Monetary Policy - The expectation begins

The Reserve Bank of India, central bank of India is the sole authority of the monetary policy. It has the command over the monetary policy and is the key player in the banking community as a whole. It is the lender of last resort.  As two sides of a coin any economy is managed by fiscal policy and monetary policy. Government implements the fiscal policy which involves government expenditure, public spending, subsidies and tax policies. The other one, monetary policy is implemented by the central bank of India that involves changes in key policy rates and amount of money supply in the economy. The RBI by regulating the monetary policy promotes financial and price stability to control inflation and promote economic growth.

The policy rates that are managed by the Reserve Bank of India are interest rates, Cash Reserve Ratio (CRR), repo rate, reverse repo rate and statutory liquidity ratio (SLR). These are the key policy rates that determine the money supply in the economy and the feasibility of personal and corporate finance in the country. The cash reserve ratio is the amount of funds that the bank must keep with the RBI as reserve in the form of cash. CRR is a tool used by the RBI to drain excess liquidity in the market and it is also used as a tool to pump in money for the growth of the economy from time to time. This is used as a powerful tool to maintain liquidity in the banking system. Increase in the CRR rate means that the banks have less funds and the money is taken out of circulation. The CRR cannot exceed more than 15 percent. The repo rate is the rate at which RBI lends money to the Indian banks. Sometimes the banks borrow money from RBI to improve their liquidity and credit balance in tough times. A reduction in the repo rate helps the banks to borrow money from RBI at cheaper rates. Reverse Repo Rate is the rate at which RBI borrows money from the commercial banks. Banks are always happy to lend money to RBI since their money is in safe hands. An increase in the reverse repo rate encourages banks to park more funds with the RBI to receive higher returns. It is also used as tool to drain away excess money out of the banking system. Statutory Liquidity Ratio (SLR) means the amount of funds the commercial banks are required to maintain with the RBI in the form of gold or government approved securities before providing credit to their customers. It is the ratio of liquid assets to the Net Demand and Time Liabilities. RBI can increase this ratio upto 40%. Some of the other monetary policy rates include cash-deposit ratio, credit-deposit ratio, investment deposit ratio, base rate and Marginal Standing Facility rate (MSF).

Every time when the RBI announces its policy announcements there is a lot of talk and expectations from bankers and the industry heads .This shows how important monetary policy affects the business and growth in the economy.  Traditionally the monetary policy is announced twice a year one from April to September and the other from October to March and now it is announced every quarter. But in recent times the monetary policy has become dynamic in nature and because of the complex environment RBI reverses it from time to time depending on the state of the economy. The mid quarter review of monetary policy is scheduled to be announced tomorrow on March 19. At this time of the hour people start anticipating on rate cuts and RBI is confronted with the difficult task of fulfilling market sentiments and reckon with economic data. The global crisis has caused a serious turmoil in the Indian economy and thus the RBI has maintained a strict monetary policy by keeping its policy rates intact for a very long period. This tight monetary policy stance was also because of the huge fiscal stimulas provided by the government post the crisis which created the present inflationary situation. Inflation and economic growth has a trade off and hence a careful implementation of policy is required knowing the present situation of persistent high inflation and sluggish economic growth.

Since March 2010 the RBI has increased the repo rate from 4.75% to 7.75% to date to control the high inflation. These high interest rates have controlled the inflation to a certain extent but have contributed to a slow economic growth. This has discouraged people from industries and they are now seriously expecting a further rate cut since the last third quarter monetary policy. The last monetary policy saw rate cuts in repo rate and CRR as expected by many. Will the RBI further cut the rates even this time to encourage growth? This time the monetary policy is quite special as it is the one that is after the budget and the last one before the start of the next financial year. The finance minister after presenting the budget has reiterated that it is now the sole responsibility of the RBI to boost the growth and move the economy forward.  The CRR and repo rate has been reduced by 25 basis points from 4.25% to 4% and from 8% to 7.75% respectively in the last monetary policy review. As now the budget is over with a move towards controlling the fiscal deficit we can now expect the RBI for rate cuts. Since the announcement of the budget there is quite good news about some of the key indicators of the economy. The Wholesale Price Index (WPI) that includes the non-food commodities came low to 6.84%. The inflation on this segment has been slowing steadily. However, the Consumer Price Index (CPI) is a big worry as it is at an all time high of 10.91 percent. The RBI along with the government, after the budget is expected to encourage household financial savings.The industrial output data, IIP numbers show some positive sign in some of the key sectors. The industrial output rose by 1 percent since last year that shows a recovery is possible. Figures in the auto sector and service sector have been showing good trend. So it is expected that the RBI will reduce its key rates by atleast 0.25 percentage points but there is no chance of increasing the rates. Though a reduction in the policy rates is expected the lending rates may not fall as the banks reduced it only a month ago since the last review.

The current rates are:

Cash Reserve Ratio (CRR): 4%

Repo Rate: 7.75%

Statutory Liquidity Ratio (SLR): 23%

Reverse Repo Rate: 6.75%

Bank Rate: 8.75%