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How inflation is controled

18 June 2010

How inflation is controled by RBI by increasing/Decreasing Lending rate ? Is CRR also place a role in controling Inflationary rate ?

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5 Replies

Siddarth R Sunder Ram (Finance Professional) (230 Points)
Replied 18 June 2010

When the RBI increases the lending rate (rate at which it lends to banks), it becomes costlier for banks to borrow from RBI. Hence:-

-- banks' borrowing from RBI is reduced

--availability of credit is less

--money supply in the economy is reduced, resulting in lesser aggregate demand and lower prices.

Similarly, when the RBI increases the CRR, the banks are required to keep higher amount of their deposits with the RBI. Thus the funds available with them for lending to public reduces, resulting in lower money supply, lower demand and lower prices.

CA Narendra Gupta (CA ) (256 Points)
Replied 19 June 2010

is there any other tactics adopted by RBI apart from this mentioned above, in order to control Inflation.

Siddarth R Sunder Ram (Finance Professional) (230 Points)
Replied 19 June 2010

Yes, RBI also undertakes open market operations, wherein it sells government securities to commercial banks so that excess cash(liquidity) in the system is sucked up and money supply comes down, resulting in lower prices. Also, you have Statutory Liquidity Ratio(SLR) just like CRR, except that banks have to keep the cash reserves with themselves instead of keeping with the RBI.

RBI can also use certain selective controls to control money supply and inflation like moral suasion, margin requirements, ceiling limit on lending etc.

CA Narendra Gupta (CA ) (256 Points)
Replied 19 June 2010

Thankyou Mr. Siddarth for sharing knowledge and having such a good conversation.

I got question from your solution is,

Is Govt. securities is compulsory for banks to purchase in inflationary period ?

SLR mean cash should be kept with bank which is not allowed to give loan from that ?

Siddarth R Sunder Ram (Finance Professional) (230 Points)
Replied 19 June 2010

It is not compulsory for banks to purchase, but they will generally purchase if it is profitable/worthwhile to purchase them i.e RBI must make it attractive for the banks to purchase.

In case of SLR, yes, the banks are supposed to keep a portion of deposits with themselves in the form of cash/gold/securities so that they will not lend from that portion.

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