How does the RBI control inflation and growth

Cash control measures adopted by the RBI

Cash control measures adopted by the RBI!

During the planning period, the Government of India and the Reserve Bank made currency control a high priority in their attempt to control inflation. Monetary policy in the country is therefore called anti-inflationary. Indeed, the main role of the RBI was to control and regulate the availability of credit, the cost of credit, and the use of the flow of credit in the economy.

In the 1951-1987 period, the RBI used a large number of traditional and nontraditional weapons for credit control, such as:

(i) Bank Rate

(ii) Open Market Operations (OMO)

(iii) Cash Reserve Ratio (CRR)

(iv) Statutory liquidity ratio (SLR)

(v) Selective Credit Control Scheme (SCCS)

(vi) Credit Authorization System (CAS)

(vii) RBI's discretionary control over refinancing

(viii) RBI funding cover

(ix) regulating the interest rates on deposits and loans from commercial banks and other interest rates

(x) Differential Interest Rate (DIR)

(xi) Quantitative upper limits for the direct allocation (rationing) of the volume and orientation of bank loans

(xii) Determination of the average and low investment ratio

(xiii) morality and suasion above all

(xiv) Loan Planning

All of these measures were carried out from time to time by the RBI in different sizes and degrees of effectiveness as required.

The basic objectives of the current monetary policy of the RBI were:

(i) To control inflation and achieve relative price stability,

ii) promote economic growth and

(iii) Ensure social equity in the allocation of bank credit.

Incidentally, since the 1960s, the tenor of the RBI's monetary policy has been characterized by the goal of "controlled expansion". Control involves controlling inflation through credit regulation, and expansion means expanding credit to meet guaranteed production and distribution requirements. In the 1970s, however, the Reserve Bank of India sought “growth with social justice and stability”. Therefore, the distributive aspect of growth was emphasized more. It was stressed that the credit requirements of the priority sectors agriculture, small industries, exports and small borrowers need to be taken into account.

However, since May 1973 the Reserve Bank has adopted a credit tightening policy or monetary policy as an anti-inflationary measure. To counter the forces of inflation and regulate the demand for credit, currency weapons have been used sharply and decisively by the Reserve Bank of India in recent years.

Recent monetary policy aims to diversify banks' advance portfolios by providing numerous incentives in the form of refinancing and concessions to facilitate lending to the priority sectors and the weaker areas and control the flow of credit for large borrowers by tightening them of the credit approval system.

Now let's briefly review the Reserve Bank's monetary policies since independence.

Bank rate:

In the absence of a well-functioning change market, the bank interest rate is defined in the Indian context as the rate at which the Reserve Bank of India advances to commercial banks on eligible securities. In Section 49 of the RBI Act. In 1934, however, the bank interest rate is defined as "the standard rate at which it (the bank) is willing to buy or re-count bills of exchange or other commercial paper that may be considered under this law."

However, until 1970 this provision had no practical significance as there was no well-developed market in the Indian credit system. Therefore, the interest rate on the Reserve Bank of India's advances to member banks has been considered the bank interest rate.

It was only since November 1970 that the rediscounting of bills by banks at the Reserve Bank of India improved with the introduction of the new bill on billing bill. In the current period, that value is close to Rs. 175 crores, while the accommodation that the banks have received from the Reserve Bank of India in the form of refinancing tends to be around Rs. 800 crores to 900 crores. The interest rate that the Reserve Bank charges for such assistance is different for different banks and depends on the borrowing, the distribution of the bank's loans by sector, the deposits of the credit institutions, etc. Obviously there seems to be a multitude of banks giving rates in practice.

However, interest rate policy for banks has two dimensions:

(i) Changing the bank interest rate affects the cost of borrowing. An increase in the bank interest rate thus implies an increase in the bank's borrowing costs. A fall in the bank interest rate would lead to a reduction in borrowing costs, which in turn would encourage banks to borrow from RBI. (Ii) The expansion or contraction of the list of eligible securities will directly affect the lending capacity of member banks. Again, the importance of the bank's interest rates in the money market is more of a pacemaker for the overall interest rate structure, both short and long term. It is common for a change in the bank's interest rate to be followed by changes in the interest rate the banks pay to their customers. Other money market agencies are also following the trend. It has been observed that in addition to commercial banks, financial institutions such as the Industrial Development Bank of India, the Industrial Finance Corporation of India (IFCI), the State Finance Corporations (SFCs), etc. have usually come into consideration when the bank interest rate is increased interest rates charged by them will be raised in due course. The increase in the bank interest rate implies a strict monetary policy by the Reserve Bank of India, which makes the money market “tight”.

