Effect of RBI Monetary Policy on Stock Market

There are billions of people in India. So, for obvious reasons, the Indian economy is a mixed and complex one. In order to attain price stability and control the flow of money into the market the central bank of India (RBI) introduced the monetary policy. By applying various instruments through the monetary policy, RBI (Reserve Bank of India) directs the liquidity of the Indian economy. The focal point of this particular content is the impact of the RBI Monetary Policy on the Indian Stock Market.

What is RBI Monetary Policy?

The Monetary Policy often refers as the “Credit Policy” or “RBI’s Money Management Policy”. In order to manage the demand and supply of money flow, RBI applies some of the money managing instruments. The policy is reviewed bi-monthly by the Monetary Policy Committee.

Types of RBI Monetary Policy

If we broadly classify monetary policy, there are two types: Expansionary and Contractionary.

Expansionary Policy

Expansionary Monetary Policy increases the money supply by lowering interest rates. It expands the overall economic activity, applicable mainly in recession.

Contractionary Policy

Contractionary Monetary Policy helps to slow down economic growth. It basically tames the inflation rate. By increasing the interest rates the specific monetary policy control the excessive money flow.

Objectives of the RBI Monetary Policy

There are some strong objectives behind introducing the Monetary Policy, as stated by RBI, are given below:

• Maintain the price stability of the economy.
• RBI is called the bankers’ bank which means it controls the bank credit as well as the money supply.
• In order to increase the productivity of investment, the monetary policy promotes fixed investment opportunities.
• To avoid over-stocking and idle money, monetary management carries out the essential function of restricting inventories.
• The policy helps to maintain and increase the efficiency of the financial system.
• RBI monetary policy tries to manage the flexibility of the economy. During the time of recession, RBI tries to increase the flow of money while during inflation they slow down the money flow.
• Developing countries like India suffers from disequilibrium in the balance of payment. Here, the monetary policy tries to maintain the balance of payment equilibrium.
• Equal income distribution also comes under the objectives of RBI monetary policy.

Instruments of RBI Monetary Policy

Let’s have a quick look at the instruments of RBI Monetary Policy:

Cash Reserve Ratio (CRR)

Each and every bank has to maintain a certain amount of cash with the RBI as a percentage of Net Demand and Time Liabilities (NDTL). If RBI wants to slow down the money supply during Inflation, it increases the CRR ratio and vice versa.

Statutory Liquidity Ratio (SLR)

Apart from the CRR, every bank is required to maintain a certain amount of assets in the form of gold, cash, and approved securities. The increase or decrease of SLR manages the stability of the economy.

Repo Rate

At this interest rate, RBI provides overnight liquidity to banks against the collateral and other securities under LAF (liquidity adjustment facility)

Reserve Repo Rate

At this interest rate, RBI absorbs excess liquidity overnight basis from banks under LAF (liquidity adjustment facility).

Bank Rate

At this rate, RBI buys commercial papers. During the time of inflation or deflation, RBI decreases or increases the interest rates.

Marginal Standing Facility

Under this, commercial banks borrow overnight money from the central bank.

Open Market Operations

Here, borrowing and selling Government securities happen to control the money supply of the economy.

Effect of RBI Monetary Policy on the Stock Market

Now, come to today’s article’s center point Impact of RBI Monetary Policy on the Stock Market.

• As I have stated earlier that through the monetary instrument, RBI manages or controls the economic balance. For instance, if the Repo rate increase, a bank needs to pay more interest to RBI. As a result, customers also have to pay more interest rates to banks against their lending money. For this reason, less liquidity position occurs in the economy.
• On the other hand, in the case of the reserve repo rate, central banks pay more interest to the banks against their depositing money. As a result, the rate infuses more liquidity into the economy.
• Companies are able to cut down the risk of capital for the monetary policy.
• Monetary policy eases the liquidity factor which has much significance in the Indian stock market.
• The banking sector equity department highly moves during the monetary policy.
• Monetary policy instruments are the main drivers in the stock market. Besides repo and reserve repo rates, there are other instruments like the cash reserve ratio, statutory liquidity ratio, open market operations, etc which affect the stock market.
• Stock price fluctuations are driven by monetary policy to some extent.
• The investment capacity of regular traders also affects the monetary policy. Due to the monetary policy when banks increase or decrease the interest rate, the capacity of investments hamper.
• So, in this sense, RBI regulates the stock market through the monetary policy to some extent.

FAQ

Conclusion

As the Indian stock market plays a significant role in the Indian economy. When inflation or recession arises, RBI slows down or infuses money into the market, and the stock market also highly moves. Apart from this, with changing rates, price fluctuations happen in the stock market. The investment policy and capacity also fluctuate as a result of the RBI monetary policy. The central bank works as the financial head of the Indian economy. Though RBI cannot control the stock market directly, indirectly it regulates the Indian Stock Market through the monetary policy.