The monetary policy tools in the hands of the Reserve Bank of India

What are the monetary policy tools in the hands of the Reserve Bank of India?

Introduction

In order to control the monetary system, the Reserve Bank of India uses seven
different tools. These tools are used to mitigate inflations. In this regard,
it is to mention that the Reserve Bank of India controls inflation by
controlling the liquid cash in the market and this is done through the
following tools:

Figure 1: Monetary Policy Tools of RBI

(Source: As created by the author)

1. Cash Reserve Ratio (CRR)

Every commercial bank in India is required to deposit a small proportion of its total
deposit with the Reserve Bank of India. This proportion or percentage of the
total deposit that the commercial banks deposit with the RBI is called the Cash
Reserve Ratio.

Importance of Cash Reserve Ratio:

If the RBI increases the CRR, the liquid cash in the hands of commercial banks
decreases. Thus, the commercial banks' lending capacity falls with the rise of
the CRR. When the economy faces the problem of inflation, the Reserve Bank of
India increases the Cash Reserve Ratio for lowering the lending capacity of the
commercial banks. Similarly, when the economy faces a lack of liquid cash, the
RBI uses this tool to combat deflation. RBI decreases the CRR to help the
commercial banks to lend more money to the public. Therefore, this monetary
policy tool has effective outcomes over the economy and due to this reason, RBI
uses this tool to control the monetary system of the country.

2. Statutory Liquidity Ratio (SLR):

Every commercial bank utilises the deposits by investing them in profitable investment
options including giving a loan to the public. However, the commercial banks
are required to deposit a small portion of the total deposit with the RBI as
CRR and another portion as liquid cash in hand. The portion of cash that the
commercial banks keep with them in form of cash is called the liquidity ratio.
This liquid money is used for meeting the demand of the depositors. Being the
regulator of scheduled banks, the RBI mandates the liquidity ratio, which is
required to be maintained by all commercial banks. This ratio is called the
Statutory Liquidity Ratio (SLR).

Importance of SLR:

If the RBI enhances the SLR, the commercial banks need to keep a higher amount of
money in their hands. This means the lending capacity of the banks will fall
with the rise in SLR. This will result in fall in liquid cash in the hands of
the public. As a consequence of this, the demand for goods or services will
fall and therefore there will be a fall in the price of commodities in the
market. However, the RBI can use this tool in case of slow economic growth. The
RBI decreases the SLR to enhance the lending capacity of the commercial banks,
and by this, the RBI can combat against low production and demand.       

3. Bank Rate:

Reserve Bank of India lends money to commercial banks in two different ways. The
advance can be made with or without any security. If the RBI lends money to
commercial banks without any security, then the rate at which the loan is
allowed to the commercial banks is called the Bank Rate.

Importance of Bank Rate:

If the bank rate rises, the cost of taking a short-term loan from the RBI becomes
high, which affects the advancing ability of the commercial banks. On the other
hand, a fall in the bank rate facilitates the commercial banks to take the loan
from the RBI at a lower rate. 

4. Repo Rate:

In case of any deficit, commercial banks take a short-term loan from the Reserve
Bank of India against some securities. The interest rate charged by the RBI is
called the Repo Rate.

Importance of Repo Rate:

The rise in the Repo Rate implies an enhancement in the cost of short-term debt for
the commercial banks. Therefore, RBI can mitigate the short-term demand for
money by increasing the Repo Rate.    

5. Reverse Repo Rate

From the name, it is clear that this is just the reverse of the Repo. This rate is
charged by the commercial banks for lending Reserve Bank of India. However, the
Reverse Repo Rate is determined by the Central Bank of the country (RBI).

Importance of the Reverse Repo Rate:

If there is a surplus of the fund in the hands of commercial banks, they can be
able to lend more money to the people. This enhances the purchasing power of
the people of the country. In this context, if the RBI offers a higher rate for
lending funds from the commercial banks, the commercial banks' ability to give
a loan to the public decreases. By this way, the RBI can control the lending
power of the commercial banks.   