From time to time the Reserve Bank of India changed the bank's interest rate. During the planning period, on November 14, 1951, the bank's interest rate was raised for the first time from 3 percent to 2 percent in order to check for an improper expansion of bank credit. The bank interest rate was raised further to 4% on May 16, 1957. However, the restrictive effect of the higher bank interest rate did not prove material to the review of the inflationary forces caused by the government's typical funding methods during Iraq's Second Period.

As an anti-inflationary instrument of the controlled expansion program of monetary policy, the Reserve Bank of India introduced a system of interest rates in October 1960. The loans of the member banks of the Reserve Bank of India were regulated by a three-tier interest structure. (i) Up to a fixed quota for each quarter equal to half the average amount of legal reserve a member bank was required to maintain with the Reserve Bank of India in the previous quarter, the bank could borrow from the Reserve Bank of America India at 4 percent bank rate; (ii) The excess of credit of up to 200 percent of the quota should bear 5 percent interest; and (iii) additional loans bore 6% interest. The system was further revised in July 1962 by changing it from a three-tier to a four-tier tariff structure. In the third panel, for example, between 200 and 400 percent of the quota was calculated at 6 percent and the credit surplus at 6.5 percent.

Table 1 Changes in bank interest rate (percent)



Bank rate


4th July 1935

3, 5


November 28, 1935

3, 0


November 15, 1951

3, 5


May 16, 1957

4, 0


January 03, 1963

4, 5


September 26, 1964

5, 0


February 17, 1965

6, 0


March 2nd, 1968

5, 0


January 09, 1971

6, 0


May 31, 1973

7, 0


23rd July 1974

9, 0


July 12, 1981

10, 0


July 04, 1991

11, 0


October 09, 1991

12, 0


April 16, 1997

11, 0


June 26, 1997

10, 0


October 22, 1997

9, 0


January 17, 1998

11, 0


March 19, 1998



April 03, 1998

10, 0


April 29, 1998

9, 0


March 1, 1999

8, 0


April 1, 2000

7, 0


July 21, 2000

8, 0


February 16, 2001



March 1, 2001

7, 0


October 22, 2001

6, 5

In September 1964 the rate was raised further to 5% and the system (quota-cum-slab) was replaced by a new system called the "liquidity ratio system". Under the new system, the rate was charged by the Reserve Bank. The bank's borrowing in India depends on the net liquidity position, which is defined as the ratio of net liquidity to the sum of claims and time deposits.

In February 1965 the bank interest rate was raised further to 6 percent. However, in March 1968 it was lowered to 5% to stimulate recovery from the 1967 industrial recession. However, in January 1971 the bank's interest rate was raised to 6%.

Since 1973 the Reserve Bank has implemented a strict monetary policy and used a credit crunch to ease inflationary pressures on the economy.

Indeed, as part of the credit crunch policy, the Reserve Bank has implemented a number of monetary policy measures with the following objectives:

(i) Improve deposit rates and increase the cost of money lent to commercial banks.

(ii) To increase costs and decrease the availability of refinancing through the reserve bank.

(iii) Limiting total bank loan funds.

(iv) increase the cost of borrowing for borrowers from banks.

Finally, the interest structure that banks have to pay to depositors in savings accounts and fixed-term deposit accounts has been increased by increasing it. The interest on savings deposits was increased to 5 percent. The love-of-money policy was highlighted in May 1973 with an increase in the bank interest rate to 7% and a further increase in the interest rate in June 1974 to 9%. A credit crunch policy was instituted by the RBI to control the country's severe inflation in 1973-74, when wholesale prices had increased by about 30% in one year.

Since 1997, the bank interest rate has been linked to all rates changed by RBI accommodation. Changes in the bank rate are shown in Table 1.

I. Between 1951 and 1974 the base rate was changed.

ii. In 1975-76 the bank interest rate was changed three times.

iii. In 1991-2001, the bank's interest rate was changed 15 times.

