LIMITATIONS OF MONETARY POLICY IN INDIA

Question 1

Why is the impact of repo rate changes limited in India compared to Western economies?

Answer 1

In India, banks have access to significant savings deposits, reducing their reliance on borrowing from the central bank. This lessens the direct impact of repo rate changes on their lending decisions.

Question 2

Explain the concept of delayed transmission of rate cuts in the Indian banking system.

Answer 2

Prior to the External Benchmark System, banks in India were slow to pass on rate cuts to customers. This created a time lag (6-24 months) between RBI rate reductions and their actual impact on economic activity and inflation.

Question 3

How do banking sector issues hinder the effectiveness of monetary policy in India?

Answer 3

Challenges within the banking system such as:

Poor management in public sector banks
Scams in private sector banks
High levels of Non-Performing Assets (NPAs) …can weaken the transmission of monetary policy signals, making it harder for the RBI to achieve its goals.

Question 4

Describe supply-side constraints and how they limit the RBI’s ability to control inflation.

Answer 4

Supply-side constraints are factors beyond the RBI’s control that affect inflation:

Agricultural shocks (poor monsoons, El Niño)
Global geopolitical tensions and oil price fluctuations
Protectionist policies in export markets …these issues drive up prices regardless of monetary policy stance.

Question 5

How did past RBI governors’ focus on inflation control potentially impact economic growth?

Answer 5

Under Raghuram Rajan and Urjit Patel, the RBI prioritized inflation control over economic stimulus, maintaining relatively high interest rates. This was criticized as unnecessarily hawkish and hindering growth potential.

Question 6

What role does the informal economy play in limiting monetary policy effectiveness in India?

Answer 6

The informal economy encompasses:

Rural moneylenders with high interest rates
Circulation of black money
Limited banking access, lack of financial inclusion, and reliance on cash … these factors make it difficult for the RBI’s policy changes to fully penetrate this segment of the economy.