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Role of RBI in Controlling Inflation & Deflation


Reserve Bank of India which was established in 1935 is India's central banking institution, which controls the monetary policy of the Indian Rupee. The preamble of RBI describes its basic function as regulation over the issuing of bank notes and keeping of reserves in view of securing monetary stability in India as well as to operate the currency and credit system of the country so as to utilise it for national advantage. So the RBI carries the great responsibility of keeping the economy stable, be it the case of either inflation or deflation.

    In 1947 Reserve Bank of India was nationalised. India after independence has had a more stable record with respect to inflation than most other developing countries. Though India came face to face with deflation in 1977 and 2009, all over since 1950, the inflation in Indian economy has been in single digits for most of the years.

Every commercial bank has to keep certain minimum cash reserves with RBI. RBI uses this tool to increase or decrease the reserve requirement depending on whether it wants to bring into effect a decrease or an increase in the money supply. Credit Control is an important tool used by the Reserve Bank of India, that is, to control the demand and supply of money (liquidity) in the economy…Its main objective being attainment of high growth rate while maintaining reasonable stability of the internal purchasing power of money.

For those who’re unaware, inflation is a rise in the general level of prices of goods and services in an economy over a period of time. This happens when the demand increases and supply is less. This causes a reduction in the purchasing power per unit of money, which is not favorable. To overcome this, the RBI sells securities held with it by the commercial banks and other financial institutions. This reduces their cash lending and credit creation capacities which causes them to increase interest rates on lending money to people. This leads to a decrease in demand, as people start to save money instead of spending it.


Similarly in case of deflation, when the demand is less and supply more, the prices of goods will fall, causing an increase in the purchasing power per unit money, which again is unfavorable.

To overcome this, the RBI buys the securities from commercial bank and other financial institutions, which increases their cash lending capacity causing them to lower the interest rates on the money it lends to people. This causes people to spend more money, instead of saving it, thus increasing demand.


 Thus one of the basic and important needs of Credit Control in the economy is to achieve the objective of controlling inflation as well as deflation. RBI uses qualitative and quantitative credit control method to control the money supply in the economy.

        The money supply in the economy is influenced by Cash Reserve Ratio. An increase in Cash Reserve Ratio (CRR) will make it mandatory on the part of the banks to hold a large proportion of their deposits in the form of deposits with the RBI. This will reduce the size of their deposits and they will lend less. This will in turn decrease the money supply. The current rate is 4.75%. RBI uses it as a major weapon to control the flow of money in the economy.

Apart from the CRR, banks are required to maintain liquid assets in the form of gold, cash and approved securities. Market liquidity is an asset's ability to be sold without causing a significant movement in the price and with minimum loss of value. Money, or cash, is the most liquid asset, and can be used immediately to perform economic actions like buying, selling, or paying debt, meeting immediate wants and needs. The ratio of liquid assets to demand and time liabilities of the commercial banks associated with RBI is known as Statutory Liquidity Ratio (SLR). Higher liquidity ratio forces commercial banks to maintain a larger proportion of their resources in liquid form and thus reduces their capacity to grant loans and advances, thus it has an anti-inflationary impact. A higher liquidity ratio diverts the bank funds from loans and advances to investment in government and approved securities.The bank’s leverage position to pump more money into the economy is restricted by increase in SLR.

     RBI time to time applies these measures to keep economy stable. India's headline inflation probably declined to 6.4% in March, the slowest rate in more than three years, but one major issue presently is the high food inflation, which continues to elude RBI’s solutions as it ponders over the point, whether further rate cuts will work in reviving Asia's third largest economy. 


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