Inflation robs the needy by decreasing the purchasing power of money.

The things that a

pension or small salary will buy shrink with each creep forward of an inflationary movement.
Thus, schoolteachers, pensioners, and those elder citizens who live upon income from a fixed
amount of capital, find themselves poorer and poorer. The savings, upon which so many of our
people rely for their support in old age, or to gain earlier independence, are constantly
diminished in value. If the inflation gains sufficient power it can easily offset any interest which
the ordinary savings account or insurance policy can pay. Workers who are beneficiaries of large
investments in private and public pension funds find themselves among the principal victims.'
Definition of Inflation in technical terms can be written as:
What Is Inflation? Inflation as used in technical terms will refer to a persistent increase in the
general level of prices. This means that some over-all inclusive index of prices continues to rise.
In a growing and changing economy some prices must go up and some must go down as supply
changes in response to changes in consumer tastes and desires and in national needs. If the overall price level is to remain stable, individual prices of commodities, services, wages, etc., must
be free to move up and down.
I will cite an exemplary statement made by economist PR Brahmananda, a former president of
the Indian Economic Association: Not caring about inflation is like going into battle without
caring about the wounded, the dying and the dead.

MEASUREMENT OF INFLATION
Inflation can be measured using the Consumer Price Index (CPI) and the Wholesale Price Index
(WPI).
Inflation for a particular period can be measured on a year on year (YOY) basis with respect to a
base year. As with any index, the sample of items considered and their weight ages are of prime
importance. Inflation can be measured at various levels for example Whole sale price index
(WPI) measures inflation at the wholesale level. Consumer price index on the other hand
measures inflation at the consumer level. Of late RBI has indicated it is watching CPI more
closely. Also there are 2 sides to inflation: supply & demand side.
Supply side inflation this is caused when there is a rise in prices due inadequacies in supply. For
ex. Food prices in India are expected to increase due to drought. {Since new crops fall, there is
not enough supply of food grains). Thus, supply side inflation occurs when supply of goods fall
below their demand side.
Demand side inflation this arises when the rise in prices is caused by an increase in demand. For
example many analysts believe that the worldwide increase in commodity prices has been due to
an excessive demand especially from china.

HISTORY OF RBI
The Reserve Bank of India (RBI) is India's central banking institution, which controls
the monetary policy of the Indian rupee. It commenced its operations on 1 April 1935 during the
British Rule in accordance with the provisions of the Reserve Bank of India Act, 1934.[5] It was
recommended in 1926 by the royal commission in Indian currency and finance (known as the
Hilton young commission).[6] Following India's independence on 15 August 1947, the RBI was
nationalised on 1 January 1949.
The inflation battle

The history of Indias battle against inflation is replete with instances of taking the foot off the
brakes just as the RBI is about to slay the inflation monster, thus giving it a breather to claw at
the entrails of the economy.
When inflation touches double digits, the RBI is severely criticized for having let the genie out
of the bottle and there is all round support for inflation control.
But as inflation falls below 7-8 per cent there is a clamor for a reduction in interest rates. It is not
appreciated that a premature drop in policy interest rates does not provide an appropriate
stimulus to kick-start the economy.
Since the mid-sixties the dear money policy (that is, higher interest rate policy) has been
pursued in India to curb the inflationary pressures in the Indian economy. As mentioned above,
the higher rate of interest on saving and fixed deposits will induce more savings by the
households and help in cutting down aggregate consumption expenditure.
Besides, higher rates of interest will discourage more investment in inventories and consumer
durables and will help in reducing aggregate demand. Not only has the bank rate had to be raised
but also the deposit and lending rates of commercial banks if full effect of the monetary
measures is to be achieved.
The new normal
If the RBI prematurely gives up the battle against inflation while it is in the 6 per cent range, the
economy gets conditioned that inflation in the region of 6 per cent is the new normal and this is
precisely how inflation at each successive surge becomes higher and higher.
Some years ago the RBI would consider that an inflation rate of 6-7 per cent was too high and
the tolerance level was considered as 4 per cent.

