Monetary Policy 📊
Definition: The policy by which RBI controls the supply of money and cost of credit (interest rates) in the economy to achieve objectives like price stability and growth.
Simple: RBI's toolkit to manage inflation and economic growth.
Types of Monetary Policy 📋
1. Expansionary (Loose) Monetary Policy 📈
- Goal: Boost economic growth (during recession/slowdown).
- How: Make borrowing cheaper and easier → People/businesses borrow more → Spend more → Economy grows.
- Tools: Reduce Repo Rate, CRR, SLR.
Example: During COVID-19 (2020), RBI cut Repo Rate to 4% (historic low) to encourage loans and spending.
2. Contractionary (Tight) Monetary Policy 📉
- Goal: Control inflation (when prices rising too fast).
- How: Make borrowing expensive and difficult → Less borrowing → Less spending → Inflation controlled.
- Tools: Increase Repo Rate, CRR, SLR.
Example: In 2022-23, inflation crossed 7%. RBI increased Repo Rate from 4% to 6.5% to cool down economy.
Tools of Monetary Policy (Quantitative) 🛠️
1. Repo Rate (Repurchase Rate) 🔄
Definition: The rate at which RBI lends money to commercial banks (short-term, overnight to 2 weeks).
How it Works:
- Banks borrow from RBI by selling government securities (G-Secs).
- Agreement to buy back (repurchase) securities next day/week.
- Interest charged = Repo Rate.
Current Rate (as of 2024): 6.50%.
Impact:
- Repo Rate ↑ → Banks borrow at higher cost → Banks increase loan rates → People borrow less → Money supply ↓ → Inflation ↓.
- Repo Rate ↓ → Opposite effect → Economic growth ↑.
Example: Your home loan rate is 8.5%. RBI increases Repo Rate by 0.5%. Your bank increases home loan rate to 9%.
2. Reverse Repo Rate ↩️
Definition: The rate at which RBI borrows money from commercial banks.
Why would banks lend to RBI?
- Banks have excess money (not lent out).
- Parking with RBI is safe (100% secure).
- Earns Reverse Repo Rate interest.
Current Rate: 3.35%.
Impact:
- Reverse Repo ↑ → Banks park more money with RBI (instead of lending to public) → Money supply ↓ → Controls inflation.
- Reverse Repo ↓ → Banks prefer lending to public → Money supply ↑.
Relationship: Repo Rate > Reverse Repo Rate (usually 0.25%-1% gap).
3. CRR (Cash Reserve Ratio) 💵
Definition: The percentage of total deposits that banks must keep with RBI in cash (not lent out).
Current CRR: 4.50%.
Example:
- You deposit ₹100 in SBI.
- SBI must keep ₹4.50 with RBI (4.50% of 100).
- Can only lend ₹95.50.
Impact:
- CRR ↑ → Banks have less money to lend → Money supply ↓ → Controls inflation.
- CRR ↓ → More money available for lending → Money supply ↑.
Important: CRR is kept in cash with RBI. Banks earn NO interest on it (it's a cost for banks).
4. SLR (Statutory Liquidity Ratio) 🏛️
Definition: The percentage of deposits that banks must invest in liquid assets (government securities, gold, cash).
Current SLR: 18.00%.
Example:
- You deposit ₹100 in HDFC.
- HDFC must invest ₹18 in G-Secs/Gold.
- Can lend ₹82 (after CRR also).
Difference from CRR:
- CRR = Cash with RBI (no interest).
- SLR = Invest in G-Secs (earns interest ~6-7%).
Impact:
- SLR ↑ → Less lending capacity → Money supply ↓.
- SLR ↓ → More lending → Money supply ↑.
Purpose: Ensures banks have liquidity (can repay depositors).
Example:
- You deposit: ₹100
- CRR (4.5%): ₹4.50 kept with RBI
- SLR (18%): ₹18 invested in G-Secs
- Total locked: ₹22.50
- Available to lend: ₹77.50 only!
That's why banks can't lend 100% of deposits!
Qualitative Tools (Selective Credit Control) 🎯
- Margin Requirements: Minimum down payment for loans (e.g., 20% for home loan).
- Moral Suasion: RBI "requests" banks to lend/not lend to certain sectors (no legal force).
- Direct Action: RBI can penalize non-compliant banks.
Monetary Policy Committee (MPC) 👥
Formed: 2016 (to set Repo Rate).
Members: 6 (3 from RBI + 3 appointed by Government).
- RBI Governor (Chairman).
- 3 RBI officials.
- 3 external economists.
Meetings: Every 2 months (6 times a year).
Decision: Majority vote (4 out of 6 needed to change Repo Rate).
Quiz Time! 🎯
Test Your Knowledge
Question 1 of 5
1. Repo Rate is the rate at which:
💡 Final Wisdom: "Repo Rate is like the accelerator/brake of the economy. RBI presses it to speed up or slow down!" 🚗💨
Next up: Types of Banks in India - Commercial, Co-operative, Development! 🏦