SUBJECT: Economic (semester 2)

TOPIC

ANALYSIS OF MONETORY POLICY IN DEVELOPING COUNTRIES

SUBMITTED TO: Prof. Ganesh Munnorcode

Kirit P. Mehta School of Law,

NMIMS (Deemed to be University)

SUBMITTED BY: Somya Gulati

(Division F, BBA LLB)

SAP ID: 81022100291

ROLL NUMBER: F001

ABSTRACT

This study explores the role of corruption on the design of monetary policy for developing
countries, generating a number of surprising findings. This essay will also give a literature
review on the relationship between monetary policy and economic growth. It also examines
how the central bank attempts to keep prices steady by controlling the quantity of money
supplied. Finally, it discusses economic growth and goals in India, as well as how monetary
policy plays a stabilising role in effecting economic growth through a number of channels.
Monetary policy is a key instrument for economic management in India. The Reserve Bank
of India (RBI) is India's monetary authority.

INTRODUCTION

Monetary policy refers to the actions made by the Reserve Bank of India to control the cost
and supply of money and credit in order to achieve the economy's socioeconomic goals.
Monetary policy has an impact on the supply of money, the cost of money or the interest rate,
and the availability of money. One of the most essential functions of the Reserve Bank is to
develop and implement monetary policy. Such a policy refers to the Reserve Bank's
employment of credit control mechanisms to manage the quantity of credit created by banks.
It also seeks to alter the level of aggregate demand for goods and services in the economy by
adjusting the cost and availability of credit. In order to successfully conduct monetary policy,
it is important to examine the effects of monetary policy on the economy. The effect of
monetary policy, from a macroeconomic standpoint, is the relationship between aggregate
demand (output) and price levels in reaction to monetary policy tightening or loosening. The
effect is identified using three major elements: effect size, time lag, and transmission route. In
developing countries, the impact of monetary policy is more volatile and inefficient than in
wealthy countries. Furthermore, evaluations of the impact of monetary policy in emerging
and developing economies are less conclusive and targeted, This emphasises the significance
of investigating the impact of monetary policy in these nations. Economic models seeking to
design a reaction function for the monetary authority are focusing on the actions of central
banks in industrialised nations. Those in developing nations, on the other hand, do not receive
the same amount of attention since it is often considered that these central banks were
established primarily to sustain government deficits. However, there is a renewed interest in
researching developing-country monetary policy. However, if they are facing severe
inflation, some emerging economies may decide that pegging the currency rate is not the
optimal monetary policy anchor. As a result, aiming for inflation may give a stronger nominal
foundation for monetary policy formulation. Monetary policy can be designed to achieve
currency stability, price stability, or output growth.

