What are the Objectives of Monetary Policy in India?

Monetary policy is an important factor for economic management in India. Its main purpose is to regulate the supply of money in India through the Reserve Bank of India (RBI). It helps control inflation and interest rates in an economy and maintain the exchange rate with other nations.

The following article talks about the various objectives of monetary policy and the tools the central bank uses to implement the policy.

Monetary policy refers to the actions undertaken by the central bank, RBI, to manage the money supply, control inflation, stabilize the currency, and achieve sustainable economic growth.

The central bank influences the availability and cost of money and credit by adjusting interest rates and reserve requirements and engaging in open market operations. This macroeconomic policy helps regulate the economy’s overall performance.

There are several objectives that a monetary policy tries to achieve. Commonly known as ‘Maudrik Niti Ke Uddeshy,’ the primary objective of this policy is to empower an environment that promotes development and maintains reasonable price stability.

Following are some of the objectives of monetary policy in India:

Employment Generation

Price Stability

Financial Market Stability

Financial market stability is one way to explain the objectives of monetary policy. The major reason for creating a country's central bank is to develop a more secure financial system.

One such way is when a central bank promotes stability by preventing financial dreads in case of bank failure. It acts as a lender and provides funds to such banks. In addition, the central bank is eventually the last source of funds in a money market.

Foreign Exchange Market Stability

Interest Rate Stability

Economic Growth

One of the major objectives of monetary policy is to ensure that there is a necessary supply of money and credit in an economy for growth. It is important as these things are vital for India's economic growth and with sufficient credit availability.

This objective is also related to employment growth because businesses invest more in their capital equipment when unemployment is low to increase productivity, thus contributing to economic growth.

Control Business Cycle

A business cycle consists of different phases, the most major of which are boom and depression, and monetary policy controls them. When a business goes through a boom phase, credit is reduced to minimize the money supply and check inflation.

However, during a depression phase, credit is increased to raise the money supply, thereby developing total demand in an economy.

Manage Aggregate Demand

Market aggregate demand is another tool used to discuss the objectives of monetary policy in India. The central bank tries to stabilize total demand with an aggregate supply of goods and services in an economy.

If total demand increases, credit is expanded, and the interest rate is lowered. Lower interest rates allow people to buy goods and services, increasing aggregate income demand and vice versa.

Regulate and Expand Banking

Ensure More Credit to the Priority Sector

Promote Exports and Substitute Imports

1. Cash Reserve Ratio (CRR)

2. Open Market Operations (OMO)

3. Statutory Liquidity Ratio (SLR)

4. Repo Rates

The repo rate is the rate at which commercial banks borrow money from the RBI to meet their daily regulatory necessity for a shorter period. Commercial banks use treasury bills and notes as collateral against the loan. These banks sell such securities and buy them back later at a promised date.

When the RBI plans to revive the Indian economy, it disincentivizes banks by providing them with lower repo rates. This helps such banks lend more money for commercial purposes and earn more returns, and vice versa.

5. Reverse Repo Rates

These are rates at which the RBI borrows money from commercial banks for a shorter period. Banks with excess funds can lend money to the RBI to earn higher interest amounts. Banks usually lend money to the RBI as it is risk-free compared to commercial lending.

In addition, when the central bank wants to reduce an economy's liquidity, it can hike the reverse repo rate to remove that money from the economy.

6. Marginal Standing Facility (MSF)

MSF is a window for commercial banks to borrow money from the RBI in an emergency when interbank liquidity dries up. Commercial banks mortgage government securities to borrow funds from the RBI at a rate higher than the repo rates in the Liquidity Adjustment Facility (LAF).

Monetary policy helps an economy stay stable by limiting inflation and unemployment. The RBI's monetary policy objectives are promoting economic development and sustaining price stability. Its main focus is creating employment in India.

1. Expansionary Monetary Policy

Expansionary monetary policy aims to increase the money supply to stimulate economic growth. It boosts economic activity - particularly during a slowdown or recession. This involves: 

• Lowering interest rates
• Reducing reserve requirements for banks
• Purchasing government securities

For example, if the RBI lowers the repo rate, borrowing becomes cheaper for businesses and consumers. This encourages spending and investment, which helps revive economic growth.

2. Contractionary Monetary Policy

Contractionary monetary policy is implemented to curb inflation and stabilize the economy by reducing the money supply. This includes: 

• Raising interest rates
• Increasing reserve requirements
• Selling government securities

For instance, if the RBI raises the repo rate, borrowing costs will increase. This reduces spending and investment, slowing down economic activity and controlling inflation.