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HindustanTimes Wed,17 Sep 2014

MONEY in monetary policy

Madhusheel Arora, Hindustan Times  Chandigarh, February 25, 2014
First Published: 15:47 IST(25/2/2014) | Last Updated: 15:52 IST(25/2/2014)

A day or two in a quarter, most general-interest publications invariably carry an item on the Reserve Bank of India's (RBI's) monetary policy review. Sometimes also referred to as the credit policy review, this is considered to be important as it is linked to the interest rates banks charge on loans and hence the Equated Monthly Installments, you and me pay and perhaps more importantly the rate at which industrialists will get their loans for expansion and thus growth.

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However, most of us are never really clear on what the buzz is all about. We try and bring you some clarity by breaking up the word "MONEY" in relation to the policy.

Money

It is assumed that until new money is printed, there is going to be a limited availability of this lifeline in the economy. So, what the policy is really doing is controlling the money available for new lending with banks and financial institutions by raising or reducing the rate of interest it charges from banks using a tool called Repo rate. Repo is the rate the RBI charges banks for money they borrow from it (for the short-term). This was raised to 8% in its last policy review on January 28, meaning banks pay 8% to the RBI. So, this is of course going to be the cost at which you and me can get funds in an ideal world. However, this is a dream and can never be true as banks have to operate and run profits and thus you and me end up getting credit at close to 10.5% or 11%, depending on category. Remember, over the years, Repo rate emerged as the single determinant of interest charged, but there are other more direct ways in which banks are asked to COMPULSARILY deposit money with the RBI like Statutory Liquidity Ratio (SLR)--- money that must be deposited as security of sorts. However, the importance of such tools has dwindled over the years.

Open-market operations

When the RBI (the banking regulator) feels that even with the tweaking of the rate it charges banks, the desired impact has not been felt, it can sell or buy-back its own bonds (long-term commitments) to suck out or release money into the system. One such bond is out in the market and has been linked to inflation.
 
Near versus far

The monetary policy has to balance two trends considered to be generally moving in a circle in opposite directions, inflation (near) and growth.

Growth, as I have written earlier in this space, is a long-term objective of all our actions and implies increased efficiencies, more services, more production et al. Inflation is the charge or the premium we pay overtime for buying those goods and services. As it rises, every rupee buys less. However, it is not necessarily a bad thing, if it's accompanied by proportional wage increases as well.

If we assumed limited money supply and then suppose, we invest it in setting up a factory we might end up with more number of units of goods. However, the demand for most always rises and thus we have a situation of more demand and less supply, leading to a situation of price rise, almost always.

Of course, this is a very simplistic model for explanation. In the Indian context, the demand supply equation is further complicated by the often-blamed supply-side bottlenecks that presumably do not allow goods and services to reach the desired consumer, leading to inflation per se, irrespective of monetary policy stance.

Nowadays, a view is emerging that over the long-term, inflation and growth learn to live with each other and policymakers will do well to note that. For instance, 6%growth at 5% inflation will be quantified, may be 10 years from now. An RBI committee has in fact recommended that inflation-targeting as a policy has its merits.

Economic linkages

In an ever-changing world, and with increasing interlinkages between nations, monetary policy essentially has to be abreast of the trends. With the US beginning the ends of what is essentially its money-printing programme, there are fears that the US will be getting more of international investors' money, who will move funds out of countries like India, creating a dent in supply here. In an hypothetical situation, this could force the RBI to release more money to fill in the void, something it might not necessarily be inclined to do.

Yield

This is the rate on interest a government bond or a security can offer you and is actually considered to be the lowest rate (interest or premium) at which something should be viably sold without subsidy in the market yearly. Most government securities and bonds sell in the range of 8.6% to 8.8%.
 

TWO KINDS OF POLICY

In common parlance, a dearer money policy restricts flow of money, making rates higher and thus investment and subsequently growth a lot harder to come by. The aim is to allow prices (inflation) to stabilise as too much money in public hands without proper use can only led to price rise as the economy cannot use the money for productive purposes fast enough.

An easy money policy means supply is relatively freer and RBI has reason to believe that money released will be put to productive use and the inflation rise due to the spend will be more or less neutralised by the rising pays due to setting up of more industries etc.

Note/Caveat: Monetary policy monitors the supply of money in the economic circle. India has been on a tightening spree since May 2013. The general trend has been to restrict supply as inflation has been termed to be the bigger concern than stimulating growth. Remember, there are no absolutes.

 

 


 

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