RBI's Credit Policy - Significance and Limitations
Posted in Finance Articles, Total Reads: 9843
, Published on 31 January 2011
Often we read in the newspapers about RBI’s monetary policy but rarely do we understand what it is actually all about. So in order to understand let us have a look at what it actually means and why is it so important for a country. The term monetary policy is also known as RBI’s credit policy or money management policy. It is basically the central bank’s view on what should be the supply of money in the economy and also in what direction the interest rates should move in the banking system. Such and many other questions related to the demand and supply of money in the economy is explained by the monetary policy
The objectives of a monetary policy are similar to the five year plans of our country. In a nutshell it is basically a plan to ensure growth and stability of the monetary system. The significance of the monetary policy is to attain the following objectives.
1. Rapid Economic Growth: It is an important objective as it can play a decisive role in the economic growth of country. It influences the interest rates and thus has an impact on the investment. If the RBI adopts an easy credit policy, it would be doing so by reducing interest rates which in turn would improve the investment outlook in the country. This would in turn enhance the economic growth. However faster economic growth is possible if the monetary policy succeeds in maintaining income and price stability
2. Exchange Rate Stability: Another important objective is maintaining the exchange rate of the home currency with respect to foreign currencies. If there is volatility in the exchange rate, then the international community loses confidence in the economy. So it is necessary for the monetary policy to maintain the stability in exchange rate. The RBI by altering the foreign exchange reserves tries to influence the demand for foreign exchange and tries to maintain the exchange rate stability.
3. Price Stability: The monetary policy is also supposed to keep the inflation of the country in check. Any economy can suffer both inflation and deflation both of which are harmful to the economy. So the RBI has to maintain a fair balance in ensuring that during recession it should adopt an ‘easy money policy’ whereas during inflationary trend it should adopt a ‘dear money policy’
4. Balance of Payments (BOP) Equilibrium: Another key objective is to maintain the BOP equilibrium which most of the developing economies don’t tend to have. The BOP has two aspects which are ‘BOP surplus’ and ‘BOP deficit’. The former reflects an excess money supply in the domestic economy, while the later stands for stringency of money. If the monetary policy succeeds in maintaining monetary equilibrium, then the BOP equilibrium can be achieved.
5. Neutrality of Money: RBI’s policy should regulate the supply of money. It is possible that the change in money supply causes disequilibrium and the monetary policy should neutralize it. However this objective of a monetary policy is always criticized on the ground that if money supply is kept constant then it would be difficult to attain price stability.
Through the monetary policy is useful in attaining many goals of economic policy, it is not free from certain limitations. Some of the important limitations of the monetary policy are
1. Existence of Non- Monetized sector: A large portion of the population is unbanked in this country and are involved in barter type of transactions instead of monetary type.
2. Excess Non Banking Financial Institutions: Due to the rapid growth of the economy a large number of NBFC’s have blossomed. They don’t come under the purview of monetary policy and thus can cause a hindrance to the effective implementation of monetary policy.
3. Existence of Unorganized Financial Markets: In rural areas, there are still moneylenders from whom people lend money. They don’t come under the purview of monetary policy and cause problems to the RBI’s monetary policy success.
4. Excess Liquidity: Due to the rapidly growing economy, the deposits of the banks keep increasing and hence the excess liquidity cannot be sucked out of the system even with the hike in CRR and SLR. So this is another limitation of the monetary policy.
5. Monetary and Fiscal policy lack coordination: Monetary policy is made by the RBI whereas the fiscal policy by the government. Both of them are supposed to be handled independently and hence it results in the lack of coordination which ultimately harms the economic policy of the country.
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