Effect of RBI Monetary Policy on Stock Market

There are billions of people in India. So, for obvious reason, the Indian economy is the mix and complex one. In order to attain the 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) direct the liquidity of the Indian economy. The focal point of the particular content is the impact of RBI Monetary Policy on Indian Stock Market.

RBI Monetary Policy and Its Objectives

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 reviewed bi-monthly by the Monetary Policy Committee. If we broadly classify the monetary policy, there are two types: Expansionary and Contractionary.

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

Contractionary Monetary Policy helps to slow down the 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:

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  • 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, monetary policy promotes fixed investment opportunities.
  • To avoid over-stocking and idle money, the monetary management carries out the essential function of restricting the 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 in 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 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 asset in form of gold, cash and approved securities. The increase or decrease of SLR manage 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 buy commercial papers. During the time of inflation or deflation, RBI decreases or increase the interest rates.
  • Marginal Standing Facility: Under this, commercial banks borrow overnight money from the central bank.
  • Open Market Operations: Here, borrowing and selling of Government securities happen to control the money supply of the economy.

Effect of RBI Monetary Policy on Stock Market

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

  • As I have stated earlier that through the monetary instrument, RBI manages or control the economic balance. For instance, if the Repo rate increase, a bank need to pay more interest to RBI. As a result, customers also have to pay more interest rate to bank against their lending money. For the reason, less liquidity position occurs in the economy.
  • On the other hand, in case of reserve repo rate, central banks pay more interest to the banks against their depositing money. As a result, the rate infuses more liquidity to 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.
  • Banking sector equity department highly moves during monetary policy.
  • Monetary policy instruments are the main drivers in the stock market. Besides repo and reserve repo rate, 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 the monetary policy to some extent.
  • The investment capacity of regular traders also affects by 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.

Conclusion

As the Indian stock market plays a significant role in the Indian economy. When inflation or recession arise, RBI slows down or infuse money in the market, 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 a 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.

Ankita is a graduate in English language and she has also done her MBA from the Calcutta University. She has a high knack in the stock markets. An experienced stock market content writer Ankita is also trading on her own account. Ankita is also preparing for the NISM Research Analyst Series XV examination seriously.



Categories: Stock Market Basics

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