RESEARCH QUESTION

1. What role do monetary policies have in a country's economic development?

2. How do monetary policy shocks affect developing countries?

3. What role does economic policy play in economic growth?

RESEARCH OBJECTIVE

1. Examine the function of monetary policy in national economic development.

2. To comprehend the implications of monetary policy shocks in developing nations.

3. Investigate the effect of monetary policy in promoting economic growth.

LITERATURE REVIEW

1. Kandil Magda (2014) in their research work On the Effects of Monetary Policy
Shocks in Developing Countries has explained, as aggregate demand's sensitivity to
monetary shocks grows, so do the real consequences of monetary shocks. The
variables that contribute to the disparities in these allocations, as well as their
consequences, are subsequently explored using cross-country regressions. Capacity
restrictions, on the other hand, limit the response of output to monetary shocks and
increase inflationary pressures. The output reaction to monetary shocks causes trend
output growth to rise across nations. The variability of production growth diminishes
in the face of monetary changes between nations, which is consistent with the
stabilising influence of monetary policy.
2. Twinoburyo, Enock Nyorekwa; Odhiambo, Nicholas M. (2018) in there paper Monetary
Policy and Economic Growth: A Review of International Literature aims to
understand and explains the current theoretical and empirical research on monetary
policy and economic development Despite several research on the current relationship
between monetary policy and economic development, there is still no solid evidence
of a link. This study examines both the theoretical evolution of the connection and the
most recent empirical findings. Overall, the outcomes of this research suggest that
 monetary policy is crucial in promoting economic growth, especially in financially
developed nations with relatively autonomous central banks.
3. Nguyen, Thi Mai Lan (2019) conducted a study on Output Effects of Monetary Policy in
Emerging and Developing Countries: Evidence from a Meta Analysis to show
Monetary policy tightening has a negative actual effect on output. Primary studies that
include a commodity price variable (or variables) tend to find more unfavourable
effects. In an economy with a developed financial system, output effects are likely to
be more negative, and in an economy with significant inflation volatility, output
effects are likely to be less effective.
4. Siami-Namini, Sima; Hudson, Darren (2019) in their research paper “The impacts of
sector growth and monetary policy on income inequality in developing countries”
Have presented a comprehensive overview. The evidence for a non-linear relationship
between growth and inequality. The findings on the impact of sectoral economic
growth shed light on the issue of income disparities. Surprisingly, changes in income
inequality are more elastic in relation to agricultural expansion than they are in
relation to industrial growth. Growth in the service sector widened economic
disparities. It's possible that real wage growth was strongest in the service sector,
resulting in the largest income gap between service and non-service employees.

THEORY

ROLE OF MONETARY POLICY IN ECOMIC DEVELOPMENT OF COUTRIES

1. Appropriate Matching of Money Demand and Supply: As the economy grows and the
subsistence sector shrinks, the transaction demand for money increases dramatically.
Furthermore, as per capita income rises and the population grows, so does the demand for
money to conduct day-to-day transactions. Because of the expanding demand for money, the
monetary authority must increase the money supply at a pace that is nearly equivalent to the
rate of increase in real income, so that prices do not fall as a result of increased national
output. Initiating a vicious downward spiral of prices and output, a declining price level has a
negative impact on the rate of economic growth. Similarly, if the amount of money available
exceeds the needs of commerce and industry, it may be used for speculative reasons, stifling
growth and producing inflation. The main point is that tighter control over money supply will
eliminate economic swings and prepare the way for rapid development. As a result, monetary
policy may play an important role in the economic development of developing countries by
limiting price fluctuations and overall economic activity by striking an acceptable balance
between the demand for money and the economy's productive capability.

2. Price Stability: Maintaining price and exchange rate stability at home is a crucial factor for
economic progress. In underdeveloped countries, however, economic development leads to
inflationary pressures due to a range of structural rigidities and imbalances. Inflationary price
increases reduce people's willingness to save and shift invertible resources to speculative and
unproductive investments like real estate, jewellery, gold, and stockpiling. As a result, the
monetary authority should maintain a continual eye on price movements and regulate the
supply and direction of money and credit in such a way that growing prices are held in line.
Similarly, inflationary price increases lead to currency devaluation on a regular basis. The
effects of fluctuating currency rates on international trade and the earning of foreign
exchange tails, which could aid in the country's development, are negative. In short, internal
price and exchange rate volatility stymies long-term economic progress, therefore monetary
policy should try to prevent excessive price increases while preserving exchange rate stability
at a reasonable level. This entails implementing monetary measures that will keep inflation at
bay and allow the currency to fluctuate less frequently.

3. Credit Control: In order to ensure a faster rate of economic growth, the monetary authority
should employ credit control strategies to influence and shape the nature and pattern of
investment and production. This will, of course, be dependent on the variety of credit
institutions in the economy as well as the kind of credit regulations used by the Central Bank.
In order to stimulate and encourage banks to extend medium and long-term loans for
constructive purposes, the monetary authority should step in and provide adequate guarantees
and rediscounting facilities. Aside from combined loans from commercial banks and state-
owned financial institutions, this can be a huge benefit. Similarly, selective credit regulations
should be used to affect investment and production patterns by separating the costs and
availability of loans to certain sectors and industries.

