Monetary And Credit Policy Of The Reserve Bank Of India

Author: LawSphereX

Category: Banking & Finance

Published: 2026-08-23T20:37:57.476484+00:00

Updated: 2026-08-30T07:12:12.844Z

MONETARY AND CREDIT POLICY OF THE RESERVE BANK

OF INDIA Anjali Bhatt, Assistant Professor (Senior- Scale), School of Law, UPES, Dehradun

ABSTRACT

After the nationalization of the Reserve Bank of India in 1948, it was felt that traditional instruments of bank rate, open market operations and minimum statutory cash reserve ratio were far too short of empowering the bank to effectively control the country’s monetary system which would emerge as a consequence of the economic planning in the country when the bank would be called upon to play a more positive and dynamic role in the economy’s planned economic growth. The Banking Regulation Act, 1949 armed the Reserve Bank of India with special powers of exercising direct control over the operations of the commercial banks in India. Both these Acts have in effect armed the Reserve Bank of India with almost dictatorial powers over the country’s monetary and banking system with regard to the control and regulation of credit in the country.

This project seeks to understand the monetary policy and the credit policy that India has formulated. India has transited different phases in its economy, with the help of RBI and its schemes. It has used different tools to ensure the current economic structure, the authors seek to examine the same. Keywords: Banking, Nationalization, Economic Planning, Credit Policy, Monetary Policy, etc.

INTRODUCTION

In the year of 1935, month of April, the Reserve Bank of India, the one that regulates all the banking functions came into being. It had the total share capital of Rs. 5 crores at that time and the shares were divided into shares of Rs. 100, which were paid up fully. 1 The entire share capital in the beginning was owned by private shareholders. 2 Also, the Government of India did not have a majority stake, it was still at minority with Rs. 2,22,000. 3 But in view of the public nature of the Bank’s functions, the Banking Regulation Act, 1934 provided for the appointment by Central Government of the Governor and two deputy Governors (who were the Directors of Central Board). The Banking Regulation Act is wide in nature, in the sense that it has provisions regarding the holding of shares and the rate that the shareholders have to pay. The RBI was nationalised in 1949.

A group of 20 people form the Central Board of Directors which direct, control and supervise4 , these 20 members consist of the Governor and four Deputy Governors, one Government official from the Ministry of Finance, ten Directors nominated by the Government of India. These ten directors represent the important components in the economic life of the country. The four below-mentioned local Boards are represented by the Central Government’s chosen and nominated Directors. Besides the Central Board, there are four Local Boards with headquarters at Bombay, Calcutta, Madras and New Delhi. 5 A term of four years is given to the members of Local Board. They are there to protect, safeguard and represent the interests of co-operative and indigenous banks. 6 The RBI had to constantly control and regulate through the use of various credit control instruments.

The existing instruments of credit control had, therefore, to be supplemented with certain new and more effective monetary policy instruments. In this project, the monetary policy of RBI and the credit policy and tools have been analysed.

MONETARY POLICY OF THE RBI

CONTROLLED EXPANSION (1951-72) With the introduction of the Five-year Plans, after the independence, it was important that suitable adjustment was done to monetary and fiscal policy. It was necessary to keep up with the pace and a pattern of planned development. 7 The 1952 policy served dual purposes of the Government:8 (a) Speed up economic development in the country to raise national income and standard of living;9 (b) to manage and cut down on the inflationary pressure in the economy This policy of the Reserve Bank of India since the First Plan period was termed broadly as one of the controlled expansion10 . It was absolutely pertinent at that time to meet the increased demand for investment funds. India was at a critical time then, having just started out on its way to economic development.

11 The Reserve Bank of India at that time sensed that there was a dire need of money supply and credit policy, alongwith the development and diversification happening in the country at that time. However, the RBI did recognise the dangers with expansion of money and credit that would lead to inflation and particularly harmful for the financial stability of the economy. Accordingly, the RBI helped the economy to expand via expansion of credit and money and attempted to check rise in prices by the use of selective controls. 12 RBI’S ANTI- INFLATIONARY POLICY SINCE 1972 Since 1972, the Indian economy has been working with considerable inflationary potentialrapid increase in money supply with the public and with the banking system. There was also expansion of bank credit to finance trade and industry. A serious inflationary situation was emerging from the beginning of 1970’s.