6. Open Market Operations:

The open market operation is to be considered as one of the most crucial roles that
the Reserve Bank of India plays in the Indian economy. The Reserve Bank of
India buys and sells government securities. The primary objective of the open
market operation is to manage the liquidity in the market.

Importance of the Open Market Operations:

When the RBI buys security from the open market, the liquid market in the economy
rises. This results in an enhancement in the aggregate demand in the economy.
Thus, the purchase of the security from open market results in a price hike.
However, the RBI use this tool for attaining higher growth rate.     

7. Marginal Standing Funding:

In case of an emergency, commercial banks can apply for funding to the RBI. Due to
this service of the RBI, it is called the lender
of last resort. In this regard, it is to be noted that the commercial banks
can get up to 1% of the total deposit and liability.

Conclusion

From the above discussion, it is clear that the RBI has seven weapons to control the
monetary policy. In this context, it is to be noted that the increase in liquid
money helps in growth in the economy. However, the inflation factor is to be
considered as another outcome of such higher liquidity. Thus, the RBI is
required to maintain the balance between the growth and inflation while setting
monetary policy.















Reference

Reserve Bank of India Monetary Policy  

Reasons Behind Depreciation of Rupee

Why the dollar rate is increasing?

Introduction 

In order to understand the reasons behind the hike of the USD price in India, we have to focus on the exchange rate trend over the past few years. In this regard, it is to be stated that the strength of the Indian Rupee (INR) had a steady declining trend since 2011. As a result of this, the price of foreign goods in India has also increased. The effect of the hike in the exchange rate had a direct impact on the fuel price over the past two or three years as fuel consumed in India is entirely purchased from foreign countries.

Figure 1: Rupee and USD exchange rate for last ten years

(Source: www.rbi.org.in)

Causes behind Depreciation of Rupee

As the oil importers of India has to pay in US Dollars a hike in Dollar price results in an increase in the price of fuels in India. The reasons behind the fall in the exchange rate may take place due to various factors such as the rise of fuel price in international market, the trade war between suppliers of crude oil and Foreign Direct Investments and Foreign Portfolio Investments in India. A brief overview of the factors that cause rupee depreciation can be discussed by considering the following heads:

1.    Restriction over Crude Oil Import from Iran:

As earlier stated in Judicial Economist, the United States of America has restricted India and other oil importers from Iran to continue business relations with Iran. This has impacted the Indian Economy and the foreign policy as Iran is the third largest oil supplier after Saudi Arabia and Iraq. In this context, it is to be stated that India imports 80% of the total oil exports of Iran. Due to geographical factors, India enjoys a low shipping and carriage cost on importing oil from Iran. Apart from this, Iran offers India the longest credit period on oil purchase, which has been the most important factor that made Iran the most trusted oil supplier. Cessation of contracts with Iran results in an enhancement in the oil import cost and due to this reason; India faces a problem of the shortfall in the exchange reserve, which ultimately forces the exchange rate to increase.     2.    Price Rise of Crude Oil in the International Market:

In the last three years, the crude oil price in the International Market has increased from $30 per Barrel to $80 per Barrel. As earlier stated, the enhancement in the oil price has been the result of the fall in the foreign exchange reserve in India. This chronic decrease in the exchange reserve results in a weak rupee in terms of the US Dollars. In May 2018, Brent crude oil price has reported the highest oil price at $80 per Barrel. Thus, this is also to be considered as another important factor that forced the exchange rate to fall.

3.    Outflow of Foreign Portfolio Investments:

 Being an important part of the global economy, India feels economic pressures of foreign countries. In this regard, it is to be stated that the decreasing trend in the Sensex and Nifty over the past two months has been the result behind losing the confidence of the foreign investors in the Indian stock market. However, NASDAQ, LSE and ASX have recorded a positive trend over the last six months. Due to this reason, foreign investors have shifted their investments from India in the last few months. In this same context, it is to be noted that the US and China tariff war has created a threat to the European and American investors to make an investment in Asian markets. This has also been another reason behind the outflow of foreign exchange in recent times.    