4. Financial Institutions Creation and Expansion: By enhancing the country's currency and
credit system, monetary policy can hasten economic development. More banks and financial
institutions are needed to provide larger loan facilities and mobilise savings for constructive
purposes, according to this proposal. Financial institutions are dying in developing countries,
and banking services are only offered to a limited extent. As a result, people's savings are
unable to be efficiently mobilised for economic development, resulting in a very slow pace of
growth. The monetary authority can assist in the expansion of financial institutions by giving
subsidies and special concessions to new institutions in the form of free remittance and
rediscounting services, as well as training facilities for their employees. The subject of rural
loans should be given special attention by the Central Bank. A network of cooperative credit
organisations with apex banks financed by the Central Bank could help rural residents meet
their credit demands. Similarly, the Central Bank and financial firms supply business and
industry with financing.

5. Appropriate Interest Rate Structure: Economic development necessitates massive

investment from both the public and private sectors. Because a cheap money policy makes
public borrowing cheap, keeps the cost of servicing public debt low, and thus stimulates both
public and private investment, the financing of very ambitious economic development
programmes in all sectors of the economy necessitates making credit available to private
entrepreneurs at as low a rate as possible. It is countered that a low-interest rate strategy may
encourage traders and speculators to borrow more from banks and use the funds for hoarding,
stockpiling, and other speculative reasons. However, this propensity among private investors
can be countered by employing selective credit control and channelling investment into more
desirable channels.

6. Debt Management: In developing economies, the government is required to borrow on a

large scale in order to implement economic development programmes. As a result, the
monetary authority, which is the country's Central Bank, is responsible for managing public
debt effectively and efficiently in order to meet the needs of economic growth. The main goal
of debt management is to "establish conditions in which public borrowing can grow year after
year and on a large scale without causing a systemic shock." Low interest rates are desired for
strengthening and stabilising the government bond market because they raise the price of
government bonds, making them more appealing to the public and ensuring the success of the
public borrowing programme.

RELATION BETWEEN MONETARY POLICY AND ECONOMIC GROWTH

By regulating the amount of money in circulation, the central bank strives to maintain price
stability. As a result, monetary policy has a stabilising effect on economic growth via a
variety of avenues. The extent of such a role, however, may be constrained by the concurrent
pursuit of other key monetary policy objectives, the structure of the monetary policy
transmission mechanism, and other considerations, such as policymakers' uncertainty and the
stance of economic policies. Furthermore, pursuing intermediate goals at the same time may
have an impact on reaching the final aim of generating sustainable growth.

The preservation of price stability is one of the contributions of monetary policy to long-term
growth. Because prolonged price increases are widely considered to be a monetary
phenomenon, monetary policy employs its tools to successfully control money supply in
order to ensure price stability over the medium to long term. Theoretical evidence in the
literature imply that lower price levels are connected with long-term growth. To put it another
way, high inflation has a negative impact on long-term economic performance and wellbeing.
Monetary policy has a substantial influence on the economy's financing circumstances,
including not just costs but also credit availability and banks' willingness to assume certain
risks, among other things. It also affects the prices of goods, asset prices, currency rates,
consumption, and investment through influencing expectations about the future direction of
economic activity and inflation.

A monetary policy move that decreases interest rates, for example, reduces the cost of
borrowing, resulting in increased investment and consumer durables purchases. The hope that
economic activity would improve may lead banks to loosen lending policies, allowing
businesses and people to increase expenditure. Stocks become more appealing to acquire in a
low-interest rate environment, increasing family financial assets. This could lead to increased
consumer spending and make businesses' investment projects more appealing. Low interest
rates also tend to induce currency depreciation because when imported goods become more
expensive, demand for domestic goods grows. These elements work together to boost
productivity, employment, investment, and consumer spending.