This was fuelled by frequent fluctuations in the agriculture production, faulty government policies, global inflationary situations directly due to hike in oil prices, Gulf war, etc. The RBI then shunned or gave up its tight restraint policy or the credit restraint it had exercised before. RBI has generally followed this kind of monetary policy with varying degrees of success. 13 The Indian economy was growing at the healthy annual rate of 8 to 9% and the general price level was generally under control. For the fiscal four years of UPA government, the emphasis was on maintaining the growth of GDP and if possible, to raise it to double digit level. Secondly, however, the Government has been jolted by rapid rise in price level. Inflation, measured by variation in the whole sale price index has been increasing from time to time. 14

OTHER

OBJECTIVES

OF MONETARY POLICY On some occasions and durations, the RBI has to tackle with short-term objectives and problems. For instance, during in two years 1994-96, RBI had to enter the foreign exchange market in a big way to prevent heavy depreciation of the rupee. This was also done during January 1998 and later to prevent the rupee following the experience of South Asian currencies. Bimal Jalan, the Governor of RBI came out strongly with a series of measures to check the rapid sliding of the rupee against the dollar. 15 These objectives can be taken as short-term objectives of monetary policy of RBI. The long term policies of RBI, however, reflect the banks’ firm commitment to pursue a low and stable order of information-the assumption is that real growth would be in jeopardy, if inflation goes beyond the margin of tolerance.

16 MONETARY TARGETING money supply in a broad sense (M3) during a given year should be in terms of the range as given below: (a) based on anticipated growth in output, and (b) in the light of the price situation,17 The modifications and the circumstances under which such modifications and circumstances under which such modifications would be made should also be announced in advance. According to the Committee, the target for money supply should be reviewed in the course of the year to accommodate revisions, if any, in the anticipated growth in output and any change in price situation. 18 The Chakravarty Report pointed out that the major cause of the substantial growth in money supply since 1970 was the rise in RBI credit to Government.

The main reason for the high degree of monetisation of debt was relatively low yields on government securities and low discount rate on treasury bills (constant at 4. 6% per annum since 1974). 19In other words, the are of interest on Government securities had been so low that neither the public nor banking, financial and other institutions willingly bought Government securities or treasury bills. The entire monetary requirement of the Government has thus to be borne by RBI; and RBI loans and advances to the Government became money. 20 In this connection, the Chakravarty Committee has recommended among other things, that RBI and the Central Government should evolve a policy framework for the regulations of RBI credit to the Government. 21 For instance, there should be higher yields on Government securities and the discount rates on treasury bills should be suitably raised.

These measures would facilitate greater participation in the Government’s borrowing programmes by the nonbank sector of the public and this would reduce the growth in reserve money, attributable to RBI credit to the Government. 22 RBI MONETARY POLICY 2015-16 AND ITS IMPACT The Reserve Bank of India cut the repo rate by 50 basis points and brought it down to 6. 75% under its monetary policy revised in October, 2015. The factors that compelled RBI to take this decision can be clubbed under three heads: (i) Low inflation, (ii) Domestic factors , (iii) Global factors. (i) Low inflation: Due to surplus commodities existing across the globe and reduction in prices in International market, India’s Chief Economic Advisor concluded that India is near deflation. Hence provided this to be the reason behind the present rate cut.

This decision has been taken to increase the growth rate and bring about stability in prices. The objective of the current policy is to bring down the inflation rate to 5% by the end of 2016-17. 23 (ii) Domestic factors: RBI has put a major emphasis on domestic factors of growth, investment and production and service activities. With regard to growth RBI has suggested that the economy is recovering but the rates are still not too great. An uneven growth persists in the manufacturing sector. In August the PMI had expanded despite of the slowdown in July. Due to low demands form the cement industry and related industries, the service industry has taken a hit. (iii) Global factors: Among the various global factors that have influenced the decision a major role is played by the Federal Reserve’s decision to postpone till the end of 2015.

