What is Inflation?When the price of commodities increases but people still purchasing the goods at any price, it means there is inflation in the system. Here demand is more than supply and people have more money in hand to expend. In other words there is excess liquidity in the system. If the RBI uses its tools by increasing policy rates which suck the liquidity from the system. Its impact will be as follows:
1.The banks have less money to advance.
2.Businessmen need to pay more in the form of interest means lesser money in their hand. Delays in implementation of projects. This again put pressure on the demand.
3.Personal/home loan seekers need to pay more and/or postpone demands
4.The increase in deposit rates resulting people start to invest in banks in the form of FDR
Now why the government wants to tame the inflation if it restrict the growth. The main reason is the poor and below middle class category people who do not have enough money to survive. They are impacted much as they have to pay more but on the same earning levels. The World Bank, which defines poverty as survival on less than $1.25 per day, says India reduced poverty from 60% of the populace to 42% between 1981 and 2005, but says the country still accounts for one-third of the world’s 1.4 billion poor people. 43% of Indian children are malnourished, a third of the world’s total. Over 35% of Indians are illiterate, and more than 20 million children are out of school.
To save the poor, lower middle class, and middle class who cannot afford the burden of rising prices, Central Bank takes these measure
RBI Policies to tame inflation
Repo Rate: Repo rate is the rate at which our banks borrow rupees from RBI. A reduction in the repo rate will help banks to get money at a cheaper rate. It is a tool in the hands of banks that whenever they have any shortage of funds they can borrow it from RBI. When the repo rate increases borrowing from RBI becomes more expensive. But the banks still need to borrow as other options may be more expensive and it may take more time to borrow from other sources.
Reverse Repo rate: is the rate at which Reserve Bank of India (RBI) borrows money from banks. Banks are always happy to lend money to RBI since their money is in safe hands with a good interest. An increase in Reverse repo rate can cause the banks to transfer more funds to RBI due to these attractive interest rates. It can cause the money to be drawn out of the banking system. The bank can invest in mutual funds but it might not be a secure option, Investment in government securities may not give such good returns as the RBI can give, Also the bank can increase its advances which again a thing of more efforts, time consuming, less safety, subject to restrictions, government policies etc.
Cash reserve Ratio (CRR): is the amount of funds that the banks have to keep with RBI. If RBI decides to increase the percent of this, the available amount with the banks comes down. RBI is using this method to drain out the excessive money from the banks. It is very effective tool in the hand of the RBI to suck the excess liquidity from the system as it is compulsory for the banks to keep the money with RBI in the prescribed percentage
1.The banks have less money to advance.
2.Businessmen need to pay more in the form of interest means lesser money in their hand. Delays in implementation of projects. This again put pressure on the demand.
3.Personal/home loan seekers need to pay more and/or postpone demands
4.The increase in deposit rates resulting people start to invest in banks in the form of FDR
Now why the government wants to tame the inflation if it restrict the growth. The main reason is the poor and below middle class category people who do not have enough money to survive. They are impacted much as they have to pay more but on the same earning levels. The World Bank, which defines poverty as survival on less than $1.25 per day, says India reduced poverty from 60% of the populace to 42% between 1981 and 2005, but says the country still accounts for one-third of the world’s 1.4 billion poor people. 43% of Indian children are malnourished, a third of the world’s total. Over 35% of Indians are illiterate, and more than 20 million children are out of school.
To save the poor, lower middle class, and middle class who cannot afford the burden of rising prices, Central Bank takes these measure
RBI Policies to tame inflation
Repo Rate: Repo rate is the rate at which our banks borrow rupees from RBI. A reduction in the repo rate will help banks to get money at a cheaper rate. It is a tool in the hands of banks that whenever they have any shortage of funds they can borrow it from RBI. When the repo rate increases borrowing from RBI becomes more expensive. But the banks still need to borrow as other options may be more expensive and it may take more time to borrow from other sources.
Reverse Repo rate: is the rate at which Reserve Bank of India (RBI) borrows money from banks. Banks are always happy to lend money to RBI since their money is in safe hands with a good interest. An increase in Reverse repo rate can cause the banks to transfer more funds to RBI due to these attractive interest rates. It can cause the money to be drawn out of the banking system. The bank can invest in mutual funds but it might not be a secure option, Investment in government securities may not give such good returns as the RBI can give, Also the bank can increase its advances which again a thing of more efforts, time consuming, less safety, subject to restrictions, government policies etc.
Cash reserve Ratio (CRR): is the amount of funds that the banks have to keep with RBI. If RBI decides to increase the percent of this, the available amount with the banks comes down. RBI is using this method to drain out the excessive money from the banks. It is very effective tool in the hand of the RBI to suck the excess liquidity from the system as it is compulsory for the banks to keep the money with RBI in the prescribed percentage
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