INDIA'S MONETARY POLICY

Monetary policy is an important tool for managing India's economy. The Reserve Bank of
India (RBI) is the central bank of the Indian government's monetary authority. It is in charge
of ensuring that the banking system satisfies genuine credit requirements rather than being
used for unproductive or speculative purposes.

INDIA'S MONETARY POLICY OBJECTIVES

'Growth with Stability' is the guiding principle of Indian monetary policy. The policy aids in
the control of money's availability, cost, and usage. The following are India's key monetary
policy objectives: Stability combined with growth In India, monetary policy has traditionally
been focused on controlling inflation. This was accomplished by reducing the money supply
and credit. However, this resulted in the economy's slow development. As a result, the RBI
implemented a new growth-with-stability policy. In layman's terms, this means that the RBI
will supply enough credit to meet the growing demands of the economy's many sectors. It
will also keep inflation within a set range.

Financial Stability Regulation, Supervision, and Development

Financial stability refers to an economy's capacity to withstand shocks while maintaining

public trust in the country's financial system. Internal and external shocks can both endanger
a country's financial stability and disrupt its financial system.

As a result, the RBI places a high value on preserving trust in the country's financial system
through proper regulation and supervision. It also assures that the goal of expansion is not
jeopardised. As a result, we may conclude that the RBI concentrates on financial stability
regulation, supervision, and development.

Priority Sector Promotion

Agriculture, export, small-scale companies, and the weaker sections of the population are
among the focus sectors of India. The Reserve Bank of India constantly guarantees that the
banking sector offers timely and appropriate credit to these groups at reasonable rates.

Creation of Employment

A country's monetary policy can impact the rate of investment and its distribution among the
country's many economic activities with variable labour intensities. As a result, it aids in the
creation of jobs.

Stability on the Outside

India's ties to the global economy are strengthening as imports and exports increase.
Historically, the RBI set the currency rate and regulated the foreign exchange market.

However, via controlled flexibility, the RBI currently only has indirect control over external
stability. The RBI controls the exchange rate through this method by purchasing and selling
foreign currencies on the open market.

Encouragement of Savings and Investing

The RBI gives attractive interest rates to encourage people to save. Furthermore, a high
saving rate encourages investment.

As a result, monetary management may mobilise savings and hence investments in the
economy through affecting interest rates.

Income and wealth redistribution

Because the RBI regulates inflation and provides cheap credit to the most vulnerable
segments of society, it may transfer income and wealth to the most vulnerable segments of
the economy

EMPIRICAL ANALYSIS

MONETARY POLICY REPORT OF INDIA

The Monetary Policy Report (MPR) for August 2021 has been released by the Reserve Bank
of India (RBI). For the sixth time in a row, it held the policy rate steady. In addition, he urged
the federal government and states to lower fuel taxes in order to minimise inflationary
pressures.

Policy Rates Have Not Changed: Repo Rate is 4%.

3.35 percent is the reverse repo rate.

4.25 percent Marginal Standing Facility (MSF).

4.25 percent bank rate

GDP Forecast:

The real Gross Domestic Product (GDP) growth rate has been set at 9.5 percent for 2021-22.

Inflation:

The Reserve Bank of India has raised its inflation forecast for the Consumer Price Index
(CPI) to 5.7 percent from 5.1 percent.

VARIABLE RATE REVERSE REPOS

Due to the better yield prospects compared to the fixed rate overnight reverse repo, the RBI
announced launching a Variable Rate Reverse Repo (VRRR) programme in order to absorb
additional liquidity in the system.
The Reserve Bank of India has agreed to gradually boost the VRRR quantum to Rs 4 trillion.

It also extended the three-month extension of liquidity support for banks to lend to troubled
enterprises until December 31, 2021.

