Decoding the Monetary Policy part-2

Qualitative tools of Monetary Policy

PSL – Priority sector lending (Credit rationing)

Priority Sector refers to those sectors of the economy which may not get timely and adequate credit. Priority Sector Lending is an important role given by the Reserve Bank of India (RBI) to the banks for providing a specified portion of the bank lending to few specific sectors.

The categories under priority sector are as follows:

• Agriculture
• Micro, Small and Medium Enterprises
• Export Credit
• Education
• Housing
• Social Infrastructure
• Renewable Energy
• Others

Margin requirement

This involves making changes in the LTV (Loan to Value) ratio. This refers to difference between the securities offered and amount lent by the banks. For example, a borrower pledged goods worth Rs. 1000 as security with a bank and gets a loan amounting to Rs. 900. Thus marginal requirement is Rs. 100 or 10%. If this margin is raised, the borrower will have to pledge goods of greater value to secure loan of a given amount. This would reduce money supply.

Moral Persuasion or Advice:

In the recent years, the central bank has used moral suasion also as a tool of credit control. Moral suasion is a general term describing a variety of informal methods used by the central bank to persuade commercial banks to behave in a particular manner. Moral suasion takes the form of Directive and Publicity. It is a sort of advice. There is no element of compulsion in it.

Direct Action

This step is taken by the RBI against banks that don’t fulfil conditions and requirements.

Types of Monetary Policy

1. Expansionary monetary policy is when a central bank uses its tools to stimulate the economy. That increases the money supply, lowers interest rates, and increases demand. It boosts economic growth. It is the opposite of contractionary monetary policy. This type of policy is also called as Easy or Expansionary Monetary Policy or accommodative policy.
2. Neutral Stance: A neutral stance of RBI provides it the flexibility to move in either of the directions.
3. Contractionary monetary policy is when a central bank uses its monetary policy tools to fight inflation. It’s how the bank slows economic growth. It is also called a restrictive monetary policy (or tight monetary policy) because it restricts liquidity. The bank will raise interest rates to make lending more expensive. That reduces the amount of money and credit that banks can lend. It lowers the money supply by making loans, credit cards, and mortgages more expensive.

What Is Quantitative Easing (QE)?

Quantitative easing (QE) is a form of unconventional monetary policy in which a central bank purchases longer-term securities from the open market in order to increase the money supply and encourage lending and investment. Buying these securities adds new money to the economy, and also serves to lower interest rates by bidding up fixed-income securities. It also expands the central bank’s balance sheet.

RBI Monetary Policy Highlights

Key highlights of RBI monetary policy as announced on August 6, 2020 are:

• Repo rate remains unchanged at 4%.
• Reverse repo rate also remains unchanged at 3.35%.
• LTV ratio for gold loans increased to 90% from 75%.
• There is no extension in EMI moratorium.
• Lenders are allowed to restructure loans of corporate and individual borrowers.
• Stressed MSME borrowers with standard loan accounts are eligible for the restructuring of debts.
• RBI to allot ₹ 5,000 crores to housing finance companies, NHB and ₹ 5,000 crores to NABARD.
• Startups to be considered as part of the priority sector.
• Positive pay mechanism applicable on payment of all cheques up to and above ₹ 50,000.
• RBI says protracted spread of COVID-19 poses downside risk to economy

PRACTICE QUESTIONS

1. _____ is the operating target of monetary policy?
   • Repo rate
   • LAF
   • Reverse Repo
   • WACR
   • None of the above

Solution: (d) WACR

The Weighted Average Call Rate (WACR) is the operating target of monetary policy.

2. The ____ ratio is a financial term used by lenders to express the ratio of a loan to the value of an asset purchased.

• LTV
• Current ratio
• Call rate
• Debt equity ratio
• None of the above

Solution: (a) LTV

The loan-to-value (LTV) ratio is a financial term used by lenders to express the ratio of a loan to the value of an asset purchased. 

3.The central bank wants to induce inflation in the economy. Which of the following actions can be taken by the RBI?

• Reduce SLR
• Reduce Repo rate
• Reduce MSF
• Reduce CRR
• All of the above

Solution: (f) All of the above

Whenever the central bank has to induce inflation, it can lower CRR, SLR, repo rate, reverse repo rate, MSF, bank rate, and buy government securities.

4.What is the current (4.9.20) SLR rate set by RBI?

• 4%
• 40%
• 18%
• 4.65%
• 3%

Solution: (c) 18%

• 5. Which of the following is another name for quantitative tools of monetary policy?
  • Direct
  • Indirect
  • Selective
  • Margin requirement
  • Moral suasion

Solution: (b) Indirect

Quantitative tools are also called general or indirect tools.

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Read More from RBI Website about Monetary Policy