Chapter 02 - Monetary Policy

Prelims Syllabus

Introduction
PYQP

Cycle of Inflation and Recession

RBI Focuses on Demand Induced Inflation Only
- Demand Increase - Demand Pull Inflation Taken Care by RBI
  
  This List is NOT Exhaustive
  1. More Money with People
  2. Increased Population
  3. Govt Spending More
  4. ROI on Loans Reduced
- Supply Decrease - Cost Push Inflation Taken Care by Government
  
  This List is NOT Exhaustive
  1. Failure of Monsoon
  2. Increase in Cost of Raw Material
- What can RBI do in Demand Inflation - Reduce Demand
  
  Suck Out Excess Money → Leads to Reduced Demand
- How does Inflation Affect - The Cycle
  - Affect to Consumer
    1. Things will become less affordable
    2. You Spend More and Savings Decrease
    3. Decrease in Purchasing Power of Rupee
      1. 2022 - Rs 20 with A - Can Buy 2 Apples
      2. 2023 - Rs 20 with B - Can Buy 1 Apple
      3. Hence, Reduction in Purchasing Power = Rate of Inflation
  - Affect on Manufacturer
    - 1. There is NO Increase in Real Profits
      %age change in real profit = %age change in nominal profit - Inflation
      
      = 100-100
      
      = 0
    1. Input Cost is Increased
    2. Labour Wages Increased
  - Affect on Indian Economy
    1. Decrease in Investment
      
      because no real profit
    2. Increase in Imports
      
      to meet the demand
    3. Decrease in Exports
      
      price higher in india, hence no market for costly material
  - Action of RBI
    1. Break the Cycle at Point of Increase in Demand
      1. Reducing Demand
      2. Sucks Out Money
      3. Contractionary Monetary Policy
      4. Policy Rates will be Increased
- Cycle of Inflation and Recession is
Impact of Inflation and Recession on Indian Economy

Impact of Inflation on Various Aspects of Indian Economy

Impact of Recession on Various Aspects of Indian Economy
How RBI Controls Inflation - Taylor’s Rule
Monetary Policy Committee of RBI

Tools to Control Monetary Policy

Summary of All Qualitative and Quantitative Tools
Quantitative Tools

Conventional Tools
- Reserve Requirement: CRR & SLR
  - Concept of NDTL
    
    Focus on Assets and Liabilities of Banks
  - Difference Between Savings and Current Account
  - In what Time Frame is CRR calculated ?
  - Understanding CRR
  - Incremental CRR
  - Exemption on CRR Maintainence
  - SLR
  - Difference Between CRR & SLR
  - Why Do Banks buy G Secs ?
  - Concept of Lazy Banking
- Liquidity Tool: Repo, MSF, SLF, Reverse Repo, SDF
  
  RBI Gives Loan to Bank
  - Repo Rate
  - Transaction of 2 Legs
    
    Here we have to take the Increment or Decrement in between the Legs of Transaction and not after the Transaction
    
    Three Types of Tools which use 2 Leg Transactions are
    1. Repo Rate
    2. Reverse Repo Rate
    3. Forex Swap
  - Types of Repo
    - Repo can be used by RBI to Give which type of Loan ?
      1. Short Term Loans and
      2. Long Term Loans
    - Fixed Rate Repo
      - Facts & Details
        
        ROI = Prevailing Repo Rate
        
        Maturity Period : Ranges from 1 to 3 Years
        
        Introduced by RBI as a Part of Aatma Nirbhar Bharat
      - ROI on Short Term Loans is higher or Long Term Loan
        
        Generally, ROI on Long Term Loans is higher
      - Why was fixed Rate Repo Introduced ?
        
