Survey Notes on Monetary Developments

The Survey Notes on Monetary Developments provide a comprehensive overview of the trends, movements, and policy actions related to the monetary sector of the Indian economy. These notes typically form a crucial part of the Economic Survey of India, which analyses key macroeconomic indicators such as money supply, credit growth, interest rates, inflation, and liquidity conditions. The purpose of such notes is to evaluate the performance of monetary policy and its role in supporting economic growth, price stability, and financial stability.

Introduction

Monetary developments refer to the changes and trends in the money supply, bank credit, interest rates, and monetary policy instruments within an economy over a specific period. In India, these developments are largely influenced by the policies of the Reserve Bank of India (RBI), which acts as the country’s monetary authority.
The RBI’s policy framework aims to achieve the twin objectives of price stability and economic growth, using instruments such as repo rate, reverse repo rate, cash reserve ratio (CRR), and statutory liquidity ratio (SLR). Monetary developments are closely linked with fiscal trends, external sector performance, and the overall macroeconomic environment.

Objectives of Analysing Monetary Developments

• To assess the impact of monetary policy on growth, inflation, and liquidity.
• To evaluate trends in money supply (M0, M1, M2, M3) and credit expansion.
• To understand changes in interest rate structure and banking system liquidity.
• To gauge the transmission of policy rate changes to the broader financial system.
• To analyse the interrelationship between monetary conditions and price stability.

Components of Monetary Developments

Monetary developments are primarily analysed through the following key components:
1. Reserve Money (M0): Also called high-powered money, it comprises currency in circulation, bankers’ deposits with the RBI, and other deposits with the RBI. It forms the base for the creation of broad money in the economy.
2. Broad Money (M3): This is the most commonly used measure of money supply and includes currency with the public, demand deposits, and time deposits with banks. M3 reflects the overall liquidity in the financial system.
3. Credit Growth: The expansion of bank credit to the commercial and industrial sectors is an indicator of monetary expansion and economic activity. Credit growth also influences investment, consumption, and inflation trends.
4. Interest Rate Movements: Interest rates—particularly the repo rate and reverse repo rate—signal the stance of monetary policy. Changes in these rates influence lending rates, deposit rates, and capital market yields.
5. Inflation Trends: Inflation, as measured by the Consumer Price Index (CPI) or Wholesale Price Index (WPI), is a key determinant of monetary policy decisions. The RBI aims to maintain inflation near the target of 4% (+/-2%) under the Flexible Inflation Targeting Framework.

Monetary Trends in Recent Years

1. Money Supply and Liquidity Conditions: In recent years, India has witnessed moderate growth in broad money (M3), largely driven by expansion in bank deposits. The RBI has actively managed liquidity through Open Market Operations (OMOs) and the Liquidity Adjustment Facility (LAF). During periods of stress, such as the COVID-19 pandemic, the central bank implemented accommodative monetary policies to ensure sufficient liquidity in the financial system.
2. Policy Rate Adjustments:

• The repo rate has been the primary policy instrument for signalling changes in monetary stance.
• During the pandemic (2020–2021), the repo rate was reduced to a historic low of 4% to support growth.
• In response to rising inflationary pressures in 2022–2023, the RBI gradually increased the repo rate to 6.50%, shifting from an accommodative to a calibrated tightening stance.

3. Credit Growth:

• Bank credit growth witnessed recovery after the pandemic-induced slowdown, supported by improved demand in retail, MSME, and services sectors.
• Public sector banks improved asset quality and reduced non-performing assets (NPAs), aiding credit expansion.
• Credit to industry and housing sectors has shown robust recovery, reflecting a revival in investment sentiment.

4. Inflation and Monetary Response:

• Inflation remained a major policy concern, driven by global commodity price shocks, food price volatility, and supply disruptions.
• The RBI adopted a balanced approach, focusing on inflation control without stifling economic recovery.
• Targeted interventions, such as variable rate reverse repos and standing deposit facilities, helped absorb excess liquidity.

5. Exchange Rate and External Sector:

• The Indian rupee experienced moderate depreciation against the U.S. dollar due to global monetary tightening and capital outflows.
• The RBI intervened through foreign exchange operations to maintain stability in the currency market while safeguarding reserves.

Policy Instruments Used by the RBI

To manage monetary conditions, the RBI employs a mix of quantitative and qualitative tools:

• Repo Rate: The rate at which the RBI lends short-term funds to commercial banks; a key indicator of monetary stance.
• Reverse Repo Rate: The rate at which the RBI borrows from banks to absorb liquidity.
• Cash Reserve Ratio (CRR): The proportion of deposits banks must maintain with the RBI in cash form.
• Statutory Liquidity Ratio (SLR): The percentage of deposits that banks must maintain in liquid assets like government securities.
• Open Market Operations (OMOs): The buying and selling of government securities to regulate liquidity.
• Marginal Standing Facility (MSF): A window for banks to borrow additional funds from the RBI during short-term liquidity shortages.

Relationship Between Monetary Policy and Economic Growth

The effectiveness of monetary policy in supporting growth depends on how efficiently changes in policy rates are transmitted to the economy — a process known as monetary transmission. Key channels of transmission include:

• Interest Rate Channel: Policy rate changes influence lending and borrowing costs.
• Credit Channel: Affects the availability of funds for investment and consumption.
• Exchange Rate Channel: Alters export and import competitiveness.
• Expectations Channel: Shapes inflation expectations and business sentiment.

Over recent years, improved monetary transmission has been observed due to greater financial sector digitalisation and better liquidity management.

Challenges in the Monetary Sector

• Inflation Volatility: Food and fuel price fluctuations remain major challenges for price stability.
• Global Monetary Tightening: Rising interest rates in advanced economies affect capital flows and exchange rates.
• Fiscal-Monetary Coordination: Balancing expansionary fiscal policies with inflation-targeting objectives is crucial.
• Structural Constraints: Slow transmission of policy rates to lending rates in some sectors.
• External Uncertainties: Global geopolitical tensions, commodity price shocks, and currency volatility impact monetary stability.

Outlook

The monetary outlook for India remains cautiously optimistic:

• Inflation is projected to moderate towards the target range, aided by stable global commodity prices and better domestic supply management.
• Bank credit growth is expected to remain strong due to robust investment activity and demand recovery.
• The RBI is likely to maintain a neutral to tightening stance, ensuring that inflation expectations are anchored while supporting growth momentum.
• The focus will continue on digital financial inclusion, payment system innovation, and macroeconomic stability.