Open market operations:

Open market operations have a direct impact on availability and borrowing costs. Open market operations policy has two dimensions: (i) it directly increases or decreases loanable funds or the creditworthiness of banks; and (ii) it leads to changes in the prices of government bonds and the structure of interest rates.

However, given India's underdeveloped security market, the Reserve Bank of India has rarely used OMO as a sharp weapon of credit control. In general, open market operations in India have been used to aid the government in borrowing and to maintain orderly conditions in the state securities market rather than to influence the availability and cost of borrowing.

An illustration of the Reserve Bank of India's open market operations is shown in Table 2.

Table 2 The Trend of the Reserve Bank of India's OMO The Central Bank of India's Open Market Operations in Securities of the Dated Securities (Rs. Crores)



Sales net purchases {+)

Net sales (-)


2, 291, 2

2, 238, 1

(+) 53, 1

(14 287, 1)

(13.725, 2)



3, 244, 8

7.327, 1

(-) 4, 082, 3

(5, 321, 7)

(9.365, 6)

(4.043, 9)


6.273, 4

11, 792, 5

(-) 5, 519, 1


967, 6

10, 804, 6

(-) 9, 837, 0


1, 560, 9


(-) 748.1


1, 145, 9

1, 728, 6

(-) 582.7



11, 140, 1

(-) 10, 434, 7


466, 5

8.080, 0

(-) 7, 613, 5



26.348, 3

(-) 26.348.3


1, 244, 0

36, 613, 3

(-) 35, 369, 3

It can be seen that, with the exception of 1951-52, 1956-57, and 1961-62 in the other years, the Reserve Bank operated a sales aspect of the OMO policy to review the loanable resources of commercial banks.

The effectiveness and sustained use in monetary policy regulations depended on the growth of the market for government securities. In this regard, the RBI and the Government of India are focusing on the following initiatives:

I. Instrument development

ii. Institutional development

iii. Strengthening the transparency and efficiency of the secondary market.

RBI's OMOs are timed so that the government's new loan program is never jeopardized.

OMDs are more effective and exceed the Cash Reserve Ratio (CRR) as a currency regulation instrument for drawing up liquidity. In addition to OMOs, these are transparent operations.

Cash Reserve Ratios:

Under the RBI Act of 1934, planned commercial banks were required to hold a minimum reserve with the Reserve Bank of India equal to 5% of their demand debt and 2% of their time debt.

The 1956 Amendment Act authorized the Reserve Bank of India to use these reserve requirements as a credit weapon, varying between 5 and 20 percent of demand debt and between 2 and 8 percent of time debt. This variability in cash reserve ratios (CRR) has a direct impact on availability and borrowing costs.

An increase in the CRR leads to an immediate containment of the banks' excess funds. When banks' lending volume decreases, so does their profit base. To maintain the same overall profit, a decrease in profitability must be offset by increasing the interest rate. When the bank's lending rates are raised, the cost of borrowing increases.

Since September 1964, the RBI has kept the minimum reserve ratio for all scheduled and non-scheduled commercial banks against their demand debt and their time obligations at 3%. Since August 1966, planned state-owned credit unions are required to maintain the same CRR, while unscheduled state-owned credit unions are required to meet 2.5 percent of their demand debt and 1 percent of their time liabilities.

Other measures:

The Reserve Bank introduced various qualitative control measures to channel the flow of credit into productive sectors and limited the funding of speculative and unproductive activities. In the case of selective measures, quantitative credit limits were set for a specific commodity and a minimum margin was prescribed for each commodity. The minimum interest rate was also set at a higher level. In adopting a selective measure, the Reserve Bank seeks to ensure that the flow of credit for real production, trade and export is not affected.

The Reserve Bank also made use of the Moral Suasion funds from 1956. The Reserve Bank's governor convened bankers' meetings, discussed the prevailing credit situation and monetary policy objectives, and urged the bank to cooperate in the effective implementation of selective measures introduced.

After the nationalization of the major commercial banks, the Reserve Bank managed to effectively implement loan planning as an integral part of economic planning as part of loan planning. An important instrument called the "Credit Authorization Scheme" was introduced in 1970, also requiring prior authorization from the Reserve Bank for granting Rs credit. 25 lakhs.