4.    Change of the US Monetary Policy

President Trump's strategy to recall domestic investment in the US has been implemented by enhancing the interest rate of the Fed. In the recent monetary policy, the Fed had increased its short-term benchmark interest rate. This rise in the short-term interest rate has been the result behind the decrease in the FPI (Foreign Portfolio Investment) and FII (Foreign Institutional Investment) in India. This outflow of the FII and FPI has resulted in a deficit in the foreign exchange reserve. Therefore, this factor is required to be considered while analyzing the reasons behind the rupee depreciation.   

5.    Current Account Deficit:

The current account deficit in India has a direct impact on the exchange rate as an enhancement in the current account deficit implies a shortfall of foreign currency in the hands of the central bank of the country. The export demand has risen due to the increase in the oil price in the international market. On the other hand, the new US trade policy includes higher tariffs on Indian goods in the US and therefore, the price of Indian goods in the USA has increased. Thus, the demand for Indian products in abroad shows a drastic decline in 2018. As the export of goods from India to abroad falls, the inflow of foreign exchange, mainly US Dollars is in decreasing trend. This has also depreciated the rupee.

Conclusion

From the above discussion, it is clear that the rupee depreciation is the result of external causes such as oil price in the international market and the US trade and monetary policies. Finally, it can be stated that this crisis of foreign exchange may continue due to the trade war between China and the USA and the USA-Iran conflict. However, the export from India is expected to show a positive move due to the increasing trend of exporting petroleum products.





Reference

Reserve Bank of India    

Evolution and Implementation of Direct Tax Code in India

Evolution and Implementation of Direct Tax Code in India: An Overview

Background and evolution of the Direct Tax Code

The Direct Tax Code would be another step towards the modernization of the Indian Tax regime after the implementation of GST. Simplification of laws by abolishment of irrelevant sections from various acts was one of the primary agendas of the BJP led NDA government and with this regard PM Modi had stated that the 50-year-old Income Tax Act is required to be replaced with the Direct Tax Code (DTC) in order to

simplify the direct tax system of the country. Initial draft bill of the DTC was released by the Government of India in 2009 for public comment and after this; the bill was revised in 2010 and 2013. Revised DTC draft bill, 2013 (DTC 2013) proposed to introduce four major aspects in the direct tax laws, which were as below:

1. General Anti Avoidance Rules (GAAR)


2. Place of Effective Management (POEM)


3. Taxation of Controlled Foreign Companies (CFC)


4. New rules regarding taxation of fees for technical services, royalty and interest.

In 2017 (November), the Ministry of Finance formed a Taskforce chaired by eminent DTDC Official Arvind Modi to recommend the Government about the inclusions and exclusions criteria of the DTC. This Taskforce has been given a deadline of six months to report the Government.  

Aims of the DTC

The primary goal of the DTC is to make financial inclusion in the economy and to attain this goal; the Government of India wants to include more taxpayers into the list. The aims of the DTC are stated below.

1.     Simplification of direct tax law,

2.     Expansion of the base of tax,

3.     Lowering the corporate tax rate to enhance the competitive environment in the economy,

4.     Decrease the number of litigations. 

Comparison of the provisions of the Direct Tax Code and the existing Income Tax Act

Point of Comparison	Direct Tax Code	Income Tax Act, 1961
Residential Status	There will be only two residential statuses: Resident and Non-Resident.	There are three residential statuses: Resident, Non-Resident. Resident but not ordinary resident
Year	Only Financial Year.	The concept of Previous year and assessment year is there in the Income Tax Act.
Income Distributed by LIC companies. and It is to the holders having the equity-oriented life insurance	Taxable @ 5%	Exempt
Income Distributed by Mutual funds companies, and it is to the holders of equity oriented MF’s	Taxable @ 5%	Exempt
Long Term Capital Gain on transfer of listed share or units	Will become part of normal income. But indexation benefit will be there. Since there is a proposal to abolish STT. So STT will not be required to be paid on trading of listed shares	It is exempt.
Assessee Definition	1) Tax-payer or/and who is liable for proceeding under the Act. 2)To whom the amount is refundable 3)finally someone who voluntarily files tax return irrespective of tax liability	1.) Tax-payer or/and who is liable for proceeding under the Act.
Income-Sources	Income is broadly classified into 2 parts 1.Special sources 2.Ordinary sources Employment income House property income Also Income Business Capital Gains Income from Residuary Sources	Income in IT Act has only one part. i.e income from ordinary sources
Tax Rate for ultra-rich (income of 10 crores or more)	35%	30%+surcharge 15%
Taxation of Dividend	15%	Under the Income-tax Act, the dividend distribution tax is to be levied. And it is at the rate of 15 per cent plus cess as applicable.
Who can conduct Tax Audit?	As per the new DTC. CA's, CS's and even cost accountant can do the tax audit	As per IT Act 1961, the tax audit was only done by the CA’s

