The project describes the Impact of monetary policy on industrial growth. It covers the data of industrial analysis starting from 2004-05 to 2012-13 and finding the trend of monetary policies adopted by RBI on industry growth.
1. IMPACT OF MONETARY POLICY ON
INDUSTRIAL GROWTH – A CASE
STUDY OF INDIA FROM 2004-05
TO 2012-13
Submitted to: Submitted by:
Dr. Jagdish Shettigar Udit Jain
Sreevatsan Natarajan
Tarun Mangal
Sonakshi Govil
Vanshika Gupta
Shruti Mittal
13DM206
13DM209
13DM204
13DM186
13DM212
13DM180
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CONTENTS
S.No. TOPIC PAGE No.
1. Monetary Policy of India 3
2. Instruments of Monetary Policy 3-10
3. Industrial growth 10
4. Impact of monetary policy on industrial growth 11-13
5.
Impact of monetary Policy on industrial growth via
inflation control 14-15
6.
Impact of monetary Policy on industrial growth via
imports 15-16
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Monetary Policy of India
Monetary policy is the process by which monetary authority of a country, generally a central
bank controls the supply of money in the economy by exercising its control over interest
rates in order to maintain price stability and achieve high economic growth.
In India, the central monetary authority is the Reserve Bank of India (RBI), is so designed as
to maintain the price stability in the economy. Other objectives of the monetary policy of
India, as stated by RBI, are:
Price Stability
Price Stability implies promoting economic development with considerable emphasis on
price stability. The centre of focus is to facilitate the environment which is favourable to the
architecture that enables the developmental projects to run swiftly while also maintaining
reasonable price stability.
Controlled Expansion Of Bank Credit
One of the important functions of RBI is the controlled expansion of bank credit and money
supply with special attention to seasonal requirement for credit without affecting the
output.
Promotion of Fixed Investment
The aim here is to increase the productivity of investment by restraining non essential fixed
investment.
Promotion of Exports and Food Procurement Operations
Monetary policy pays special attention in order to boost exports and facilitate the trade. It is
an independent objective of monetary policy.
Desired Distribution of Credit
Monetary authority has control over the decisions regarding the allocation of credit to
priority sector and small borrowers. This policy decides over the specified percentage of
credit that is to be allocated to priority sector and small borrowers.
Equitable Distribution of Credit
The policy of Reserve Bank aims equitable distribution to all sectors of the economy and all
social and economic class of people
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Instruments of Monetary Policy
Among the various techniques and methods, we have taken into account the most
important and selected monetary instruments such as Bank rate, CRR(Cash Reserve Ratio),
SLR(Statutory Liquidity Ration), OMO(open Market Operations), and Repo and Reverse Repo
rates.
1. Bank Rate
The dictionary meaning of Bank Rate is the discount rate of a central bank. Now it is known
as the base rate and it is also called as the Minimum Lending Rate (MLR). It is the rate at
which the central bank lent to the other banks.
The Reserve Bank of India Act defines Bank Rate as the standard rate on which it is prepared
to buy or rediscounts bills of exchange or other commercial papers eligible for purchase
under this Act‖. That is why Bank Rate is known as the ‘Rediscount Rate‘.
In India, the Bill market is not so well developed and the RBI makes advances to banks
mainly in other forms such as against Government securities and as refinance. Hence, the
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bank rate is not the key lending rate, though it does form the basis for multiplicity of the
RBI‘s lending rates charged for various types of advances. However, the efficiency of this as
a tool of credit control has often been questioned. Current bank rate in 8.75%.
Bank Rate Graph from 1991 to 2011
2. Cash Reserve Ratio (CRR)
Cash Reserve Ratio is a certain percentage of bank deposits which banks are required to
keep with RBI in the form of reserves or balances. Banks have to keep a certain proportion
of their total assets in the form of cash, partly to meet the statutory reserve requirement
and partly to meet their own day-to-day needs for making cash payments. Cash is held
partly in the form of ‘cash on hand’ and partly in the form of ‘balances with the RBI‘. All such
cash is cash reserves and can be classified into two such as required reserves and excess
reserves. Required reserves are cash balances which a bank is required statutorily to hold
with the RBI. They are calculated on average daily basis over a fortnight.