        To Inject Long Term Liquidity in Economy
        
        During Covid Times, RBI wanted to Pump In Money
        
        Normal Years, LT Loans would be 7% When Normal Repo would be 6%
        
        But in Covid Time, LT Loan was given at Repo Rate.
      Type of Fixed Rate Repos
      - LTRO - Long Term Repo Operation
        
        ROI = Repo Rate
        
        Maturity : 1 to 3 Years
        
        No Guidelines on where to invest money
      - TLTRO - Targeted LTRO
        
        ROI = Repo Rate
        
        Not applicable to Small Finance Banks
        
        Maturity : 1 to 3 Years
        
        Compulsorily to be invested to a Specified Sector
        
        For Example: Aviation Company
        
        Either Give them Loan
        
        Or Invest in this Companies Corporate Bonds
        
        Maturity Period: > 1 Year
        
        Commercial Paper Maturity Period: <1 Year
        
        SLTRO - Special LTRO
        
        Applicable Only to Small Finance Bank
      - Mind Map
    - Variable Rate Repos
      1. To Pump in Money
      2. ROI : Decided by Auction or Bidding
      3. Duration : Different Durations
        
        Overnight Repo : for Just 1 Day
        
        Fortnight Repo : 14 Days
        
        28 Days
        
        56 Days
        
        Usually they are for a period less than 1 Year
      4. RBI Notification about Bidding
        
        The ROI Bidding Start cannot be less than the Prevailing Repo Rate
    - Mind Map
  - MSF - Marginal Standing Facility
    
    Difference Between Repo and MSF
  - Concept of BPS - 1 Basis Point (BPS)
    
    1 BPS = 0.01 % of RoI
    
    25 BPS = 0.25%
    
    100 BPS = 1%
  - SLF - Standing Liquidity Facility
    
    It is means of taking loans from RBi for Stand Alone Liquidity Facility
  Bank Gives Loan to RBI
  - Reverse Repo
    - Introduction
      1. Repo > Reverse Repo → Repo will always be greater than Reverse Repo
        
        To Prevent Banks from Giving RBI the Money as Loan, which it borrowed from RBI Itself → Phir Hera Pheri Nahin Karne Ka
      2. Repo → used for Injection
      3. It also has all types of Repo Things - Fixed and Variable Reverse Repo Rates
    - Concept of Reverse Repo
  - SDF
    1. Introduced Last Year - It is Part of Current Affairs
    2. Introduced on Recommendation of Urjit Patel Committee
    3. RBI Act, 1934 was Amended, SDF has been Introduced
    4. ROI is higher than Reverse Repo because its a Collateral Free Loan
    5. Difference between Reverse Repo and SDF
- Summary of Repo, MSF, Rev Repo, SLF & SDF
- Monetary Policy Corridor
  - Symmetric and Asymmetric Monetary Policy Corridor
  - Bank Rate
    - Defintion
      
      Rate at Which RBI Rediscounts Bill of Exchange or Buys Commercial Paper
    - Earlier Case
      
      Bank Rate → Defunct
      
      Now Only as Penalty Rate of Interest for not maintaining CRR & SLR
    - Current Situation
    - Process - Not functioning right now, this is just for understanding
- OMO - Open Market Operations
  - OMO - Think You are RBI
    
    Suck Money - Sell G-Sec - During Inflation
    
    Inject Money - Buy G-Sec - During Recession
  - Mind Map
Unconventional Tools
- Concept of Rupee Appreciation & Depreciation
- Remember Important Point *
  
  Demand / Supply = Value
  
  Demand Inc - Value Inc
  
  Demand Dec - Value Dec
  
  Supply Inc - Value Dec
  
  Supply Dec - Value Inc
- Market Stabilisation Scheme
- Forex Swap
  
  Forex Buy Sell Swap
  
  Forex Sell Buy Swap
- Yield Rate Management
  - Factors Affecting Yield Rates Are
    1. Government Borrowings
    2. ROI in USA & US Fed Bank Policies
    3. Rate of Interests DP to
- Why increasing yield is not good for Govt
- Types of Loans Given by Bank
  - Fixed Rate Loans
  - Floating Rate Loans
- Ways to Control Yield Rates → OMO, Operation Twist, G SAP
Qualitative Tools
- Margin Requirement & 5 Concepts
- US Fed Dot Plot
- Monetary Policy Stand of RBI
  - Accomodative - Expansioning
  - Neutral
  - Calibrated Tightening - Contractionary / Dear Money / Tight Money

Money