Besides The Crr

Besides the CRR, banks are required to invest a portion of their deposits in government securities as a part of their statutory liquidity ratio (SLR) requirements. The government securities (also known as gilt-edged securities or gilts) are bonds issued by the Central government to meet its revenue requirements. Although the bonds are long-term in nature, they are liquid as they can be traded in the secondary market. Since 1991, as the economy has recovered and sector reforms increased, the CRR has fallen from 15 per cent in March 1991 to 5.5 per cent in December 2001. The SLR has fallen from 38.5 per cent to 25 per cent over the past decade. What impact does a cut in CRR have on interest rates? From time to time, RBI prescribes a CRR or the minimum amount of cash that banks have to maintain with it. The CRR is fixed as a percentage of total deposits. As more money chases the same number of borrowers, interest rates come down. Does a change in SLR and gilts products impact interest rates? SLR reduction is not so relevant in the present context for two reasons: First, as part of the reforms process, the government has begun borrowing at market-related rates. Therefore, banks get better interest rates compared to earlier for their statutory investments in government securities. Second, banks are still the main source of funds for the government. This means that despite a lower SLR requirement, banks' investment in government securities will go up as government borrowing rises. As a result, bank investment in gilts continues to be high despite the RBI bringing down the minimum SLR to 25 per cent a couple of years ago. Therefore, for the purpose of determining the interest rates, it is not the SLR requirement that is important but the size of the government's borrowing programme. As government borrowing increases, interest rates, too, rise. Besides, gilts also provide another tool for the RBI to manage interest rates. The RBI conducts open market operations (OMO) by offering to buy or sell gilts. If it feels interest rates are too high, it may bring them down by offering to buy securities at a lower yield than what is available in the market. How does the Monetary Policy affect the domestic industry and exporters in particular? Exporters look forward to the monetary policy since the central bank always makes an announcement on export refinance, or the rate at which the RBI will lend to banks which have advanced pre-shipment credit to exporters. A lowering of these rates would mean lower borrowing costs for the exporter. The stock markets and money move similarly, in some ways. Why? Most people attribute the link between the amount of money in the economy and movements in stock markets to the amount of liquidity in the system. This is not entirely true. The factor connecting money and stocks is interest rates. People save to get returns on their savings. In true market conditions, this made bank deposits or bonds (whose returns are linked to interest rates) and stocks (whose returns are linked to capital gains), competitors for people's savings.

A hike in interest rates would tend to suck money out of shares into bonds or deposits; a fall would have the opposite effect. This argument has survived econometric tests and practical experience. Is the money supply related to jobs, wages and output? At any point of time, the price level in the economy is determined by the amount of money floating around. An increase in the money supply - currency with the public, demand deposits and time deposits - increases prices all round because there is more currency moving towards the same goods and services. Typically, the RBI follows a least-inflation policy, which means that its money market operations as well as changes in the bank rate are generally designed to minimise the inflationary impact of money supply changes. Since most people can generally see through this strategy, it limits the impact of the RBI's monetary moves to affect jobs or production. The markets, however, move to the RBI's tune because of the link between interest rates and capital market yields. The RBI's policies have maximum impact on volatile foreign exchange and stock markets. Jobs, wages and output are affected over the long run, if the trends of high inflation or low liquidity persist for very long period. If wages move slower than other prices, higher inflation will drive real wages lower and encourage employers to hire more people. This in turn ramps up production and employment. This was the theoretical justification of a long-term trend that showed that higher inflation and employment went together; when inflation fell, unemployment increased. What are the measures to regulate money supply? The RBI uses the interest rate, OMO, changes in banks' CRR and primary placements of government debt to control the money supply. OMO, primary placements and changes in the CRR are the most popular instruments used. Under the OMO, the RBI buys or sells government bonds in the secondary market. By absorbing bonds, it drives up bond yields and injects money into the market. When it sells bonds, it does so to suck money out of the system. The changes in CRR affect the amount of free cash that banks can use to lend reducing the amount of money for lending cuts into overall liquidity, driving interest rates up, lowering inflation and sucking money out of markets. Primary deals in government bonds are a method to intervene directly in markets, followed by the RBI. By directly buying new bonds from the government at lower than market rates, the RBI tries to limit the rise in interest rates that higher government borrowings would lead to. Considering that interest rates are now tweaked looking at market conditions, is the Monetary Policy losing its importance? Bimal Jalan has said he would make the Credit Policy a 'non-event' and would use the policy only to review developments in the banking industry and money markets. Interest rate announcements since 1998-99 were based on economic and market developments.

The policy now concentrates mostly on structural issues in the banking industry. Some Monetary Policy terms: 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. 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. 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. Money Supply (M3) 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. The 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 second, M2, is a measure of money, supply, including M1, plus personal deposit accounts - plus government deposits and deposits in currencies other than rupee. 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. 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. 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. 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.