CRR Graph from 1992 to 2011
Higher the CRR with the RBI lower will be the liquidity in the system and vice-versa. RBI is
empowered to vary CRR between 15 percent and 3 percent. But as per the suggestion by
the committee Report the CRR was reduced from 15% in the 1990 to 5 percent in 2002. As
of October 2013, the CRR is 4.00 percent.
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3. Statutory Liquidity Ratio (SLR).
Every bank is required to maintain a minimum percentage of their net demand and time
liabilities as liquid assets in the form of cash, gold and unencumbered approved securities.
This ratio of liquid assets to demand and time liabilities is known as statutory Liquidity Ratio
(SLR).
The difference between CRR and SLR is that cash Reserves are to be kept with the Central
Bank whereas statutory ratio is maintained by the commercial banks concerned. Current
SLR rate is 23%.
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4. OPO (Open Market Operations)
The term, ‘open market operations’ stands for the purchase and sale of Government
securities by the RBI from/to the public and banks on its own account. In its capacity as the
Government‘s banker and as the manager of public debt, the RBI buys all the unsold stock of
new Government loans at the end of the subscription period and thereafter keeps them on
sale in the market on its own account.
The open market operation policy is that policy by which the central bank contracts or
expands the credit by sale or purchase of securities in the open market. Hence, it attempts
to increase or decrease the credit in the system by directly influencing the cash reserves
with the banking system.
Credit Ceiling
In this operation RBI issues prior information or direction that loans to the commercial
banks will be given up to a certain limit. In this case commercial bank will be tight in
advancing loans to the public. They will allocate loans to limited sectors. Few example of
ceiling are agriculture sector advances, priority sector lending.
Credit Authorization Scheme
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Credit Authorization Scheme was introduced in November, 1965 when P C Bhattacharya
was the chairman of RBI. Under this instrument of credit regulation RBI as per the guideline
authorizes the banks to advance loans to desired sectors.
Moral Suasion
Moral Suasion is just as a request by the RBI to the commercial banks to take so and so
action and measures in so and so trend of the economy. RBI may request commercial banks
not to give loans for unproductive purpose which does not add to economic growth but
increases inflation.
Reforms in the Government Securities Market
Year Reform Initiated Objective Outcomes
5. Repo Rate
Repo rate is the rate at which the RBI lends short term money to banks. When the repo
rate increases, borrowing from RBI becomes more expensive. Therefore, we can say that
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in case, 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. Current Repo rate is 7.75%.
6. Reverse Repo Rate
Thus Reverse repo rate is the rate at which RBI borrows money from banks. Banks are
always happy to lend money to RBI, since their money is in safe hands with a good
interest. An increase in reverse repo rate can cause the banks to transfer more funds to
RBI due to these attractive interest rates. It can cause money to be drawn out of the
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banking system. Due to this fine-tuning of RBI using its tools of CRR, Bank Rate, Repo
Rate and Reverse Repo rate, our banks adjust their lending or investment rates for
common man. Current Reverse Repo rate is 6.75%.
INDUSTRIAL GROWTH
Industrial Production Index is an economic indicator that measures changes in output for
the manufacturing, mining, and utilities. Although these sectors contribute only a small
portion of GDP, they are highly sensitive to interest rates and consumer demand. This
makes Industrial Production an important tool for forecasting future GDP and economic
performance. Industrial Production figures are also used by central banks to measure
inflation, as high levels of industrial production can lead to uncontrolled levels of
consumption and rapid inflation.
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IMPACT OF MONETARY POLICY ON INDUSTRIAL GROWTH
Impact of Bank Rate
Graph- A
Graph- B
Graph- C
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When RBI increases bank rate, interest charged by banks also rises. This in turn leads to
decline in investment expenditure, which in turn reduces the industrial growth along with
the GDP. From Graph- A, it is clear that RBI kept bank rate constant from 2004-10 at 6%.
