INFLATION AND R.B.I.POLICY

Inflation Inflation is a rise in the general level of prices of goods and services in an economy over a period of time. When the price level rises, each unit of currency buys fewer goods and services. A chief measure of price inflation is the inflation rate. When Prices rise the Value of Money falls.

Causes of Inflation DEMAND PULL INFLATION Causes for Increase in Demand :- Increase in Money Supply Increase in Black Marketing Increase in Hoarding Repayment of Past Internal Debt Increase in Exports Deficit Financing Increase in Income h) Demonstration Effect I) Increase in Black Money j) Increase in Credit facilities

Cost Push Inflation Causes for Increase in Cost :- Increase in cost of raw materials Shortage of Supplies Natural calamities Industrial Disputes Increase in Exports Increase in Wages Increase in Transportation Cost Huge Expenditure on Advertisement

Effects of Inflation Inflation can have positive and negative effects on an economy. Negative effects of inflation include loss in stability in the real value of money and other monetary items over time; uncertainty about future inflation may discourage investment and saving and high inflation may lead to shortages of goods if consumers begin hoarding out of concern that prices will increase in the future. Positive effects include a mitigation of economic recessions, and debt relief by reducing the real level of debt.

Annual rate of inflation (WPI) and alternative indicator of inflation (CPI-IW) Year WPI Inflation Rate CPI-IW 2001-02 3.6 4.3 2002-03 3.4 4 2003-04 5.5 3.9 2004-05 6.5 3.8 2005-06 4.5 3.5 2006-07 5.6 6.7 2007-08 4.7 6.2 2008-09 8.4 9.1 2009-10 9.5 12.4 2010-11 9.6 10.4 2011-12 8.9 8.3 2012-13 7.6 8.0 Aug,30,2013 - 11.63

Base Year of Wholesale Price Index A comparative statement of weights, no. of items and quotations the old and new series is given for major groups in the table. Sr. No Group of items Number of item Weights Number of Quotations 1993-94 series 2004-05 1 Primary Article 98 102 22.02% 20.12% 455 579 2 Fuel power,light &lubricants 19 14.23% 14.91% 72 3 Manufactured products 318 555 36.75% 64.97% 1391 4831 4 All commodities 435 676 100.00% 1918 5482

What is the Monetary Policy? The Monetary and Credit Policy is the policy statement, traditionally announced twice 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. Besides, the RBI also announces norms for the banking and financial sector and the institutions which are governed by it.

What are the objectives of the Monetary Policy? The objectives are to maintain price stability and ensure adequate flow of credit to the productive sectors of the economy. Stability for the national currency (after looking at prevailing economic conditions), growth in employment and income are also looked into. The monetary policy affects the real sector through long and variable periods while the financial markets are also impacted through short-term implications.

INSTRUMENTS OF MONETARY POLICY 1. Bank Rate of Interest 2. Cash Reserve Ratio 3. Statutory Liquidity Ratio 4. Open market Operations 5. Repo Rate 6. Reverse Repo Rate

Bank Rate It is the interest rate which is fixed by the RBI to control the lending capacity of Commercial banks . During Inflation , RBI increases the bank rate of interest due to which borrowing power of commercial banks reduces which thereby reduces the supply of money or credit in the economy .When Money supply Reduces it reduces the purchasing power and thereby curtailing Consumption and lowering Prices.

Cash Reserve Ratio CRR, or cash reserve ratio, refers to a portion of deposits (as cash) which banks have to keep/maintain with the RBI. During Inflation RBI increases the CRR due to which commercial banks have to keep a greater portion of their deposits with the RBI . This serves two purposes. It ensures that a portion of bank deposits is totally risk-free and secondly it enables that RBI control liquidity in the system, and thereby, inflation.

Statutory Liquidity Ratio Banks are required to invest a portion of their deposits in government securities as a part of their statutory liquidity ratio (SLR) requirements. If SLR increases the lending capacity of commercial banks decreases thereby regulating the supply of money in the economy.

