and persons visiting foreign countries. •Objective to facilitate external trade and payment and promote orderly development and maintenance of foreign exchange market in India.
•It always works under the limit of IMF and bring stability in foreign exchange rate. Collection and Publication of Data: •RBI collects information relating to banking and other financial sector of economy. •It publishes two reports which are monthly and annually. •In monthly bulletin RBI not only provide statically and other information in summary form but also important studies and investigation. •Annual publication deals with report on currency and finance. Monetary Authority: •Formulates implements and monitors the monetary policy.
•Objective: maintaining price stability and ensuring adequate flow of credit to productive sectors. Regulator and supervisor of the financial system: •Prescribes broad parameters of banking operations within which the country’s banking and financial system functions. •Objective: maintain public confidence in the system, protect depositors’ interest and provide cost-effective banking services to the public. • Keep the eye on commercial bank in order to safeguard the national economy. Developmental role: •Performs a wide range of promotional functions to support national objectives.
MONETARY POLICY Monetary policy is the process by which the central bank or monetary authority of a country controls:- ? The supply of money, ?Availability of money, and ?Cost of money or rate of interest In order to attain a set of objectives oriented towards the growth and stability of the economy. The Monetary and Credit Policy is the policy statement, traditionally announced once a year, through which the Reserve Bank of India seeks to ensure price stability for the economy. These factors include – money supply, interest rates and the inflation.
In banking and economic terms money supply is referred to as M3 – which indicates the level (stock) of legal currency in the economy. Monetary policy is generally referred to as either being an expansionary policy, or a contractionary policy, where an expansionary policy increases the total supply of money in the economy, and a contractionary policy decreases the total money supply. Expansionary policy is traditionally used to combat unemployment in a recession by lowering interest rates, while contractionary policy involves raising interest rates in order to combat inflation.
Monetary policy should be contrasted with fiscal policy, which refers to government borrowing, spending and taxation. Monetary policy is primarily associated with interest rate and credit. For many centuries there were only two forms of monetary policy: (i) Decisions about coinage; (ii) Decisions to print paper money to create credit. Interest rates, while now thought of as part of monetary authority, were not generally coordinated with the other forms of monetary policy during this time.
Monetary policy was seen as an executive decision, and was generally in the hands of the authority with seigniorage, or the power to coin. But now the scenario has changed. It must now take into account such diverse factors as: •short term interest rates •long term interest rates •velocity of money through the economy •exchange rates •bonds and equities (corporate ownership and debt) OBJECTIVES: The objectives are to maintain price stability and ensure adequate flow of credit to the productive sectors of the economy. 1.
To stabilize internal price level: The main objective of any Central bank is to attain the price stability in the economy. Excess or deficit flow of money in the economy is not acceptable. So the Central Bank act as a custodian of credit control 2. To stabilise the rate of foreign exchange: Limitations: 1. Predominance of currency: In the context of Indian conditions, a limitation on the effective use of monetary policy arises from the predominance of currency in total money supply. his fact inhibits the credit creating capacity of the banking system.
With currency forming a large proportion of money supply, banks have to face the problem of large outgo of currency every time they create credit. In India, people prefer to make use of cash rather than cheques. This means that a major portion of the cash generally percolates in the economy without returning to the banking system in the form of deposits. This reduces the capacity of the banking system to create fresh credits. 2. Underdeveloped Money Market: Monetary policy is more effective, is in an organized sector consisting of Reserve Bank, the State Bank, Foreign Banks, Indian joint stock banks etc.
Indian economy consists of a large number of NBFC’s and indigenous banks. And worse the linkages between these two sectors are not so well developed. 3. Existence of Black Money: A serious obstacle in the efficient working of monetary policy is the circulation of large amount of money in the black market. The transactors i. e. , borrowers and lenders keep their transactions secret. The result is that the supply and the demand of money do not remain as desired by RBI. 4. Government policies/ Fiscal Policies:
The scope of the monetary policy is further restricted because the RBI could not pursue independent line in monetary affairs. The creation of new money to meet the government deficits is one such case. First Quarter Review of the Annual Statement on Monetary Policy for the Year 2008-09 RBI Governor presented the First Quarter Review of Annual Statement on Monetary Policy for the Year 2008-09 today. Highlights • Bank Rate kept unchanged. • Reverse Repo Rate under LAF kept unchanged. • Repo Rate increased by 50 basis points from 8. 5 per cent to 9. 00 per cent.
• Cash Reserve Ratio to be increased by 25 basis points to 9. 0 per cent with effect from the fortnight beginning August 30, 2008. • GDP growth projection for 2008-09 revised from the range of 8. 0-8. 5 per cent to around 8. 0 per cent, barring domestic or external shocks. • While the policy actions would aim to bring down the current intolerable level of inflation to a tolerable level of below 5. 0 per cent as soon as possible and around 3. 0 per cent over the medium-term, at this juncture a realistic policy endeavour would be to bring down inflation from the current level of about 11.
