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RBI (007) V/S Inflation - Monetary Policy

Now we have a brief knowledge about Inflation (Click Here) and its effect on the economy, So as customary there will always be a hero against a villain ,fighting for supremacy and sabotaging it to ashes.For the purpose we have our own Desi Mr.007 and the name is Rajan… Raghuram Rajan, RBI with the help of its periodically revised monetary policy try to fight against inflation.

Monetary policy consists of two tools-

DIRECT TOOLS- these tools are the special powers of RBI through which it can direct and control the amount of flow of money in the market, these consists of SLR (statutory liquidity ratio) and CRR (Cash reserve ratio), lets understand them individually.

Cash Reserve Ratio - CRR is 4% of NDTL(Net Demand and Time Liability), this the amount of money banks park with RBI in the form of cash.(must for banks)

Statutory liquidity ratio - SLR is 21.5% of NDTL, this the amount that the banks has to maintain in the form of gold or govt. securities before lending to the public.(must for banks).

NOTE- NDTL is the sum of all the demand (current account and savings account sum in bank ) and time (fixed deposits or recurring deposits etc. which are to be paid on maturation), these are assets for us but a liability(debt) for the banks.

Here is an example to show the effect of CRR and SLR.

Let say our Arundhati madam had 100 Rs as NDTL they can give this much amount of loan to the needy hence 100 Rs will flow in the market (can cause inflation), so Rajan 007 (RBI) said keep 4% with us and 21.5% as SLR in the form of govt securities and gold(which can’t be given as loans) so Madam is left with only 74.5% [100-(21.5 + 4)] of the NDTL resulting in less money to be given as loans and then in market resulting in check on inflation.

INDIRECT TOOLS/OMO (Open Market Operations)- An open market operation (also known as OMO) is an activity by a central bank to buy or sell government bonds on the open market. these tools indirectly help in controlling inflation. Different methods in OMO’s are-

LAF (Liquidity Adjustment Facility)-
These contains Repo rate and Reverse Repo rate

REPO RATE (Repurchase Agreements)- this is the rate at which the banks borrow the money from RBI to meet their sudden demands, these are done with the help of repurchase agreements (these are govt securities which has a date on it claiming to be re bought at some certain date).

How RBI controls inflation with this -- RBI increase the Repo rate in the conditions of high inflations so that banks are not encouraged to borrow money from RBI and release them in to the market resulting in lesser flow of money and hence inflations decreases. RBI decreases the REPO rate when the inflation is under control and to increase economic growth Rajan 007 encourage Madam ji to give money in the market by taking it from RBI.
Current REPO rate stands at 7.75 % of NDTL.

Reverse Repo – This is the opposite of the repo rate and is the rate at which banks park their excess money with RBI which in turn gives the govt. securities under repurchase agreement . Banks do this because their money is in safe hands and they get a healthy rate of interest against the park amount.
Current Reverse Repo rate is at 6.75 % of NDTL (-1% of REPO rate)

Bank Rate-When banks borrow long term funds from RBI. They’ve to pay this much interest rate to RBI.
Current Bank Rate is at 8.75% of NDTL(+1% of Repo rate)

MSF(Marginal Standing Facility)- the difference between Repo and MSF is that there is a minimum amount of Rs 1 cr to be borrowed by banks and this facility is only for Scheduled Commercial Banks (SCBs).this is done to balance the daily mismatches of banks.
Current MSF is at 8.75 % of NDTL (+1 % of Repo rate) .

MSF and Bank Rate + 1 %  = Repo Rate - 1 % = Reverse Repo Rate

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