Open market Operations It refers to the buying and selling of Govt. securities in the open market . During inflation RBI sells securities in the open market which leads to transfer of money to RBI. Thus money supply is controlled in the economy.

Repo (Repurchase) Rate Repo rate also known as 'Repurchase rate' is the rate at which banks borrow funds from the RBI to meet short-term requirements. RBI charges some interest rate on the cash borrowed by banks. This interest rate is called 'repo rate'. If the RBI wants to make it more expensive for the banks to borrow money, it increases the repo rate; similarly, if it wants to make it cheaper for banks to borrow money, it reduces the repo rate.

. Reverse Repo Rate Reverse Repo rate is the rate at which Reserve Bank of India (RBI) borrows money from banks. This is the exact opposite of repo rate. RBI uses this tool when it feels there is too much money floating in the banking system. If the reverse repo rate is increased, it means the RBI will borrow money from the bank by offering lucrative rate of interest. Banks feel comfortable lending money to RBI since their money would be in safe hands and with a good interest. It is also a tool which can be used by the RBI to drain excess money out of the banking system.

Movements in Bank Rate: The first Bank Rate announced by RBI in 1935 was 3.5%. Till April 2-2000 it moved to 7%. It is increased to 8% in July 2000 and afterwards it showed a continuous decrease till 2010. Bank Rate is stable from April 2003to 2010 at 6%. It can be understood that the Bank Rate was not active during the period of these seven years.RBI kept it constant to maintain stable liquidity. Movements in CRR: The first CRR decided by RBI in 1935 was 13.5 %. Till 1999 it moved to 9% from 1999 to 2004 CRR is continuously decreased to 5% to enhance liquidity. From 2004 to Aug 2008 it showed continuous increase to absorb excess liquidity and it climbed to 9% in Aug 2008. From Oct 2008 it started decrease to expand credit and reached to 5% in Jan 2009 and again showed slight increased to 6% in April 2010.

Movements in SLR: SLR stared with 20% in 1949 and showed ups and down till 1998. It was 25% in Oct 1997 and remained constant till Nov-2008. In Nov- 2008 it is decreased to 24% to expand credit. Aging it is increased to 25% in Nov 2009. The movements in SLR show that it was not much changed during the last 12 years. Movements in Repo Rate: Repo Rate shows continues and frequent changes. In June 2000 the Repo Rate was 9.05%. It showed several changes till March 2001 where it was 9.00%. It was highest of 19% in Aug 2009. then it showed decrease till July 2010 up to 5.50%. Movements in Reverse Repo rate: The reverse Repo Rate has been changed continuously and frequently. It was 7% in July 2010 and after frequent changes it remained 4.5% in July2010. The highest reverse Repo Rate was 15.50% in Aug 2000 and then it showed a decreasing trend which almost continued till July 2010 where it was 4.5%.

Frequency of change in Monitory Instrument in India (2001-02 to 2012-13) Year/ No. of Time CRR Bank Rate Repo Rate Reverse Repo Rate SLR 2001-02 4 2 3 2002-03 1 2003-04 2004-05 2005-06 2006-07 5 2007-08 2008-09 10 8 2009-10 2010-11 7 2011-12 2012-13

Types of Money Supply M0,M1,M2,M3,M4 1 Types of Money Supply M0,M1,M2,M3,M4 1. M0 - Reserve Money M0 = Currency in Circulation + Bankers' Deposits with RBI + Other deposits with RBI 2. M1 - Narrow Money M1 = Currency with public + Demand deposits with the Banking system + Other deposits with RBI 3. M2 M2 = M1 + Time Liabilities Portion of Savings Deposits with the Banking System + Certificates of Deposit issued by Banks + Term Deposits of residents with a contractual maturity of up to and including one year with the Banking System (excluding CDs) 4. M3 - Broad Money M3 = M2 + Term Deposits of residents with a contractual maturity of over one year with the Banking System + Call/Term borrowings from 'Non-depository' Financial Corporations by the Banking System 5. M4 M4 = M3 + All deposits with post office savings banks

Presented by, Dr. Anil Wavare Department of Economics Chhatrapati Shivaji College, Satara