Monetary Policy of India-Qualitative Instruments

By admin
Mar 4th, 2012
monetary policy

In our previous post on monetary policy of India we discussed about few quantitative instruments of monetary policy which are used to curb inflationary pressures in an economy namely Bank Rate, OMO, VRR and LAF.

Today we will try and understand the othercategory of instruments that are qualitativeand see how they can help in attaining the aforesaid objectives of centralbank.
So, let us discuss the qualitativeinstruments.
MarginRequirements: Manyof you must have applied for loans and even if you haven’t you must be abreastof the procedure. When you apply for the loan you need to mortgage a securityagainst which the loan is granted. So let us suppose you mortgaged a houseworth of Rs. 1 million with the bank but the bank wouldn’t give you a loan of 1million. They may give you loan of say Rs. 800 thousand. Thus, Rs. 200 thousandin this case is margin requirement that is 20%.
So, whenever central bank wants torestrict the flow of credit in an economy or to a particular sector, it willincrease the margin requirement of loan either for whole economy or for thosesectors. And vice versa is the case when central bank (RBI) wants to increasethe credit for a particular sector.
Rationing ofcredit: Ingeneral terms, it means fixing quota for credit. You must have definitely heardof quotas. Quota is basically restricting an amount or quantity or anything inparticular to a certain limit.
Same is the case with banks. Central bankor RBI fixes the quota of credit for commercial banks. It means at maximum, howmuch volume of money a commercial bank can grant as loan for a particularactivity. Thus by increasing this quota RBI can increase the credit supply inan economy and by decreasing quota RBI can restrict credit supply.
Control throughDirectives: Wheneveryou are playing any game you are provided with a set of directions beforehand.Same way RBI frequently issue sets of directions or directives to member banks.These directives may be in respect to bills rediscounting, credit limits, notissuing credits to certain specific activities etc.
Moral Suasion: When at home your parents orat office your boss wants you to do a certain activity what course of actionthey generally take? They may either use persuasion or pressurize you toperform that activity.
Same way RBI, central bank can make themember banks to agree to the directives issued by RBI either through persuasionor pressure. Thus, banks are advised or forced to restrict credit supply duringinflation and be liberal while granting loan during deflation.
Direct action: This is harsher than moralsuasion. If you don’t follow the code of conduct at office or at college orschool, what action is taken by authorities? Well, they can terminate orrusticate you from the organization. 
RBI does the same with commercial banks.RBI can use direct actions like derecognizing the member bank if they fail tocomply with RBI directives.
So these were the few qualitativeinstruments of monetary policy of India.

Here along with the previous part, we come to an end of our attempt to explainbasics of the monetary policy of India in a short and simple manner. Hope you enjoyedreading and learning.
Posted by our guest author Priyanka

Priyanka Maheshwari
About Priyanka :

Priyanka Maheshwari, a student of The Institute of Company Secretary enjoys reading novels.

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