To prevent abuses of the cash-credit system, the new Bill Market Scheme was introduced in 1970 by the Reserve Bank.

The Reserve Bank also issued a directive to banks on August 28, 1970 asking them to curb speculative lending and convert loans into equity for advances above Rs. 50,000.

1. The Reserve Bank of India's lending policy continued to emphasize restraint in 1976/77. The main quantitative credit control tools have been used to regulate bank lending by placing the commercial banks' cash reserves and their bonds with the Reserve Bank of India.

2 Current credit policy also aims at targeted credit control so that the funding opportunities provided for legitimate productivity and investment activities are not hindered.

3. The Reserve Bank of India noted that the sharp rise in credit expansion in the commercial sector was a major problem with overall credit expansion, which required strict quantitative control. Finally, on September 4, 1976, the Reserve Bank of India increased the reserve requirement from 4 to 5 percent and further increased it to 6 percent

November 13, 1976. The Reserve Bank of India therefore used the CRR as a drastic measure to curb credit expansion twice in the same year.

On May 27, 1977, the Reserve Bank of India also announced that commercial banks should adopt restrictive monetary and credit policies to control the flow of excessive expansion in money supply and contain the forces of inflation. Loans should also be used to stimulate investment, promote production and export, and improve the supply position of important consumer goods and industrial raw materials through imports.

The incremental cash reserve ratio of U% of the sight and time deposits that have accrued since January 14, 1977 should therefore be continued. The Reserve Bank of India's refinancing and rediscounting facilities would typically be rather selective and discretionary. In order to limit refinancing for food procurement loans, the margin-to-margin margin that is not eligible for refinancing good advances has been increased by Rs. 1,000 crowns to 15,000 rupees.

To encourage long-term capital investment, banks were advised to lower their interest rates on term loans from 14.15 percent to 12.5 percent.

In addition, the entire structure of the deposit rates of the banking system has been streamlined. The savings accounts have been divided into: (i) transaction-oriented savings accounts and (ii) savings accounts. The former contained check facilities and were supposed to have a lower interest rate of 3 percent per year, while the latter without check facilities received a higher interest rate of 5 percent per year with effect from June 1, 1977. A new interest rate for fixed-term deposits was also set from the same date.

The benefits of banks' savings in interest should be passed on to borrowers in the priority sectors by granting preferential loans.

In summary, the following can be concluded from the RBI annual report 1976/77: “The persistent imbalance between total demand and total supply and the resulting price pressure combined with comfortable liquidity conditions on the money market have underscored the need to further regulate the lendable resources of banks.

At the same time, persistent investment sluggishness and fears that industrial growth would slow down after signs of a recession in demand in some sectors demanded some flexibility from the restrictive framework. The aim of the credit policy published on May 27, 1977 was therefore still limited to containing the expansion of the money supply as much as possible, while at the same time it was combined with the promotion of investment, the promotion of production and export as well as the supply of important consumer goods and industrial raw materials through Imports.

Overall, it can be said that the RBI pursued a goal of "controlled expansion" by limiting total bank credit within a limit and favoring the borrowing of the priority sectors and the weaker parts of the Indian community. As the monetary authority, the RBI was involved in anti-inflationary monetary policy measures in the current situation of price increases. However, it has not been able to stop inflation to the extent desired through more effective monetary policy. This is because there is no effective control over the real causes of inflation.

There was a lack of financial discipline, particularly deficit financing and the government's tax policy, unilateral planning, high population growth, exports of goods, lack of solid income policies, wage inflation, strikes, electricity shortages, undeclared work. Marketing, smuggling, etc.

There is little that the Reserve Bank of India can do about these inflationary forces in the country. So unless production is improved, planning streamlined and effectively implemented, population growth controlled, the accomplishments, black marketing and hoarding will end, fiscal policy coordinated with monetary policy, and solid income policy developed. Inflation will tend to remain uncontrolled in our economy. Despite efforts on the currency front, the fight against inflation is being lost due to weaker defenses against other inflationary forces in the country.

Selective Credit Control (SCC):

Provisions on selective credit control within the meaning of Sections 21 and 35A of the Banking Regulation Act authorize RBI to carry out selective credit control. The main tools of SCC are:

I. Minimum margins for lending.

ii. Upper limit for the creditworthiness of the stocks of selected raw materials.