This article credited by
Abhay Kumar, Asstt. General Manager (Faculty), State Bank Institute of HRD.
Money Supply in the age of COVID-19
COVID-19 has impacted every sphere of life, different sectors of economy could not remain untouched either. Economic activity coming to a near standstill as remaining alive and saving lives became the prime objective of people, societies and nations. However, in the longer run, we cannot continue to survive without economic activities. With jobs disappearing and volatility increasing in the market, everyone is compelled to be on safer side with having adequate liquidity in hand. In this background, RBI has taken many initiatives to ensure money supply to support economic activities in the country. Let us discuss the Monetary Policy Framework as also new initiatives taken by RBI to combat the impact of COVID-19 on the Indian Economy.
Monetary Policy Framework
RBI regulates the market by putting in place a Monetary Policy. The policy revolves around ensuring supply of money to meet the requirements of all sectors of economy, credit expansion as also containing inflation. The Central Government, in consultation with RBI, sets target for inflation every five years under the Flexible Inflation Targeting Framework (FITTF). (The inflation target for the period starting from 5th August 2016 to 31st March 2021 has been set at 4%, with tolerance level of 6% and lower limit of 2%.) The inflation target is considered as not achieved if the average inflation remains above the upper level or below the lower limit for any three consecutive quarters. The Monetary Policy Committee constituted by the Central Government determines different policy rates viz., Repo Rate, Reverse Repo Rate, Marginal Standing Facility (MSF), Liquidity Adjustment Facility (LAF) etc., to contain the inflation within the target set by the government. RBI uses different instruments available under Monetary Policy to keep inflation in check.
The instruments of Monetary Policy are categorised as Quantitative or Qualitative in nature. Quantitative instruments influence the volume of money and supply of credit in the system and include bank rate, open market operations and reserve ratio requirements. Qualitative instruments or Selective instruments affect the direction of credit supply in the economy. This is done through margin requirements, moral suasion, credit ceiling and discriminatory rates of interests.
Repo Rate, Bank Rate and Reverse Repo Rate
Lending money to and borrowing money from commercial banks in India, are the important activities of RBI to modulate supply of money in the market under the Monetary Policy Framework. Under expansionary monetary policy, RBI increases supply of money by lending money to commercial banks and decreases money supply by borrowing from the banks under contractionary monetary policy.
As normal commercial operations, interest is paid on borrowing and is charged on lending. A decrease in the Repo Rate encourages banks to borrow from RBI thereby making money and credit available at cheaper rate thus pushing the economic growth. However, reduction in Repo Rate may increase inflation. Hence RBI reduces Repo Rate only in such a situation when the inflation is well under control and a slight rise in it will not have any negative impact on the economy. Likewise, an increase in Repo Rate will make money and credit available at higher rate and decrease in supply of money in the market. While Repo Rate is for short term, Bank Rate is the long-term rate at which RBI lends money to banks or financial institutions. Currently, bank rate is not being used by RBI for monetary management.
(The views and opinions expressed in the article are solely of the author and not of the Bank)
To be concluded