Most of us in Mumbai, see this huge structure called the Reserve Bank of India and wonder what it really does. It’s also a tourist attraction!! It has so many other offices and again one wonders why they need to have so many offices. I’m going to try and highlight a very interesting part of RBI’s work and how it helps us directly on a day-to-day basis.The RBI does a review of the monetary policy of the country at frequent intervals during the year. So how does the monetary policy help us investors to take smart decisions?
Monetary policy is a tool by which the RBI decides to raise interest rates or reduce interest rates or keep them steady.
In our country, as we’re an oil importing nation, this decision is very closely linked to Oil. Oil to a large extent contributes to inflation. We all know what happens when inflation keeps rising. We in India unfortunately do not see too much of inflation falling and things becoming cheaper.
Oil is Not Well
So when oil prices rise i.e. we see a rise in crude oil prices almost instantly we can expect rising food prices. This is because there is going to be a rising cost pressure for manufacturing & services. This rise obviously gets passed onto the retail consumers.
When this happens RBI adopts a hawkish stance, tries to pull money out of the system by raising interest rates. Now when interest rates rise no one seems to be interested in borrowing. This immediately puts a brakes on money circulation. Less money chasing goods decreases the demand for money. This way it controls inflation.
There is yet another tool that the RBI has and that is known as the CRR or the cash reserve ratio. This ratio in simple words means the amount of cash that the bank must maintain with the RBI as the percentage of the total assets. So when this increases banks are forced to park more with the RBI and this is also a way to control inflation.On the other hand when things look dull, when there is a recession of sorts, the RBI comes to the rescue and gets into action to kickstart growth in the country. It does this by lowering the interest rates. This we all will understand quite easily because we see a direct benefit of this happening. We see a fall of interest outgo in our EMI’s for the home loan that we are carrying. New loans become cheaper.
Individuals are motivated to go out and make purchases, whether it is for a washing machine or a piece of real estate. Businesses are motivated to go out and borrow to buy more machinery, to expand capacity, to hire more staff and manpower and basically do everything that will add to the growth of business.
Economic growth results as a result of all this. It is also during this time that stock market rises, we see a rally in stock prices and mutual fund NAV’s jumping higher and higher each day. There is prosperity all around.
As you can see that the central bank of the country has a very very important role to play. If it makes a mistake, things can go really wrong. Imagine like the USA or Japan if our interest rates were very low; everyone would run to borrow, they would borrow more than they require because it would be cheap and easy to borrow. And that is very individuals would run into what is known as the debt trap, because someday you’ll have to pay back.
Each day the central bank attempts to make sure that everything in our country remains stable and financially there’s nothing that goes wrong dramatically.
Kartik Jhaveri is an expert at planning money, life and aspirations. He is a Certified Financial Planner, Wealth Manager & Financial Freedom Coach.