Also the low demand for Chinese products, has led to global commodity glut. Thereby, easing the inflation in the country, and have helped India in achieving its fiscal consolidation objectives. 24 A major impact has also been left by recession prevalent in Brazil and Russia. 25 RESERVE BANK OF INDIA'S CREDIT POLICY The Reserve Bank of India has the objective of making a credit policy that seeks to achieve higher growth rates with simultaneous stability in prices. High rates of economic growth means more production of goods and services in terms of quantity in varied economic sectors; however price stability does not signify stagnant price rates of commodities and services but rather decreased rates of inflation. 26 Ample financing options should be generated for agriculture and industrial activities by way of credit policy of RBI.

The role played by commercial bank is very crucial whenever the credit policy of RBI is implemented. Flow of credit from commercial banks to different sectors of the economy is highly dependent on actual credit cost and availability of funds in the economy. 27 RBI AS CONTROLLER OF CREDIT The Reserve Bank Of India performs a major function of controlling credit. Major regulation lies with respect to the rates and the quantity of credits that can possibly be made available in the market. This controlling function can be divided into general and selective control forms. The major instruments used for general control of credit quantities are Variable Reserve Requirements, Open Market Operations and the Bank rates. When practicing selective controls of credit, due regard is given to the purpose for which credit is to be advanced and maintenance of margins in respect of secured advances.

Also Reserve Bank of India follows the practice of persuading banks through meetings and letters so as to persuade them to agree to adopt the course suggested by RBI. 28 By way of practicing open market operations, RBI controls the cash and reserve that lies with the banks. 29 When this gets affected, the credit giving capacity of banks in turn also stands affected. Whenever sale of securities are made, the reserves present with the banks reduces and hence the banks are forced to bring a contraction in their credits and in case of a vice versa situation, they expand their credits. 30 The method of variable reserve requirements, directly affects the credit creating capacity of banks. By increasing the reserves which the banks are supposed to keep with the RBI as a part of their deposits, reduces the credit creating capacity of the banks and vice versa.

Whenever changes are brought in the rate at which the RBI discounts bills of exchange, it affects the cost of funds and the credit amounts. 31

OBJECTIVES

OF CREDIT CONTROL IN INDIA The major objectives of Credit control policy in India are: • Maintenance of stability when it comes to internal purchasing power of the money along with achieving higher growth rates. • Attaining adequate level of liquidity by utilizing the resources to the maximum but without bringing about any change in inflationary pressure. 32 • Stabilizing the money market and exchange rates of the country. METHODS OF CREDIT CONTROL IN THE MARKET USED BY RBI QUALITATIVE METHOD This method of credit control is implemented by the Reserve Bank of India whenit starts maintaining a close scrutiny on the purposes for which the credits may be advanced in the markets. 33 This is done as a part of its objective to achieve economic stability and management of credit. This method channelizes the cash and credit flow in the economic setup.

This is because it selectively controls and restricts credit for specific section whereas brings about an expansion for the others sections depending upon their position in its priority lists. 34 If the banks sense that the major portion of the credits advanced are being captured by the huge capitalists and industrialists and agriculture sector is being deprived of the much needed credits, then this approach is usually resorted to. 35 MARGIN REQUIREMENTS Margin requirements are changed so as to bring about a significant influence on the flow of credit against particular commodities. 36The borrower manages to secure loans from commercial banks only by way of offering securities to the banks in exchange of the loans which must be acceptable to the banks.

37The amount that the commercial banks lend is generally not equivalent to the full amount of the security but is always less than its actual value. These margin requirements against specific securities are decided upon by the RBI that consequentially influences the flow of credits. 38A fall in the requirement of margin causes an increase in the borrowing value of the security and similarly, a rise shall lead to an expansion in the borrowing value of the security. CREDIT RATIONING Under this method, the RBI puts an upper limit to advances and loans that can be granted by the commercial banks of the nation and cannot be exceeded at any cost. Categorization is done before fixing or assigning ceiling rates. Credit flow is kept under check by such specific rationing. 39 REGULATION OF CONSUMER CREDIT repaid.

40 Liberalization and constriction of loan conditions are done by the RBI by using this method. 41 MORAL SUASION This is one of the frequently used methods of credit control. The Reserve Bank of India uses its influence and the position of being the highest and the supreme bank in the country to convince all the commercial banks of the country to abide by the guidelines and decisions taken by the RBI specially when it comes to those pertaining to the credit policies drafted. 42 Credit contraction and expansion during times of inflation and deflation are regulated and supervised by the RBI. It is since 1949, that the Reserve Bank Of India has been using this method to control and convince commercial banks within the country. 43 QUANTITATIVE METHOD BANK RATE Bank rate is also known by the name discount rate and is payable on the loans from or rediscounts given by the Reserve Bank of India.