0-12. 0 per cent to a level close to 7. 0 per cent by March 31, 2009. • While there are early signs of some moderation in money supply and deposit growth, they continue to expand above the indicative projections warranting continuous vigilance and appropriate and timely policy responses. • In view of the evolving environment of heightened uncertainty in global markets and the dangers of potential spillovers to domestic markets, liquidity management will continue to receive priority in the hierarchy of policy objectives over the period ahead.
• Barring the emergence of any adverse and unexpected developments in various sectors of the economy, assuming that capital flows are effectively managed, and keeping in view the current assessment of the economy including the outlook for growth and inflation, the overall stance of monetary policy in 2008-09 will broadly continue to be: • To ensure a monetary and interest rate environment that accords high priority to price stability, well-anchored inflation expectations and orderly conditions in financial markets while being conducive to continuation of the growth momentum.
• To respond swiftly on a continuing basis to the evolving constellation of adverse international developments and to the domestic situation impinging on inflation expectations, financial stability and growth momentum, with both conventional and unconventional measures, as appropriate. • To emphasise credit quality as well as credit delivery, in particular, for employment-intensive sectors, while pursuing financial inclusion. Domestic Developments • Real GDP growth in 2007-08 was revised upwards to 9. 0 per cent by the Central Statistical Organisation (CSO) in its end-May 2008 estimates from the advance estimates of 8.
7 per cent released in February 2008. • Inflation, measured by variations in the wholesale price index (WPI) on a year-on-year basis, increased to 11. 89 per cent as on July 12, 2008 from 7. 75 per cent as at end-March 2008 and 4. 76 per cent a year ago. • On a year-on-year basis, inflation based on the consumer price index (CPI) for agricultural labourers and rural labourers increased to 8. 8 per cent and 8. 7 per cent, respectively, in June 2008 from 7. 8 per cent and 7. 5 per cent a year ago. • Year-on-year inflation based on CPI for industrial workers and urban non-manual employees stood at 7.
8 per cent and 6. 8 per cent, respectively, in May 2008 as compared with 6. 6 per cent and 6. 8 per cent a year ago. • The CPI-based inflation measures have increased in the range of 2. 0-3. 2 percentage points over their levels in January 2008. • The price of the Indian basket of crude oil increased from US $ 99. 4 per barrel in March 2008 to US $ 129. 8 in June 2008 and further to US $ 141. 5 on July 3, 2008 before declining to US $ 121. 9 on July 25, 2008. • Money supply (M3) increased by 20. 5 per cent on a year-on-year basis on July 4, 2008, lower than 21. 8 per cent a year ago.
• The year-on-year growth in aggregate deposits of scheduled commercial banks (SCBs) at 21. 7 per cent (Rs. 5,89,646 crore) up to July 4, 2008 was lower than 24. 6 per cent (Rs. 5,36,617 crore) a year ago. • Up to July 4, 2008 non-food credit of scheduled commercial banks (SCBs) rose by 25. 9 per cent (Rs. 4,85,709 crore) on a year-on-year basis, higher than 24. 6 per cent (Rs. 3,69,109 crore) a year ago. • Public sector oil marketing companies have been provided US $ 4. 3 billion (Rs. 19,325 crore) against oil bonds purchased under the Special Market Operation (SMO) scheme up to July 25, 2008.
• The total overhang of liquidity as reflected in the balances under the LAF, the MSS and the Central Government’s cash balances taken together declined from an average of Rs. 2,42,370 crore in April 2008 to Rs. 2,12,201 crore in May 2008 and Rs. 1,93,726 crore in June 2008 (with an intra-year peak of Rs. 2,93,048 crore on April 8, 2008) before declining to Rs. 1,45,200 crore on July 25, 2008. • Financial markets reflected the changes in liquidity conditions during the first quarter of 2008-09. • Yields in the Government securities market hardened substantially during the current financial year in both primary and secondary segments.
• Deposit rates of SCBs increased, particularly at the longer end of the maturity spectrum, during the first four months of 2008-09 (up to July 25). • The equity markets witnessed a major downturn in both the primary and secondary segments during the current financial year so far, continuing the moderation that had set in by early January 2008. • Commercial banks’ holdings of Government and other approved securities was 27. 7 per cent of the banking system’s net demand and time liabilities (NDTL) which was marginally lower than 27. 8 per cent at end-March 2008 and 28. 7 per cent a year ago.
• Gross market borrowings of the Central Government through dated securities at Rs. 72,000 crore (Rs. 73,000 crore a year ago) during 2008-09 so far (up to July 25, 2008), constituted 41. 0 per cent of the budget estimates (BE) whereas net market borrowings at Rs. 47,982 crore (Rs. 45,232 crore a year ago) constituted 48. 5 per cent of the BE. External Developments • Information released by the DGCI&S indicates that exports increased by 21. 7 per cent in US dollar terms during the first two months of the current financial year, as compared with 24. 2 per cent in the corresponding period of the previous year.
