The Reserve Bank of India

The RBI is the central bank of India. It was established in 1935 under a special
act of the PARLIAMENT. The RBI is the main authority for the monetary policy
of the country. The main functions of the RBI are to maintain financial stability
and the required level of liquidity in the economy.
The RBI also controls and regulates the currency system of our economy. It is
the sole issuer of currency notes in India. The RBI is the central banks
that control all the other commercial banks, financial institutes, finance firms
etc. It supervises the entire financial sector of the country.
Function # 1. Monopoly of Note Issue:
• Like any other central bank, the RBI acts as a sole currency authority
of the country. It issues notes of every denomination, except
one-rupee note and coins and small coins, through the Issue
Department of the Bank.
• One- rupee notes and coins and small coins are issued by the
Government of India. In actuality, the RBI also issues these coins on
behalf of the Government of India. At present, notes of
denominations of rupees two, five, ten, twenty, fifty, one hundred
and five hundred are issued by the RBI.
Function # 2. Banker’s Bank

• As bankers’ bank, the RBI holds a part of the cash reserves of commercial
banks and lends them funds for short periods. All banks are required to
maintain a certain percentage (lying between 3 per cent and 15 per cent) of
their total liabilities. The main objective of changing this cash reserve ratio
by the RBI is to control credit.
• The RBI provides financial assistance to commercial banks and State
cooperative banks through rediscounting of bills of exchange. As the RBI
meets the need of funds of commercial banks, the RBI functions as the
lender of the last resort. The RBI has been empowered by law to supervise,
regulate and control the activities of commercial and cooperative banks.
The RBI periodically inspects banks and asks them for returns and necessary
information.
• Function # 3. Banker to the Government:
• The RBI acts as the banker to the government of India and State Governments (except
Jammu and Kashmir). As such it transacts all banking business of these Governments.
• The RBIi) Accepts and pays money on behalf of the Government.
• (ii) It carries out exchange remittances and other banking operations.
• As the Government’s banker, the RBI provides short-term credit to the Government of
India. This short-term credit is obtainable through the sale of treasury bills. Not only this,
the RBI also provides ways and means of advances (repayable with 90- days) to State
Government. It may be noted that the Central Government is empowered to borrow any
amount it likes from the RBI.
• The RBI also acts as the agent of the Government in respect of membership of the IMF
and World Bank.
• Furthermore, the RBI acts as the adviser of the Government not only on banking and
financial matters but also on a wide range of economic issues (like financing patterns,
mobilisation of resources, institutional arrangements with regard to banking and credit
matters, arrangements with regard to banking and credit matters, international finance)
etc.
Function # 4. Controller of Credit:

