Page 130 - DMGT401Business Environment

Unit 5: Monetary Policy

10. Moral Suasion: Besides all these, the RBI also circulates letters to the banks regarding the Notes
policies and priorities of the RBI about credit control and money supply. It also regularly
discusses its policies with the bank. The objective is that the banks should work in the
same direction.
11. Liquidity Adjustment Facility (LAF): LAF is a new technique of monitory policy in India.
It matches the new requirement which emerges because of newer economic policies. LAF
was introduced on June 5, 2000.

LAF introduced variable REPO auctions with same-day settlement. The amount of REPO
and reverse REPO are changed on a daily basis to manage liquidity. The maturity of
REPOs is between one day to fourteen days. The funds under LAF are expected to be used
by the banks for their day-to-day mismatches in liquidity. All transferable Government of
India dated securities/TB (except fourteen days TBs) can be traded in REPO and reverse
REPO markets.
Interest rates in the REPO market usually emerge out of bids (i.e. auctions are conducted
on "uniform price" basis), and the RBI occasionally conducts fixed interest rate (multiple
price) auctions to send signals to the market. Under LAF, the RBI, periodically, if necessary
even daily, sets/resets its REPO and reverses the REPO rate. It uses 3-day or 4-day REPOs
to siphon off liquidity from the market. The REPOs are used for absorbing liquidity at a
given rate (floor), and not infusing liquidity through reverse REPOs at a given rate (ceiling).
REPOs: A REPO is purchase of one loan against the sale of another. They involve the sale
of securities against cash with a future buy back agreement. Under such an agreement, the
seller sells specified securities with an agreement to repurchase the same at a mutually
decided future date and price. Similarly, the buyer purchases the securities with an
agreement to resell the same to the seller on an agreed date at a predetermined price. The
transaction is called a REPO when viewed from the perspective of the seller of the securities,
and a reverse REPO when viewed from the perspective of the buyer of the securities.
REPOs are part of open market operations undertaken to influence short-term liquidity.

There are two types of REPO auctions: discretionary price auctions and fixed rate auctions,
or uniform price auctions. Under the former, bidders submit multiple price-quantity
sealed bids. Under the fixed rate REPOs auction, the rates are pre-announced and the
bidders are required to submit bids indicating the volume of REPOs.
(a) Monetary policy in India has been formulated in the context of economic planning,
whose main objective has been to accelerate the growth process in the country. In a
country like India that has followed an expansionary fiscal policy, which leads to
inflationary conditions, to manage a monetary policy under these circumstances is
like tightrope walk. During the planning period prior to liberalisation, the RBI used
higher CRR and SLR rates to control inflation.
(b) After 1992, the demand of the day was development and investment and the
development sector was expanding and was and in need of money.
(c) Indian corporations had to compete with companies, which were getting money at
4% to 5% interest rates. Then the RBI had to reduce CRR and SLR to reduce interest
rates and to make available money for investment purposes.

Task Prepare the present Credit Policy of the RBI (Consult the RBI website).

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