44Any change that is brought in the bank rate subsequently leads to changes in other rates of interest as well. It there is an increase, then other rates of interest increase and if there is a decrease, then other rates too decrease. Bank rates are deliberately manipulated by the RBI so as to immediately influence the demand , cost and availability of credit. 45 Higher bank rates lead to higher credit costs; a contraction in demand for credit putting a restriction on the total money present in the economy and controls inflation. 46 Likewise, lowering of the bank rates acts as an anti deflationary measure.

OPEN MARKET OPERATIONS

Whenever sale and purchase of securities are made by the RBI to the commercial banks in the market, it is known as open market operation. Whenever securities are sold by the RBI to commercial banks, they fall short of cash reserves. 47A decrease in a cash reserve decreases the credit advancing power on commercial banks and hence this measure serves effectively well in reducing inflation. Similarly, when securities are sold to RBI by the commercial banks that reduces, due to opposite effects, it serves as an anti-deflationary measure of control. Government securities are frequently sold by The Reserve Bank of India to the commercial banks. Ambidextrously, open market operations increase the budgetary resources on one hand and also drain off the excessive liquidity in the economic system on the other hand.

48 VARIABLE RESERVE RATIOS: Variable reserve ratios refer to that portion of the deposits of the bank which the commercial banks are required to maintain so as to ensure liquidity for the outflow of credits created by them in the market. The deposit multiplier falls with an increase in the cash reserve ratio. Also if a fall occurs in the cash reserve ratio, the deposit multiplier increases. A fall in the value of deposit multiplier serves as an anti-inflationary measure. An increase in the value of deposit multiplier leads to creation of more credit, thereby increasing the availability of finance for consumption and investment purposes. This acts as an anti deflationary measure. The RBI brings about changes and decide upon the actual requirements of the reserve. There are two types of Cash reserve Ratio viz.

the Statutory Liquidity Ratio (SLR) and the Cash Reserve Ratio (CRR): The statutory liquidity ratio is an cumulative deposits which the banks have to keep in a liquid form. This money is used by the banks for buying government securities. Hence, it is used to remove the excess liquidity existing in the banking system,and also generates revenue for the government. It can be raised upto 40 percent of the total deposits present with commercial banks. Presently, it is at 25 per cent. 49 On the other hand, cash reserve ratio refers to that fraction of the deposits which the commercial banks should maintain with the Reserve Bank of India which is 9 percent at present. 50

CONCLUSION

The monetary policy of Reserve bank of India has made commendable achievements but simultaneously has certain restrictions and limitation as well. Achievements: There are certain advantages that the RBI policy has brought to the economy of the country over these years.

1. Financial Stability:- The Reserve Bank of India has been successful in keeping the

macroeconomy of the country stable during times of global economic crisis. This has been done by the different rules and regulations that it imposes.

2. Financial inclusion:- A huge influence has been left on the microfinancing and its growth.

Various self help group models are supported by the policies of RBI. NABARD and other microfinancing institutions have been given a great boost by the monetary policy of RBI.

3. Adaptability:- Due to flexible nature of India’s monetary policy, it develops new methods

of controlling credit and has significantly shifted from monetary targeting to multiple indicator approach. Various limitations of the policy are:

1. Unorganised Money Market :- Since RBI has no regulative control over the unorganized

sector of money market, its policies become less effective in this area.

2. Less Accountability:- the objectives of the policy in India are not elucidated in clear terms

which becomes more problematic due restrictions on the freedom of using the instrument. Here, accountability weakens due to vagueness in the responsibility of RBI and the Governments.

3. Increase Volatility :- The amalgamation of domestic and foreign exchange markets has

resulted in an increase in the volatility in the domestic markets. There has been a tremendous widening of market of foreign exchange and development relating to rupee - foreign exchange swap has lead to the reduction of risks and volatility.

These have been the significant advantages and limitations of the monetary and credit policy of The Reserve bank of India.51