• The RBI controls the total supply of money and bank credit to sub
serve the country’s interest. The RBI controls credit to ensure price
and exchange rate stability.
• To achieve this, the RBI uses all types of credit control instruments,
quantitative, qualitative and selective. The most extensively used
credit instrument of the RBI is the bank rate. The RBI also relies
greatly on the selective methods of credit control. This function is so
important that it requires special treatment.
Function # 5. Exchange Management and Control:
• One of the essential central banking functions performed by the Bank is
that of maintaining the external value of rupee. The external stability of the
currency is closely related to its internal stability, the inherent economic
strength of the country and the way it conducts its economic and monetary
affairs.
• Domestic, fiscal and monetary policies have, therefore, an important role in
maintaining the external value of the currency. Reserve Bank of India has a
very important role to play in this area. The RBI has the authority to enter
into foreign exchange transactions both on its own account and on behalf
of the Government.
• The official external reserves of the country consist of monetary gold and
foreign assets of the Reserve Bank, besides SDR holdings. The Reserve
Bank, as the custodian of the country’s foreign ex- change reserves, is
vested with the duty of managing the investment and utilisation of the
reserves in the most advantageous manger.
Function # 6. Promotional and Developmental Functions:
• Apart from these traditional function, the RBI performs various activities of
promotional and developmental nature. It attempts to mobilise savings for
productive purposes. This is done in various ways. For instance, RBI has helped a
lot in building the huge financial infrastructure that we see now.
• This consists of such institutions as the Deposit Insurance Corporation (to
safeguard the interests of depositors against bank failure), the Agricultural Re
finance and Development Corporation (to meet the needs of agriculturists), IFCI,
SFCs, IDBI, UTI (to meet the long and medium term needs of industry), etc.
• As for cooperative credit movement, the RBI’s performance in really
commendable. This has resulted in curbing the activities of moneylenders in the
rural economy.
• Thus, it is clear that RBI is not a typical Central Bank as is traditionally understood.
It is something more than a Central Bank. It regulates not only currency and credit
but aids the development of the Indian economy by conducting various types of
promotional activities. As such, in RBI we see many activities combined into one.
• Instruments of Monetary Policy
• Monetary policy is a way for the RBI to control the supply of money in the
economy. So these credit policies help control the inflation and in turn help
with the economic growth and development of the country. So now let us
take a look at the various instruments of monetary policy that the RBI has
at its disposal.
• 1] Open Market Operations
• Open Market Operations is when the RBI involves itself directly and buys or
sells short-term securities in the open market. This is a direct and effective
way to increase or decrease the supply of money in the market. It also has a
direct effect on the ongoing rate of interest in the market.
• Let us say the market is in equilibrium. Then the RBI decides to sell
short-term securities in the market. The supply of money in the
market will reduce. And subsequently, the demand for credit facilities
would increase. And so correspondingly the rate of interest would
also see a boost.
• On the other hand, if RBI was purchasing securities from the open
market it would have the opposite effect. The supply of money to the
market would increase. And so, in turn, the rate of interest would go
down since the demand for credit would fall.
• 2] Bank Rate
• One of the most effective instruments of monetary policy is the bank
rate. A bank rate is essentially the rate at which the RBI lends money
to commercial banks without any security or collateral. It is also the
standard rate at which the RBI will buy or discount bills of exchange
and other such commercial instruments.
• So now if the RBI were to increase the bank rate, the commercial
banks would also have to increase their lending rates. And this will
help control the supply of money in the market. And the reverse will
obviously increase the supply of money in the market .
• 3] Variable Reserve Requirement
• There are two components to this instrument of monetary policy, namely –
The Cash Reserve Ratio (CRR) and the Statutory Liquidity Ratio (SLR). Let us
understand them both.
• Cash Reserve Ratio (CRR) is the portion of deposits with the commercial
banks that it has to deposit to the RBI. So CRR is the percent of deposits the
commercial banks have to keep with the RBI. The RBI will adjust the said
percentage to control the supply of money available with the bank. And
accordingly, the loans given by the bank will either become cheaper or
more expensive. The CRR is a great tool to control inflation.
• The Statutory Liquidity Ratio (SLR) is the percent of total deposits that
the commercial banks have to keep with themselves in form of cash
reserves or gold. So increasing the SLR will mean the banks have fewer
funds to give as loans thus controlling the supply of money in the economy.
And the opposite is true as well.
• 4] Liquidity Adjustment Facility
• The Liquidity Adjustment Facility (LAF) is an indirect instrument for
monetary control. It controls the flow of money through repo rates and
reverse repo rates. The repo rate is actually the rate at which commercial
banks and other institutes obtain short-term loans from the Central Bank.
• And the reverse repo rate is the rate at which the RBI parks its funds with
the commercial banks for short time periods. So the RBI constantly changes
these rates to control the flow of money in the market according to the
economic situations.
• 5] Moral Suasion
• This is an informal method of monetary control. The RBI is the Central Bank
of the country and thus enjoys a supervisory position in the banking
system. If there is a need it can urge the banks to exercise credit control at
times to maintain the balance of funds in the market. This method is
actually quite effective since banks tend to follow the policies set by the
RBI.
 INSTRUMENTS OF FISCAL POLICY
• 1. Optimum allocation of economic resources. The aim is that fiscal policy
should be so framed as to increase the efficiency of productive resources.
• To ensure this, the government should spend on those public works which
give the maximum employment.
• 2. Fiscal policy should aim at equitable distribution of wealth and income. It
means that fiscal policy should be so designed as to bring about reasonable
equality of incomes among different groups by transferring wealth from the
rich to the poor.
• 3. Another objective of fiscal policy is to maintain price stability. Deflation
leads to a sharp decline in business activity. On the other extreme, inflation
may hit the fixed income classes hard while benefiting speculators and
traders. Fiscal policy has to be such as will maintain a reasonably stable
price level thereby benefiting all sections of society.
• 4. The most important objective of fiscal policy is the achievement and
maintenance of full employment because through it most other
objectives are automatically achieved.
• Instruments of Fiscal Policy:
• The tools of fiscal policy are taxes, expenditure, public debt and a
nation’s budget. They consist of changes in government revenues or
rates of the tax structure so as to encourage or restrict private
expenditures on consumption and investment.
• Public expenditures include normal government expenditures, capital
expenditures on public works, relief expenditures, subsidies of various
types, transfer payments and social security benefits.
• Government expenditures are income-creating while taxes are
primarily income-reducing. Management of public debt in most
countries has also become an important tool of fiscal policy. It aims at
influencing aggregate spending through changes in the holding of
liquid assets.
• During inflation, fiscal policy aims at controlling excessive aggregate
spending, while during depression it aims at making up the deficiency
in effective demand for raising the economy from the depths of
depression. The following considerations may be noted in the
adoption of proper policy instruments.
• The structure of tax rates has to be varied in the context of conditions
prevailing in an economy. Taxes determine the size of disposable
income in the hands of general public and therefore, the quantum of
inflationary and deflationary gaps. During depression tax policy has to
be such as to encourage private consumption and investment; while
during inflation, tax policy must curtail consumption and investment.
• Public Debt:
• A sound programme of public borrowing and debt repayment is a
potent weapon to fight inflation and deflation. Government
borrowing can be in the form of borrowing from non-bank financial
intermediaries, borrowing from commercial banking system, drawings
from the central bank or printing of new money.
• Borrowing from the public through the sale of bonds and securities
which curtails consumption and private investment is anti-inflationary
in effect. Borrowing from the banking system is effective during
depression if banks have got excess cash reserves.
• Thus, if unused cash lying with banks can be lent to the government,
it will cause a net addition to the national income stream.
Withdrawals of balances from treasury are inflationary in nature but
these balances are likely to be so small as to be of little importance in
the economic system. However, the printing of new money is highly
inflationary.
• Public Expenditure:
• Public expenditure can be used to stimulate production, income and
employment. Government expenditure forms a highly significant part
of the total expenditure in the economy. A reduction or expansion in
it causes significant variations in the total income. It can be
instrumental in adjusting consumption and investment to achieve full
employment.
• During inflation, the best policy is to reduce government expenditure
in order to control inflation by giving up such schemes as are justified
only during deflation. While expenditures are reduced, attempts are
made to increase public revenues to generate a budget surplus.
• Fiscal policy is therefore the use of government
spending, taxation and transfer payments to influence aggregate
demand. ... When the economy is experiencing a
recession, fiscal authorities use expansionary fiscal policy by
increasing government spending, lowering taxes or raising transfer
payments.