This maintained the growth while the recessionary trend was taken care of by the other
monetary tools. To check the rapid increase in inflation, RBI increased the bank rate to
8.75%, thus leading to reduction in investment. This has affected the industrial growth
adversely, which has declined since the increase in bank rate.
Impact of Lending Rate on Industry Growth
India’s prime lending rate is the rate at which banks lend to companies and individuals. Thus
it decides the investment in the economy as high lending rates will attract less investments
and vice-versa. By comparing Graph- A and B, we can see that till January 2007, interest rates
were pretty much stable. This was because economy was in a sound condition and industrial
production was also consistently rising. The fluctuations in the interest rate came after
recession hit United States of America and the slowdown followed in the other parts of the
world.
Impact of Industry Growth on Lending Rate
In 2007, India saw high industrial growth which in turn led to inflation. This is when the
interest rates were increased so as to reduce the money supply and discourage excessive
investments in the economy. India saw the effects of US recession on its economy by
January 2009, when industrial production hit extremely low.
To fight this, in 2010, RBI started reducing interest rates in order to encourage investment in
the economy and boost production and industrial growth. This in turn saw increase in the
industrial production.
Impact of Repo Rate
Graph- A
G
Graph- A
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Graph- B
Interest rate in the graph-A, refers to the Repo rate. As we can see, in 2004, Repo rate was
around 4.5 %, thus RBI tried increasing the money supply in the economy, which in turn
increased the production. In the coming years, Repo rate was increased to maintain stability
and prevent inflation. Though when recession hit the country, the rates were again brought
down to induce lending by banks at a lower rate of interest. This helped in improving the
industrial growth. But then as inflation crept in, RBI is following a tight monetary policy
under which Repo rate has been increased to 7.75%. This is affecting the industrial growth,
which has declined over the years.
Impact of Open Market Operations
An open market operation is an instrument of monetary policy which involves buying or
selling of government securities from or to the public and banks. This mechanism influences
the reserve position of the banks, yield on government securities and cost of bank credit.
The RBI sells government securities to commercial banks to contract the flow of credit and
in turn downgrade the industrial growth as investment decreases. It buys government
securities to increase credit flow and increase the industry growth. Open market operation
makes bank rate policy more effective and maintains stability in government securities
market.
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Impact of monetary Policy on industrial growth via inflation control
Graph- A
Graph- B
The inflation condition in country forces the RBI to apply contractionary policy to control
inflation, which is done by increasing the Repo rate, Bank rate and Cash reserve ratio and
increase Statutory Liquidity Ratio. This in turn decrease the money supply in the market and
decrease the investment, which downgrade the industrial growth.
From graph- A the inflation is clearly seen in Jan 2009 and March 2011 and from graph-B the
industrial growth shows dip in year Jan 2009 and March 2011.
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Similarly, in case of disinflation, the RBI uses expansionary policy to increase money supply
in the market, which in turn allow people to invest more and support the industrial growth.
From graph- A in late 2009, it is clear that country face the recession but industrial growth
took a positive trend which was in trough till 2009. There is some delay seen in the
improvement of industry because the policies take some time to shows their effect.
Impact of monetary Policy on industrial growth via imports
Monetary policy has an indirect impact on imports of country as in contractionary policy is
being applied by RBI, the purchasing power is less and the import of raw material or semi
finish goods, machine and their parts and technology would decrease to a great extent.
This decrease will directly impact the industries which are majorly dependent on the
imports of one or many things. On the other hand, if the expansionary policy is being used
by RBI, the imports will be favoured and the industrial growth is better.
This could be validated from the table- 1, where if we compare the data of industrial GDP
growth and inflation growth, we can find a direct relation between import and industrial
growth.
In the year 2007-08 to 2008-09, the industrial GDP growth was decreased from 9.64 to 4.44
and imports were also decreased from 35.10% to 19.80% and similarly in the year the
industrial GDP was increased from 7.32 to 9.81 and import were also increased from 24.1 to
48.60.