Chapter - 05
India’s Monetary and Fiscal Policy
MONETARY POLICY OF INDIA
► Monetary policy is primarily concerned with the
management of supply of money in a growing economy and
managing the rate of growth of money supply per period.
► Historically, the monetary policy was announced twice a
year—a slack-season policy (April–September) and a busy-
season policy (October–March) in accordance with
agricultural cycles. These cycles also coincide with the
halves of the financial year.
► Initially, the RBI used to announce all its monetary
measures twice a year in the monetary and credit policy.
The monetary policy has now become dynamic in nature as
RBI reserves its right to alter it from time to time,
depending on the state of the economy.
OBJECTIVES OF THE MONETARY POLICY
► There are four main “channels” which the
RBI looks at. They are
1. Quantum channel: money supply and credit (affects real output and
price level through
changes in reserves money, money supply, and credit aggregates).
2. Interest-rate channel.
3. Exchange-rate channel (linked to the currency).
4. Asset price.
MEANING OF CRR AND SLR
► CRR, or cash reserve ratio, refers to a portion of
the deposit (as cash) which banks have to keep/
maintain with the RBI.
► Besides the CRR, banks are required to invest a
portion of their deposit in government securities as
a part of their statutory liquidity ratio (SLR)
requirements.
► Since 1991, as the economy has recovered and
sector reforms increased, the CRR has fallen from
15 per cent in March 1991 to 5.5 per cent in
December 2001. The SLR has fallen from 38.5 per
cent to 25 per cent over the past decade.
IMPACT OF THE MONETARY POLICY
RBI’S MONETARY POLICY MEASURES
► In recent years, the monetary policy of the
country has been following two sets of objectives.
Firstly, the policy is trying to enhance the flow of
bank credit in adequate quantity to industry,
agriculture and trade to meet the requirement,
and also to provide special assistance for
neglected sectors and weaker sections of the
community. Secondly, monetary policy of the RBI
is also trying to maintain internal price stability by
controlling the flow of credit to the optimum level.
Credit Control
As per the RBI Act, 1934 and the Banking Regulation Act, 1949, the RBI has been empowered
to adopt credit control measures for proper regulation of the volume of credit. Th e credit control
measures are of two types, that is, quantitative controls and qualitative controls. While the quantitative
controls are trying to control the volume of credit in general the qualitative controls
are trying to control the volume of credit in a selective manner. Th e following are some of the
measures adopted by RBI to control credit.
Bank Rate: By adopting a variation in the bank rate, the RBI is trying to infl uence the interest
rate charged by the commercial banks on its lending. Initially, the bank rate was fi xed by the
RBI at 2 per cent till November 1951. Aft er the bank rate was gradually raised to 12 per cent in
October 1991 and, then, reduced again gradually to 6 per cent in January 2009.
Open Market Operations (OMO): Th e RBI has also been empowered to buy and sell shortterm
commercial bills and securities so as to control the volume of credit.
Cash Reserve Ratio (CRR): Th e variation in the CRR is another method of credit control
pursued by the RBI. As per RBI Act, 1934. Th e commercial have to keep certain minimum cash
reserve with the RBI. Accordingly, the CRR has been raised from 3 per cent in 1962 to 15 per cent
in July 1989 and then it, subsequently, declined to 5 per cent in January 2009.
Selective Credit Control (SCC): As per Banking Regulation, 1949, the RBI is empowered to control credit on
qualitative basis, that is, in a selective manner. Accordingly, the SCC was first introduced in 1956. The SCC
wanted to check speculation activities in the market and, thereby, controls the flow of credit selectively. Since
1993–94, the RBI adopted stricter SCC. Accordingly, stricter controls have been imposed on six broad groups of
commodities, which include—food grains, sugar, oilseeds, cotton, vegetable oil, and cotton textiles.
Regarding the effectiveness of SCC, the RBI quotes: The efficacy of the selective credit controls should not be
assessed mainly in terms of their positive influence on prices since the latter primarily depends on the availability
of supply of the relevant commodities relative to demand. The success of these controls is to be judged in a
limited sphere, viz., their impact on the pressure of demand originating from bank credit—in this sense, the
measures should be deemed successful, but for their operation it is likely that the price situation might have been
somewhere worse.
FISCAL POLICY OF INDIA
► An effective fiscal policy is composed of
► policy decisions relating to entire financial
structure of the government, including tax
revenue, public expenditures, loans,
transfers, debt management, budgetary
deficit, and so on.
OBJECTIVES OF THE FISCAL POLICY
Th e following are some of the important objectives of fiscal policy adopted by the
Government of India:
1. To mobilise adequate resources for financing various programmes and projects adopted
for economic development;
2. To raise the rate of savings and investment for increasing the rate of capital formation;
3. To promote necessary development in the private sector through fiscal incentive;
4. To arrange an optimum utilisation of resources;
5. To control the inflationary pressures in economy in order to attain economic stability;
6. To remove poverty and unemployment;
7. To attain the growth of public sector for attaining the objective of socialistic pattern of
society;
8. To reduce regional disparities; and
9. To reduce the degree of inequality in the distribution of income and wealth.
In order to attain all these aforesaid objectives, the Government of India has been
formulating its fiscal policy by incorporating the revenue, expenditure, and public debt
components in a comprehensive manner.