Rates of Interest:

The council decided to hold rates unchanged due to rising inflation and a slower economic
recovery. In the coming months, interest rates in the banking sector are projected to remain
constant.

Due to the Covid second wave and state-wide lockdowns, recovery has been difficult.

It determined to maintain an accommodative approach for as long as it is required to

stimulate and sustain growth on a long-term basis, as well as to continue to mitigate the
effects of Covid-19 on the economy, while keeping inflation within the target moving
forward. When a central bank takes a dovish posture, it reduces interest rates in order to
infuse money into the financial system when it is needed.

CONCLUSION

The theoretical literature on the link between monetary policy and economic growth, the role
of monetary policy in country economic development, and India's monetary policies and aims
were examined in this study. Furthermore, the essay discusses how monetary policy drives
economic growth and how the central bank seeks to preserve price stability by limiting the
quantity of money in circulation. As a result, monetary policy has a number of avenues via
which it might stabilise economic development. The lack of a clear declaration of monetary
policy direction has impeded analysis of monetary policy in developing countries. Many
emerging-market central banks are seen as being obligated to pay their governments' growing
budget deficits. There has never been a thorough examination of the function of monetary
policy in developing countries. The estimation represents the allocation of monetary growth
shocks between production growth and price inflation, based on data availability. It also
covers the importance of monetary policy in controlling the Indian economy. The Reserve
Bank of India (RBI) is the country's central bank. It controls the issue of money and bank
credit. It is in charge of ensuring that the banking system is used for genuine credit
requirements rather than for speculative or unproductive purposes.

REFRENCES
1. Green, S. L. (1986). Monetary Policy in Developing Countries and the New Monetary
Economics. Journal of Economic Development, 11(2), 7-23.
2. Ma, Y., & Lin, X. (2016). Financial development and the effectiveness of monetary
policy. Journal of banking & Finance, 68, 1-11.
3. Kandil, M. (2014). On the effects of monetary policy shocks in developing
countries. Borsa Istanbul Review, 14(2), 104-118.
4. Cordero, J. A., & Montecino, J. A. (2010). Capital controls and monetary policy in
developing countries. Center for Economic and Policy Research, 3, 1-29.
5. Carranza, L., Galdon‐Sanchez, J. E., & Gomez‐Biscarri, J. (2010). Understanding the
relationship between financial development and monetary policy. Review of
International Economics, 18(5), 849-864.
6. Abuka, C., Alinda, R. K., Minoiu, M. C., Peydró, J. L., & Presbitero, A. (2015).
Monetary policy in a developing country: loan applications and real effects.
7. Siami-Namini, S., & Hudson, D. (2019). The impacts of sector growth and monetary
policy on income inequality in developing countries. Journal of Economic Studies.
8. Nguyen, T. M. L. (2020). Output effects of monetary policy in emerging and developing
countries: Evidence from a meta-analysis. Emerging Markets Finance and Trade, 56(1),
68-85.
9. Eshag, E. (1983). Fiscal and monetary policies and problems in developing countries.
10. Huang, H., & Wei, S. J. (2003). Monetary Policies for Developing Countries: The Role
of Corruption.
11. Twinoburyo, E. N., & Odhiambo, N. M. (2018). Monetary policy and economic growth:
A review of international literature. Journal of Central Banking Theory and
Practice, 7(2), 123-137.
12. Cavoli, T., & Rajan, R. S. (1998). Monetary policy rules for small and open developing
economies: A counterfactual policy analysis.
13. Krause, S., & Rioja, F. (2006). Financial development and monetary policy
efficiency. Emory Economics, 613(158), 100-121.
14. Ramlogan, C. (2004). The transmission mechanism of monetary policy: evidence from
the Caribbean. Journal of Economic Studies.
15. Page, S. (2013). Monetary policy in developing countries.
16. Huang, H., & Wei, S. J. (2006). Monetary policies for developing countries: The role of
institutional quality. Journal of International Economics, 70(1), 239-252.