If the RBI now gives up the battle against inflation at the current
level.http://www.gktoday.in/quantitative-measures-vs-qualitative-measures-of-credit-control/

Let us imagine that there is a monster called Inflation. It feeds on two things1. Money Supply
2. Supply of commodities.
Now imagine a hero called RBI. Everyone expects RBI to tame the monster called Inflation. RBI
is armed with a very powerful weapon - called the Monetary Policy. Monetary Policy works by
adjusting the money supply. It can adjust the money supply by influencing the interest rates of
the banks, such that it can severely affect one of the sources that feed Inflation. However
monetary policy is totally useless against influencing the supply of commodities.
The second weapon that can straighten inflation is Fiscal Policy. It is based on the mechanism of
effective taxation policies. It again does not influence the supply of commodities in the market,
but it can play a role side by side monetary policy. Sadly RBI doesn't have it, so clearly it is not
well armed. This of course does not mean that RBI should have the weapon of Fiscal policy.
Some other player- the Finance Ministry uses it, but it uses it as a fall out of populist measures,
hence does not use it properly.
Now here is the scenario.
1. There is a lot of money in the country which flows in the dark alley of what is called a
Parallel Economy. It is a result of some merchant not declaring his income, and paying less
tax. Some property deal without declaring the right price to avoid stamp duty etc. The extra
money saved cant be put into banks. So where does it go? It goes into what you
call Conspicuous Consumption.
2. The populist, top-down policies of farm loan waiver, MNREGA, weaver loan waiver- It
adds a lot of money in the system without much of productive work. Plus there is a lot of
corruption that eats up the money meant for the poor. Where does this money go- again
from the dark allays of Parallel Economy to Conspicuous Consumption.
3. Poor supply chains. Dependence on monsoon for agriculture. Not enough diesel,
electricity to run tube wells. Fragmentation of farm holdings. Pathetic condition of cold
chains and few warehouses. The land hence is not used to its full capacity and even the food
produced is wasted. But surprisingly India still produces enough to feed almost all the
people. So why do we have highly inflated food prices? Answer is right below4.Hoarding- Onion hoarders of Laselgaon Mandi is a prime example. It is said that the

entire onion produced in India is controlled in the end by some 12 families. Call it The
Onion Mafia, but many such Godfathers exist for other commodities too, who artificially
inflate the prices of the food produce. And what is the percentage of food inflation on overall
Inflation- 24.3% on WPI and 48.4%on CPI.
So in such a scenario, our hero RBI has been asked to tackle a powerful monster alone. It is
not well armed. Its friends, like Finance Ministry and other government channels are doing
more to create fodder for the monster than to slay it. It is no surprise hence that Inflation
runs wild and RBI struggles hard to stop it.
RBI still does a good job..!

Varying reserve requirements

When it is sought to restrict credit, the central bank may raise the reserve ratio. The banks then
have lower funds for lending. In 1960, for instance, the RBI reqd. the scheduled banks to
maintain with it additional reserve equivalent to 25% of the increase in their bank deposits (later
raised to 50%).
The RBI also has the power to vary the CRR which the banks have to maintain with it from the
minimum requirement of 3% up-to 15% of the aggregate liabilities...
Variations of reserve requirements affect the liquidity position of the banks & hence their ability
to lend. The raising of reserve requirements is an anti-inflationary measure in as much as it
reduces the excess reserves of member-banks for potential credit expansion. The lowering of the
reserve ratios has the opposite effect.
The higher the rate of interest, the greater will be the cost of borrowing from the banks by the
business firms. As anti-inflationary measure, the rate of interest has to be kept high to discourage
businessmen to borrow more and also to provide incentives for saving more.
It has therefore been pointed that for reducing inflation through raising interest rate some growth
has to be sacrificed.
There are however, limitations to the success of this weapon of credit control:
{A} the banks may have very large excess reserves with them, which may nullify the rise in
reserve requirements.
{B} A large net inflow of gold in payment of persistent export surplus may increase the banks
power to lend; and

{C} The govt. policy of keeping interest rate low and stable may discourage too drastic increases
in reserve requirements.

