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Monetary Policy and Fiscal Policy
Monetary policy consists of measures aimed at altering the economy's money supply and in turn the interest rates for stabilizing the
aggregate output, employment and price level. In effect, monetary policies are tools to regulate the interest rate and money supply expansion that prevail in the economy. Monetary policy controls supply of money, availability of money and cost of money. In India, RBI is vested with the powers for formulating, supervising and controlling the monetary and banking system.
Objectives of Monetary Policy:
Monitoring of global and domestic economic conditions and respond quickly Ensuring availability of credit to productive sectors of the
economy and protect the credit quality. Maintain price stability and financial stability Emphasis interest rate management, inflation
management and liquidity management. Category of instruments of monetary policy : RBI uses 2 categories of instrument
1. General category, it has powers to conduct open market operations (OMO), change the reserve ratios and alter
the discount rates.
2. Special category it can have various credit direction program (priority sector, export credit, food credit etc.) and specifying
margins and level of credit in special categories (called selective credit control).
Bank rate : Bank rate is the rate of interest which RBI charges from banks while lending to Banks. When Bank rate is increased, it
increases the cost of borrowing by banks from RBI. Thus banks tend to reduce their borrowing from RBI, which lowers the lend-able
resources of banks and consequent decline in money supply increases the interest rates. The opposite happens when RBI reduce bank
rate. Role of Bank rate has been very limited in affecting the lend-able resources with banks.
CRR refers to the ratio of bank's cash reserve balances with RBI with reference to the bank's net demand and time liabilities to ensure the
liquidity and solvency of the scheduled banks.
Extent of CRR
Under RBI Act 1934 (Section 42(1) all scheduled banks are required to keep certain minimum cash reserves with RBI. Important features
are: Wef June 22, 2006 (as per RBI Amendment Act 2006), RBI has been empowered to fix CRR (without any floor or ceiling) at its discretion
(instead of earlier 3 to 2o% range by notification) of the net demand and time liabilities. It is to be maintained at fortnightly average basis
(Saturday to following Friday- 14 days) on reporting Friday (advised by RBI to banks at the commence of the year).on a Bail yhasi8 it should be
70% of the average balance wef Dec 23, 2002.
In order to check inflation, when RBI intends to reduce money supply with the banking system, it increases the CRR. On the other hand in
recessionary situation, when RBI wants to increase the liquidity, it reduces the CRR.
Section 24 (2A) of Banking Regulation Act 1949 requires every banking company to maintain in India equivalent to an amount which shall not
at the close the business on any day be less than as prescribed by RBI (earlier 25%) as a percentage of the total of its net demand and time
liabilities (to be computed as in case of CRR) in India, which is known as SLR.
RBI powers - RBI can change SLR with minimum at its discretion and maximum 4o%).
SLR is to be maintained as at the close of business on every day i.e. on daily basis based on the NDTLs as obtaining on the last Friday of the
2nd preceding Fortnight.
Components of SLR : RBI issued the notification•dated Sept 08, 2009 giving the list of assets to be maintained by the banks (or Sec 24
of Banking Regulation Act, 1949, as under:
(a) Cash, or (b) Gold valued at a price not exceeding the current market price, or © Unencumbered investment in the following instruments
which will be referred to as "Statutory Liquidity Ratio (SLR) securities":
Objective of maintaining SLR :
1 It helps RBI to control the growth of bank credit. By changing SLR, RBI can impact the availability of funds with the banks for lending
purpose. Maintenance of SLR enhances the solvency position of the banks RBi can compel banks to meet the govt. borrowing program by
subscribing to Govt. securities. Open market operationsIt refers to buying and selling of govt. securities by RBI in the open market. By
its impact on the reserves of banks, OMO help control the money supply in the economy.When RBI sells Govt. securities to banks, the lendable
resources of4h&latter aze reduced and banks are forced to reduce or contain their lending, thus curbing themoney supply.When money supply is reduced, thaeonsequeattsiaerease=in,theinterest rates tends to limit spending and investment.

Repo and Reverse Repo
Under a Repo transaction RBI purchases_gqvt. securities from banks and thus inducts liquidity in the banking system. Repo transactions are undertaken at Repo rate, which keeps on changing fromtime to time. By increasing repo rate, RBI increases the cost of borrowing by banks.
Under a Reverse Repo transaction, RBI sells govt. securities to banks and thus absorbs, liquidity in the banking system.
Sterilization Operation (Market Stabilization Scheme).Under this mechanism, RBI uses MSS Bonds, with a view to absorb liquidity
created by inflow of foreign exchange in to India. The MOS-instruments are in the form of treasury bills or dated securities which RBI
isstiet through ailetion. This is also knows as Sterilization operation.
Govt. uses fiscal policy, to influence the level of aggregate demand in the economy, with a view to achieve economic objectives of price
stability, full employment and economic growth. Fiscal policy is the process of policy decision making in relation to the financial structure
of the govt. receipts and payment. It includes the actions and strategies on tax policy, revenue and expenditure, loans and borrowing,
deficit financing etc. Primarily, it is the budgetary policy of the Govt. and is reflected through the annual budget formulation.
The objective of the policy are:
1 Moblisation of resources for meeting the financial requirements for economic growth. 2 Improve savings & investment rate to
improve the capital formation. 3 To initiate steps to remove poverty and unemployment and improve the standard of living of the people. 4
To reduce regional disparities.
With a view to bring the Central finance under discipline, The Fiscal Responsibility & Budget Management Act (FRBM) notified on July 02,
2004 has come into fore w.e.f July 5, 2004 (recommendations of Dr. EAS Sarma Committee). The Act provides for an institutional framework binding the Government to pursue a prudent fiscal policy. It casts responsibility on the Central Government to ensure fiscal  management and long-term macroeconomic stability by achieving sufficient revenue surplus, removing fiscal impediments in the conduct of monetary policy and prudential debt management through limits on borrowings and deficits.
Targets :
The Act provides for the following targets for the Central Govt.:
Reduce the fiscal deficits to 3% of GDP. To eliminate revenue deficit by March 31, 2009 (to be reduced minimum by 0.5% point beginning the financial year 2004-05 (Zero to be achieved by 31.3.2010 as per Budget 2008).To set a ceiling on guarantees - 0.5% of GDP.Total debt increase capped at 9% of GDP during 2004-05.
Report to the Parliament: Government is required to place before the Parliament, 3 statements each year along with the Budget, covering
Medium Term Fiscal Policy, Fiscal Policy Strategy and Macro Economic Framework. The Parliament is also to be informed through quarterly reviews on the implementation. No deviation permitted without approval of Parliament.
Borrowing from RBI : The Act prohibits the Center from borrowing from RBI (i.e. restriction on deficit financing through money creation.
Temporary Ways and Means Advances to tide over cash  flow problems are permitted till April, 2006.

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