Page 264 - DECO502_INDIAN_ECONOMIC_POLICY_ENGLISH

Indian Economic Policy

Notes As regards the effectiveness of bank rate as an instrument of monetary control, India’s experience,
and also that of other countries, shows that the bank rate has not proved to be an effective
method of controlling money supply. The reason is that banks do not depend on the RBI greatly
for their financial requirements. Besides, even if commercial banks borrow from the RBI, their
total borrowing accounts for a small proportion of the total credit created by the commercial
banks, especially when there are other sources of credit.
2. Cash Reserve Ratio (CRR) : The CRR is another traditional monetary tool that RBI has been
using to control inflation in the country, and also to restrain credit flow to the business sector.
Recall that CRR refers to the percentage of net demand and time liabilities (NDTL) which
commercial banks are required to maintain in the form of ‘cash reserves’. The NDTL are essentially
the net demand and time deposits. The cash reserves are practically divided under two heads : (i)
‘required reserves (RR)’, and (ii) ‘excess reserve’. The required reserve is the cash reserve that
commercial banks are statutorily required to maintain with the RBI. Incidentally, this is a non-
traditional method. The RBI was empowered in 1956 to impose the ‘statutory cash reserve
ratio’ between 3 percent and 15 percent of bank’s demand and time deposits. The ‘required
reserve’ is calculated fortnightly (on the second Friday of the month) on the basis of average
daily deposits. The excess reserve is the cash reserve which banks maintain as ‘cash in hand’
with the purpose of meeting the currency demand by the depositors. The excess reserves are
determined generally by the bank’s own experience regarding the ‘currency drain’.
As regards the use of the CRR method as monetary control, till 1973, the RBI used this method
only once in 1960. However, As shown in Table 3, since 1973, the RBI has been using CRR quite
frequently as a major instrument of controlling the excess supply of money. The RBI raised the
statutory CRR from 3 percent fixed in 1935 to 5 percent in 1960 and raised it further frequently.
As a result, the bank rate had gone up to 15 percent in July 1989. This rate was maintained till
1994. But, since 1995, the CRR has been regularly reduced by the RBI until January 2006, as
shown below. However, due to inflationary pressure in the economy, the RBI began to raise the
CRR and raised it 8.75% in July 2008. With inflation rate declining, the RBI cut down the CRR to
5 percent in June 2009.

Table 3 : Changes Made in CRR
Month and Year CRR (%)

1994-95 15.00
November 1995 14.50
December 1995 14.00
May 1996 13.00
July 1996 12.00
January 1997 10.00
February 2001 7.50
March 2001 7.00
October 2001 6.50
October 2002 6.25
June 2003 4.50
March 2005 to Jan. 2006 5.00
April 2007 6.50
July 2008 8.75

3. Statutory Liquidity Ratio (SLR) : In addition to CRR, the RBI was empowered to impose
‘statutory cash reserve ratio’ (SLR) to control and regulate the credit creation by the banks for
the private sector and the availability of finance to the government. Under the SLR scheme, the

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