Selective Cr. Controls: Varying/fixation margin requirements:

Another important weapon in the hands of the central bank for controlling cr. is to vary the
margin requirements. While lending money against securities, the banks keep a certain margin.
They do not advance money to the full value of the security pledged for the loan. In case it is
desired to curtail bank advances, the central bank may issue directions that a higher margin be
kept. For instance, in 1960, the RBI raised to 50% minimum margin requirement for bank
advances against equity shares.
The raising of margin requirements is designed to check speculation in the stock markets & to
prevent the typical boom-bust pattern, in the stock markets. In this way, demand for speculative
credit is controlled. The higher the margin reqd. The less credit one would obtain for the
purchase of stocks and shares.
The RBI made use of selective Cr. controls for the first time in 1956. It issued directions to banks
to refrain from excessive lending against food-grams, sugar, groundnuts & shares. As already
mentioned, in 1960, margin requirements for advance against equity shares were raised to 50%.
The selective Cr. controls have been operated since then by the RBI with suitable modifications
from time to time.
It is stated under section 21 of the banking regulation Act, 1949 {with reference to selective
credit control} the Reserve Bank is empowered to issue directives to banking companies
regarding making of advances. These directions may be as follows:

The purpose for which advances may or may not be made.

Fixing the margin requirements for advances against each commodity.

Fixing of maximum limit to be advanced by banks to a particular borrower.

Fixing of rate of interest and other terms for making advances.

Fixing of maximum guarantees may be given by the banks on behalf of any firm or
company.

The commercial banks generally advance loans to their customers against some security or
securities offered by the borrowers and acceptable to the banks. The commercial banks do not
lend up to the full amount of the value of a security but lend an amount less than its value. The
margin requirements against specific securities are determined by the Reserve Bank. RBI
changed the margin frequently according to the credit policy. Changes in margin requirements
are designed to influence the flow of credit against specific commodities. Arise in the margin
requirements results in contraction in the borrowing value of the security and similarly, a fall in
the margin requirement results in expansion in the borrowing value of the security. If RBI desires
that more loans should be advanced against particular securities, it can lower the margin
requirement. Similarly, if RBI desires to check the expansion of credit against particular
securities it can raise the margin requirement.

Selective Credit Controls:

By far the most important anti-inflationary measure in India is the use of selective credit control.
The methods of credit control described above are known as quantitative or general methods as
they are meant to control the availability of credit in general.
Thus, bank rate policy, open market operations and variation in cash reserves ratio expand or
contract the availability of credit for all purposes. On the other hand, selective credit controls are
meant to regulate the flow of credit for particular or specific purposes.
Whereas the general credit controls seek to regulate the total available quantity of credit (through
changes in the high powered money) and the cost of credit, the selective credit control seeks to
change the distribution or allocation of credit between its various uses. These selective credit
controls are also known as Qualitative Credit Controls. The selective credit controls have both
the positive and negative aspect.
In its positive aspect, measures are taken to stimulate the greater flow of credit to some
particular sectors considered as important:

(1) Changes in the minimum margin for lending by banks against the stocks of specific goods
kept or against other types of securities.
(2) The fixation of maximum limit or ceiling on advances to individual borrowers against stock
of particular sensitive commodities.
(3) The fixation of minimum discriminatory rates of interest chargeable on credit for particular
purposes.

Cash Reserve Ratio

In terms of Section 42 (1) of the Reserve Bank of India Act, 1934 the Reserve Bank, having
regard to the needs of securing the monetary stability in the country, prescribes the CRR for
SCBs without any floor or ceiling rate.
Cash Reserve Ratio is a certain percentage of bank deposits which every schedule bank is required
to keep with RBI in the form of reserves or balances. Higher the CRR with the RBI lower will be
the liquidity in the system and vice versa. RBI is empowered to vary CRR between 15 percent and 3
percent. The official view on CRR has been changing. During the period of financial repression

before 1990s, CRR was the most preferred monetary policy tool. The Narsimham committee of
1991 recommended gradual reduction in CRR and increased use of indirect market-based
instruments. This was broadly accepted and the CRR was reduced from more than 15 per cent to
4.5 per cent by 2003.
But since 2004, the use of CRR as an instrument of sterilisation and also a monetary tool has
gained ground again.
The RBI controls credit through change in Cash Reserve Ratio of commercial bank. Reserve
Bank itself changed this ratio according to the credit requirement of the economy. It has been
changed several times in the history of Reserve Bank of India. The cash reserve ratio affects on
the lendable funds of commercial banks. If this ratio increases the credit creation capacity of
commercial banks decreases. On the other hand if this ratio decreases the credit creation capacity
of commercial banks increases.
In 2008, the Reserve Bank of India hiked the cash reserve ratio of scheduled commercial banks,
regional rural banks, scheduled state co-operative banks and scheduled primary (urban) co-

operative banks by 50 basis points to 8 per cent in two stages effective 26 April 2008 and 10
May2008. The monetary authority stated that as a result of the above increase in CRR on
liabilities of the banking system, an amount of about Rs.18,500 crore of resources of banks
would be absorbed. In this context, it may be noted that surplus liquidity in the banking system
amounted to Rs.2, 43,566 crore as on 4 April 2008.

