The economy of any nation is bound by many influencing factors and in this regard, monetary policy is one of the essential tools of economic regulation. It is the key formative tool that enables central banks to control interest rates, money supply, and economic stability. By adjusting the amount of money and credit in an economy, monetary policy in India can help control inflation, increase the level of employment, and support the growth of the economy. But what is monetary policy and how does it work?
In this blog, we will attempt to unpack the meaning of monetary policy, its kinds, and the definition of which instruments the central banks employ to implement it.
In India, monetary policy is carried out with the aim of more than just curbing inflation. It is a balancing act intended to sustain economic growth with neither overheating nor collapsing. The monetary policy in India, which is formulated and executed by the Reserve Bank of India (RBI), is based on several economic indicators, not only inflation: these include real GDP, unemployment rate, external trade, and the state of the world economy.
Drawn from the RBI overview, it is also aimed at addressing rural poverty, income inequality, and large informal economy which cannot be represented in many Western economies. All the facts show that the role of the RBI is not only limited to maintaining price stability but it has broader objectives in all the factors of economic development. The impact of price stability is supposed to be balanced between urban and rural centers, which is a difficult job for many authorities.
Expansionary monetary policy is a common characteristic of India’s policies whenever the economy is in the phase of growth or there are external shocks. For example, the RBI quickly shifted to expansionary policy after the 2016 demonetization so that more liquidity could be added to the economy and consumers could spend more. In the same manner, when economic activity slowed down during the year 2019-2020, the RBI’s cuts in the interest rates helped boost the demand in the housing and manufacturing sectors.
This is where India’s unique challenges lie: a large informal economy and a deep financial inclusion divide. Even when there is a joint policy measure for cutting interest rates, the given impact on rural borrowers or small-scale business units can be minimal without opportunities being created to cut these gaps through measures directed at financial inclusion.
On the contrary, contractionary monetary policy in India becomes relevant whenever there is excessive inflation which is beyond the acceptable levels of the Reserve Bank of India. A peculiar facet of India’s inflationary situation is attributed to food prices, the sources of which are volatile and aggravate a major portion of the Consumer Price Index (CPI). Although the Indian authorities cannot do much to curb global inflation as well as oil prices, the RBI needs to manage the domestic inflationary pressure with the restraints within its means which may include food prices, housing, and transport costs.
Most of the news focuses on the repo rate but this does not indicate the true impact of this type of rate. Changing a repo rate means changing a monetary policy stance. It goes beyond lowering the cost of borrowing alone when the repo rate is cut. This also alters the balance within the equity markets because bond pricing becomes less enticing. Investors are then encouraged to practice equities which in most cases pushes the prices of the stock exchange making it an important barometer of people’s economic optimism.
OMOs appear to be an academic subject, but they are one of the most potent tools available to the RBI for altering liquidity in the system. In India, ‘OMOs’ have a broader scope than merely dealing with inflation; they aim at stabilizing the exchange rate as well. For instance, the buying of government securities by the RBI increases liquidity, which helps maintain the value of the rupee when the currency is under stress due to crude oil price shocks. It is through the effective and efficient management of GDPs that the RBI can dampen fluctuations in the forex market, thus enhancing India’s competitiveness in the international marketplace.
The set of tools employed by the RBI in support of its monetary policy in India is extensive and encompasses interest rate and quantitative measures. One of the central objectives over the medium term is financial inclusion, including those who reside in the rural hinterland or work in the informal sector. While instruments such as CRR or SLR affect the operations of commercial banks, the real future of monetary policy in the country will be anchored on the extent to which these instruments are utilized to integrate a substantial segment of the Indian population that is outside the formal banking system into the scope of the monetary system of India.
There is of course much more to India’s monetary policy in India than just the twin objectives of inflation control and interest rates, it is a process for dealing with the always difficult task of a growing and diverse economy. RBI’s apprehension is not only about meeting the immediate requirements of the economy but about even meeting and enabling its future potential sustainably and inclusively.
The reserves of India certainly don’t wish for such a situation where its monetary policy tools resonate with a limited number and cover areas stretching from megacities to the farthest corners of the country. As with all policies, awareness of the principles and workings of these policies is essential for every Indian citizen as they determine the future of the economy, not only for the economists.
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