1 A2 Flashcards
Open Market Operations refers to:
A) Borrowing by banks from RBI
B) lending by commercial banks to industry and trade
C) purchase and sale of govt securities by the RBI
D) NOTA
C
Which of the following measures would result in an increase in the money supply in the economy ?
1) Purchase of government securities from the public by the Central Bank.
2) Deposit of currency in commercial banks by the public.
3) Borrowing by the government from the Central Bank.
4) Sale of government securities to the public by the Central Bank.
Select the correct answer using the codes given below
a) 1 only b) 2 and 4 c) 1 and 3 d) 2, 3 and 4
C) 1 and 3
With reference to India economy, consider the following :
Bank rate
Open market operations
Public debt
Public revenue
Which of the above is/are component/components of Monetary Policy?
A) 1 only
B) 2, 3 and 4
C) 1 and 2
D) 1, 3 and 4
C) 1 and 2
What does Security mean?
A security means a certificate/document indicating that it’s holder is eligible to receive a certain amount of money at a particular time.
The interest rates for corporate bonds depends upon?
- Credit rating of the company: lower credit rating - higher interest rate
- Inflation
- Bank deposit interest rates: higher deposit rates - higher bond interest rates to attract households to shift to corporate bonds
- Yield on G-sec: high G-sec yield -offer higher bond interest rates to attract investment
What is bond yield?
Bond yield is the Profit an investor earns on a bond investment
Bond yield relation with price
Inversely proportional
Bond value increase - price increases - bond yield decreases
Factors affecting bond yield
- When economy is booming - investors sell bonds at lower rates and buy shares so bonds selling price decreases and yield increases
- when there is recession - investors sell shares and buy bonds - bond demand is high so bond selling increases - yield decreases
Functions of Monetary Policy Committee
Determine policy rate required to achieve inflation target
Synonyms for policy rate
Repo rate, benchmark interest, rate of central bank, policy rate
Composition of monetary policy committee (MPC) and its quorum
6 - 3 RBI and 3 Govt members
RBI Gov - ex officio Chairman
Dpty Gov - responsible for monetary policy. Michael Patra (from 2020 Jan)
One person nominated by RBI Central Board, Janak Raj( Executive Director, RBI)
Govt Side
Dr. Chetan Ghate, Indian Statistical Institute
Dr. Pami Dua, Delhi School of Economics
Dr. Ravindra H. Dholakia, IIM-A
Quorum - min 4 including governor
What is Operation Twist?
Commercial banks were reluctant to lend money to private companies due to bad loans and non performing assets. Such companies could borrow money by issuing corporate bonds at cheaper interest rates.
RBI starts buying long term G-sec - demand rises and long term G- sec yield falls hence less attractive to park money in G-sec and investors start investing in Corporate bonds
What is inverted yield curve? (not under monetary policy)
When the yield of short term bonds is greater than the yield of long term bonds then it is said that the yield curve is inverted
What is negative bond yield? (not under monetary policy)
In 2002 Italy changed its currency from Italian Lira to Euro. In 2019, it underwent great political and economic crisis and Italian mutual and pension funds started parking clients money in Germany’s Govt bonds and sold the return at a slightly higher price due to which the investor’s yield was in minus- This is called negative bond yield
Monetary Policy: Quantitative tools (SLR, CRR, Repo etc) control - Qualitative tools (PSL, LTV etc) control -
Quan - control volume of loans
Qual- control distribution of loans to particular sector of economy(eg: agriculture)/segment of society (eg: farmers, women, SC/ST)
Qualitative tools also known as
Selective or Direct tools
what are the strategies or ways of making a monetary policy?
- Exchange Rate Stability - Singapore and other export-oriented economies use this. they want to keep the local currency at a certain rate against US dollar to boost exports.
- Multiple Indicators- Central Bank tries to focus on Economic growth, employment, inflation control and exchange rate stabilisation. India’s RBI followed this strategy upto 2016
- Inflation targeting/ Price stability- central bank only aims to control inflation and other factors (economy growth, employment, exchange rate) automatically fall in line. Model successful in Western Nations. RBI’s Urjit Patel Committee Report (2013-14) recommended it for India and it was adopted from Oct-2016 by amending the RBI Act sec 45
Tenure of the Monetary Policy Committee members
For RBI members- tenure tied with their ex-officio job tenure.
For Govt members - 4 years, no reappointment
Number of meetings legally required to be held in a year by the Monetary Policy committee
4/year
In practice, they meet every two months to decide bi-monthly monetary policy
updates. (Although during Corona-lockdown met more frequently).
Monetary Policy Committee decides what?
It decides only the repo rate. Other decisions such as CRR-SLR cut, PSL norms, banning magnetic chip cards etc are decided separately alone by the RBI Governor.
During Atmanirbhar Bharat what happened to the policy corridor
reverse repo rate decreased
With the fail of RBI’s MCLR, what did they implement?
- Banks must link their loan interest rates with “External Benchmark + Spread + Risk premium” system.
- Individual bank free to pick any one External Benchmark such as
1) RBI repo rate or
2) 91-day T-bill yield or
3) 182-day T-bill yield or
4) any other benchmarks by Financial Benchmarks India Ltd. - Banks must feed the latest data of external benchmark in above formula, atleast once every three months.
Benefits of Marginal Cost of Funds Lending Rate (MCLR)
Better transmission of monetary policy, transparency and accountability to borrowers
Limitations of MCLR system
From January to Oct 2019, RBI has reduced its repo rate by 135 bps but banks reduced their loan interest rates by merely 40-47 bps. Thus, even though the RBI reduces its repo rate, banks are not quickly reducing their loan interest rates.
External Benchmark system is applicable for what loans?
new loans given for:
1) Personal loans (taken for any sudden emergency expenditure)
2) retails loans (home, vehicle, electronics etc)
Loans to micro & small enterprises
4) Loans medium enterprises (this 4th category is to be added from 1/April/2020).
Limitations of Monetary Policy
- Repo not a major source of funds for Indian banks due to higher level of savings and deposits (unlike in Western countries)
- Before the External Benchmark System: Indian Banks did not immediately pass on the RBI rate cuts to customers, citing NPA/Bad loans / profitability problem, hence it took a long time for repo rate cut to benefit end customer.
- Poor Management in Public Sector Banks (PSB), scams in the private sector banks, large level of Non-Performing Assets (NPA) also stymie the impact of monetary policy.
- Supple side issues: RBI can’t control poor monsoons or oil price hikes.
- refer handout Pg 57-58