The Reserve Bank of India (RBI) Act implicitly prescribed the CRR originally at a minimum
of 3 per cent of any banks net demand and time liabilities. That restriction was removed by an
amendment in 2006. While the RBI is now free to prescribe this rate, any CRR above 3 per cent
can still be viewed as a monetary tool to contain expansion of money supply by influencing the
money multiplier. But the way in which the CRR was operated historically made it serve a much
wider role. During the 1990s, when there was influx of foreign funds through non-resident
Indian (NRI) deposits, a differential CRR was prescribed on such deposits to restrict their
inflows.
This role CRR being used as an instrument of regulating NRI deposit flows got relegated
to the background once the relative attraction of such deposits vis-a-vis rupee deposits was
removed. Now that the interest rates on NRI deposits have been freed, the above role of CRR
could well be revived again.
In the period after 2004, when there was a huge influx of foreign capital through varied forms of
debt and non-debt flows, and the RBI ended up accumulating large forex reserves, the CRR
became an optional instrument to sterilize the rupee resources released from such dollar
purchases. This was particularly enabled by not paying any interest on CRR balances maintained
by banks with the RBI. The other options of sterilization through open market operations and the
repo operations through the liquidity adjustment window (LAF) cost the central bank, just as the
market stabilization scheme cost the Government fiscally in terms of interest payments.
As of March 2016, the CRR is 4.00 percent.[3]

Statutory Liquidity Ratio

Every financial institution has to maintain a certain quantity of liquid assets with themselves at
any point of time of their total time and demand liabilities. These assets have to be kept in non
cash form such as G-secs precious metals, approved securities like bonds etc. The ratio of the
liquid assets to time and demand assets is termed as the ratio.
According to the section 24 of the Banking Regulation Act. Every schedule Bank has to maintain
a minimum of 25% as cash of its total deposits. The Reserve Bank of India is empowered to
change this ratio. There was a reduction of SLR from 38.5% to 25% because of the suggestion
by Narshimam Committee. The current SLR is 21.5 % (w.e.f.11/12/15). It also influences the
credit creation capacity of the banks. The effect of both cash reserve ratio and statutory liquidity
ratio on credit expansion is similar. Penalties are levied by RBI for not maintaining these ratios
from scheduled banks.
The most important specified liquid asset for this purpose is the Government securities. To mop
up extra liquid assets with banks which may lead to undue expansion in credit availability for the
business class, the Reserve Bank has often raised statutory liquidity ratio.
The minimum prescription in this manner was 25 per cent of banks demand and time liabilities.
But it was also more a way of finding a captive market for government securities, particularly
when they were bearing below market interest rates. Not surprisingly, this ratio touched about 38
per cent around 1991.
SLR, A CUSHION FOR SAFETY
SLR can also be viewed as a hybrid instrument of a different variety. The SLR, according to
some, is not a monetary tool and is only a prudential requirement to serve as a cushion for safety
of bank deposits.
For the SLR too, the Narasimham Committees view was to bring it down to 25 per cent and
resort to auctioning government securities at market related rates. Accordingly, the SLR was
reduced to 25 per cent by 1997. Just as for CRR, RBI now has the freedom to also fix the level
of SLR.
The effective SLR, ironically though, never fell to 25 per cent at least for public sector banks and
as of March, 2016 the SLR stands at 21.5%.

MORAL PERSUASIONS
Moral persuasion refers to those cases where the Reserve Bank endeavours to achieve its object
by making suitable representations to the banking institutions concerned and relying on its moral
influence and power of persuasion. Being an apex institution and lender of the last resort, the

RBI can use its more pressure and persuade the commercial bank to follow its policy. During
inflationary conditions it may request the commercial banks not to press for frequent loans, to
refuse loans to the customers and to refrain from investing funds in the unproductive or
less productive occupations.