Present Scenario of DTC and Expected Time of Implementation

The Taskforce formed by the Ministry of Finance was initially given a time limit of six months for reporting the government, which ended on 21^st of May, 2018. However, the Taskforce demanded an extension for three months. On the basis of the report, the draft bill shall be prepared, which will be published again for public comment and recommendations of the stakeholders. Hence, it can be stated that the implementation of the DTC (However it will be named as Income Tax) is not possible before 2019 General Elections.  

Reference:

Income Tax India

Simple tips to use Cash Flow information for investment decision making

In order to understand the financial position of a company, Indian investors rely upon the information provided by the brokers and the artificial confidence of the broker makes an ordinary person invest their money in the stock market. The unprofessional approach, aiming supernormal profit, and giving false assurance to the clients are to be considered as the basic character traits of an Indian Broker. So-called analysts, who have become stock market analysts due to the unemployment trend in India, represent note or document provided to them by stockbroking houses showing high sales and high profit of a company to convince the investors to buy stocks of that particular company. With wow! So intelligent feeling, investors blindly follow the so-called analysts' view and make investments. Therefore, personal understanding has no impact on buying any stock. In this same context, investment Guru Warren Buffett cited that “you should never invest in businesses that you don’t fully understand”.

Investment decision making by using the information of cash flow statement

Cash flow statement consists of Cash Flow From Operating Activity, Cash Flow From Investing Activity and Cash Flow From Financing Activity. In the operating activity, the cash profit is presented as deducted by the net increase in the working capital. The Investing activity represents the purchase and sale of trading and non-trading fixed assets. In the final section of the cash flow statement, the inflow of long-term capital and redemption or buyback of long-term capital are presented. A listed company is required to abide by either International Accounting Standard 7 of Indian Accounting Standard 3 (In India only) to prepare the Cash flow statement. 

In order to take a decision on whether to invest in a company or not, you have to make a comparative analysis of cash flows from the above-stated activities. The implication of the activity wise cash flows is discussed below:

1.      Cash flow from the operating activity:

As stated above, operating cash flow represents the cash of the company sourced from the primary operation of the company. A company, which has performed well in the last accounting year, would have generated most of its cash from this activity. A negative cash from operating activity reflects a loss or excessive increase in the working capital, and therefore, companies with negative cash flow are to be rejected while making an investment decision.     

2.      Cash flow from investment activity:

Unlike operation activity, a negative cash flow in the investment activity implies a sound future prospect of a company. If a company is having a negative cash flow from investing activity, it could be the result of investment in non-current assets, which will be used for expanding the business operation. Thus, you may invest in a company, with a negative cash flow.

3.      Cash flow from financing activity:

A positive cash flow from the financing activity represents a capital formation and therefore, it can be considered as a symptom of good financial health. However, if the company forms capital out of debt capital, it would create pressure on the income statement and as a result, the net profit will fall. Thus, positive financial cash flow is not always good for a company. If the cash flow from financing activity decreases over years due to repayment or redemption of debt, the company would have a higher net profit in the future. Hence, if this kind of situation occurs, one should invest in that particular company. Finally, it is to be stated that enhancement in the cash flow from this activity due to the issue of equity capital is to be considered as a reason behind low financial risk for the future.