Imports rose by 31. 8 per cent as compared with 37. 9 per cent in the corresponding period of the previous year. • While non-POL imports moderated to 24. 6 per cent from 43. 8 per cent a year ago, POL imports increased by 48. 6 per cent on account of the surge in crude oil prices as compared with 25. 7 per cent in the corresponding period of the previous year. As a result, the merchandise trade deficit widened to US $ 20. 7 billion during April-May 2008 from US $ 13. 9 billion in the corresponding period last year. • Foreign exchange reserves declined marginally by US $ 2.
6 billion during the current financial year so far and stood at US $ 307. 1 billion on July 18, 2008. • During the current financial year up to July 25, 2008 the rupee depreciated by 5. 4 per cent against the US dollar, by 5. 0 per cent against the euro, by 5. 2 per cent against the pound sterling and by 1. 3 per cent against the Japanese yen. Global Developments • According to the update of World Economic Outlook (WEO) of the International Monetary Fund (IMF) released in July 2008, global real GDP growth on a purchasing power parity basis is expected to decelerate from 5.
0 per cent in 2007 to 4. 1 per cent in 2008 (3. 7 percent in WEO, April 2008) and further to 3. 9 per cent in 2009 (3. 8 per cent in WEO, April 2008). • Inflation has become a global phenomenon in recent months. Inflation pressures have raised serious concerns in emerging market economies (EMEs) across Asia, Latin America and Africa, mainly on account of supply-demand imbalances in food, fuel and commodity markets. • Prices of crude oil, which have rebounded since July 2007, increased by 60. 0 per cent up to July 25, 2008 from their level a year ago.
World oil markets have been particularly tight during the first half of 2008, with year-on-year growth in world oil consumption outstripping growth in non-Organisation of the Petroleum Exporting Countries (OPEC) production by over 1 million barrels per day. • In the global financial markets, sentiment has been adversely affected by concerns relating to a deep and prolonged recession in the US, somewhat alleviated by recent data on consumer sentiment, durable goods orders, consumer spending and oil prices. In addition, losses to the financial sector continue to mount in addition to rising debt defaults.
• Central banks have continued to work together and to consult regularly on liquidity conditions in financial markets. • The confluence of slowdown in growth and mounting inflation alongside financial vulnerabilities has complicated the task of monetary authorities across the world and rendered the future direction of policy setting highly uncertain. • Some central banks that have tightened their policy rates in the recent months include the ECB; the Reserve Bank of Australia; Bank Indonesia; Bank of Thailand; the Banco Central de Chile; Banco Central do Brasil and Banco de Mexico.
Overall Assessment • Domestically, aggregate demand pressures appear to be strongly in evidence, exacerbated by the slack in supply response. • The upsurge in inflation during the current financial year reflects a combination of forces at work: the pass-through of international crude prices to domestic administered prices effected on June 5, 2008; inflationary pressures in addition to crude oil prices; and movements in international prices of key commodities indicating elevated upside pressures for domestic prices of a number of commodities with implications for the evolving scenario.
There are some signs of moderation in key monetary and banking aggregates in response to monetary measures, which have withdrawn liquidity from the system and tightened interest rates across the term structure. • The rates of money supply and deposit growth have started to moderate in consonance since June, edging towards the trajectory set for 2008-09. • The balancing of monetary and liquidity conditions has not, however, impacted the demand for bank credit which has accelerated on a year-on-year basis.
• Downside risks to global economic prospects appear to have intensified since the Annual Policy Statement of April 2008 with slowdown of growth spreading from the US to several other advanced economies with housing and labour markets weakening sharply.
• The deepening financial turbulence in major financial centres has worsened the macroeconomic outlook further by erosion of consumer and business sentiment and tightening of financing conditions with indications that a generalised credit squeeze may take hold. • The impact of the slowdown in developed economies on EMEs cannot but be adverse, but it has so far been limited by the strength of domestic demand, particularly investment, and consumption spending has remained stable. • The slowing of import demand from developed economies could, however, pose a risk to the growth outlook for these economies.
• Inflation has emerged as the biggest risk to the global outlook, having risen to very high levels across the world, levels that have not been generally seen for a couple of decades. • Developed and emerging economies alike are reporting multi-year highs in inflation, driven mainly by escalating commodity prices, particularly of energy, food and metals amidst growing concerns across economies that rising food and energy prices are triggering a more generalised inflation spiral through second-round effects.
• In the global financial system, while a possible crisis in global finance seems to have been averted, several vulnerabilities persist in the leading financial centres heightening the uncertainty characterising the outlook. • Central bank interventions in this context have also been extraordinary and on a scale not seen since the Great Depression, demonstrating a resolve to act decisively against threats to financial stability.
• In some developed countries, the policy response to inflation has been constrained by relatively overarching concerns for financial stability in the context of the ongoing financial turmoil. • In the overall assessment, several risks looming over the global economy at the time of the Annual Policy Statement of April 2008 have either materialised or intensified with implications for every national economy, including India, warranting heightened vigilance and stress testing of the preparedness to deal with these developments.