Page 265 - DECO502_INDIAN_ECONOMIC_POLICY_ENGLISH

Unit 20: Indian Financial System: Money Market and Monetary Policy

commercial banks are required by statute to maintain a certain percentage of their total daily Notes
demand and time deposits in the form of liquid assets. Liquid assets, as specified by the RBI,
include (i) excess reserves, (ii) unencumbered government securities, e.g., bonds of IDBI, NABARD,
Development banks, cooperative debentures, debentures of port trusts, etc., and (iii) current account
balance with other banks. The method of determining the SLR can be specified as follows.
+
+
ER GS CB
SLR =
+
DD TD
where ER = excess reserves, GS = Government (unencumbered) securities, CB = current account
balance with other banks, DD = demand deposits, and TD = time deposits.
The basic purpose of using SLR was to prevent the commercial banks from going for liquidating
their assets when CRR was raised to control money supply. When CRR was raised, what
commercial banks used to do was to convert their liquid assets into cash to replenish the fall in
their funds due to the rise in the CRR and maintained their credit creation ability. This made
monetary policy ineffective. The SLR, as a tool of monetary control, works in two ways : (i) it
provides an alternative to the borrowing of the government from the RBI, and (ii) it affects
banks’ freedom of buying and selling the government bonds. In both ways, it affects the money
supply, depending on whether the RBI wants to control or enhance the money supply. When
the intention is to increase money supply, the RBI reduces the SLR and when it wants to reduce
the money supply with the public, it increases the SLR.
The SLR was first imposed in 1949, and was fixed at 20 percent, and remained unchanged till
August 1964. In September 1964, the SLR was raised to 25 percent and was maintained at the
same level till September 1970. Since then, the SLR has been raised quite frequently as shown
below. The SLR was raised in September 1990 to 38.5 percent — very close to the prescribed
upper limit of 40 percent. The SLR, as tool of monetary control, has, in fact, been used as a
monetary-fiscal tool. The deficit financing method — a fiscal measure — led to rapid increase in
money supply which continued to build inflationary pressure in the economy. The RBI now
used the SLR for controlling the short-term money supply. The use of SLR restricted the flow of
funds from the banks to the private sector. Since 1992, however, the SLR has been gradually
reduced. It was reduced to 25 percent in April 1992, mainly because the rate of inflation had
declined to around 5 percent in the early 1990s. The SLR continues to be maintained at 25
percent.
Year SLR (%)

1971 25.0
1972 30.0
1973 32.0
1974 33.0
1978 34.0
1990 34.5
1992 25.0
2009 25.0

4. Open Market Operations (OMO) : In developed countries like the USA and the UK, open
market operation is considered to be a very powerful and efficient tool of monetary management.
But in India, the open market operation has not been until recently a successful instrument of
monetary management for the following reasons.
(i) In India, the security market, especially the Treasury bill market, is not yet well developed
and fully organized, and the Government securities market is almost non-existent; and
(ii) The government bonds were earlier not very popular because of low rate of return. The
rates were much lower than the market rate of interest.

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