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GROWTH OF MONEY MARKET IN INDIA
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While the need for long term financing is met by the capital or financial markets, money market is a mechanism which deals with lending and borrowing of short term funds. Post reforms period in India has witnessed tremendous growth of the Indian money markets. Banks and other financial institutions have been able to meet the high expectations of short term funding of important sectors like the industry, services and agriculture. Functioning under the regulation and control of the Reserve Bank of India (RBI), the Indian money markets have also exhibited the required maturity and resilience over the past about two decades. Decision of the government to allow the private sector banks to operate has provided much needed healthy competition in the money markets, resulting in fair amount of improvement in their functioning.
Money market denotes inter-bank market where the banks borrow and lend among themselves to meet the short term credit and deposit needs of the economy. Short term generally covers the time period upto one year. The money market operations help the banks tide over the temporary mismatch of funds with them. In case a particular bank needs funds for a few days, it can borrow from another bank by paying the determined interest rate. The lending bank also gains, as it is able to earn interest on the funds lying idle with it. In other words, money market provides avenues to the players in the market to strike equilibrium between the surplus funds with the lenders and the requirement of funds for the borrowers. An important function of the money market is to provide a focal point for interventions of the RBI to influence the liquidity in the financial system and implement other monetary policy measures.
Quantum of liquidity in the banking system is of paramount importance, as it is an important determinant of the inflation rate as well as the creation of credit by the banks in the economy. Market forces generally indicate the need for borrowing or liquidity and the money market adjusts itself to such calls. RBI facilitates such adjustments with monetary policy tools available with it. Heavy call for funds overnight indicates that the banks are in need of short term funds and in case of liquidity crunch, the interest rates would go up.
Depending on the economic situation and available market trends, the RBI intervenes in the money market through a host of interventions. In case of liquidity crunch, the RBI has the option of either reducing the Cash Reserve Ratio (CRR) or pumping in more money supply into the system. Recently, to overcome the liquidity crunch in the Indian money market, the RBI has released more than Rs 75,000 crore with two back-to-back reductions in the CRR.
In addition to the lending by the banks and the financial institutions, various companies in the corporate sector also issue fixed deposits to the public for shorter duration and to that extent become part of the money market mechanism selectively. The maturities of the instruments issued by the money market as a whole, range from one day to one year. The money market is also closely linked with the Foreign Exchange Market, through the process of covered interest arbitrage in which the forward premium acts as a bridge between the domestic and foreign interest rates.
Determination of appropriate interest for deposits or loans by the banks or the other financial institutions is a complex mechanism in itself. There are several issues that need to be resolved before the optimum rates are determined. While the term structure of the interest rate is a very important determinant, the difference between the existing domestic and international interest rates also emerges as an important factor. Further, there are several credit instruments which involve similar maturity but diversely different risk factors. Such distortions are available only in developing and diverse economies like the Indian economy and need extra care while handling the issues at the policy levels.
Diverse Functions
Money markets are one of the most important mechanisms of any deve-loping economy. Instead of just ensuring that the money market in India regulates the flow of credit and credit rates, this mechanism has emerged as one of the important policy tools with the government and the RBI to control the monetary policy, money supply, credit creation and control, inflation rate and overall economic policy of the State.
Hence, the first and the foremost function of the money market mechanism is regulatory in nature. While determining the total volume of credit plan for the six monthly period, the credit policy also aims at directing the flow of credit as per the priorities fixed by the government according to the needs of the economy. Credit policy as an instrument is important to ensure the availability of the credit in adequate volumes; it also caters to the credit needs of various sectors of the economy. The RBI assists the government to implement its policies related to the credit plans through its statutory control over the banking system of the country.
Monetary policy, on the other hand, has longer term perspective and aims at correcting the imbalances in the economy. Credit policy and the monetary policy, both complement each other to achieve the long term goals determined by the government. It not only maintains complete control over the credit creation by the banks, but also keeps a close watch over it. The instruments of monetary policy, including the repo rate, cash reserve ratio and bank rate are used by the Central Bank of the country to give the required direction to the monetary policy.
Inflation is one of the serious economic problems that all the developing economies have to face every now and then. Cyclical fluctuations do affect the price level differently, depending upon the demand and supply scenario at the given point of time. Money market rates play a major role in controlling the price line. Higher rates in the money markets reduce the liquidity in the economy and have the effect of reducing the economic activity in the system. Reduced rates, on the other hand, increase the liquidity in the market and bring down the cost of capital substantially, thereby increasing the investment. This function also assists the RBI to control the overall money supply in the economy. Such operations supplement the efforts of direct infusion of newly printed notes by the RBI.
Future of Open Markets
Financial openness is said to be a situation under which the residents of one country are in a position to trade their assets with residents of another country. A slightly mild definition of openness may be referred to as financial integration of two or more economies. In recent years, the process of globalization has made the money market operations and the monetary policy tools quite important. The idea is not only to regulate the economy and its money markets for the overall economic development, but also to attract more and more foreign capital into the country. Foreign investment results in increased economic activity, income and employment generation in the economy. Free and unrestricted flow of foreign capital and growing integration of the global markets is the hallmark of openness of economies.
Indian experience with open markets has been a mixed one. On the positive side, the growth rate of the country has soared to new levels and the foreign trade had been growing at around 20 per cent during the past few years. Foreign exchange reserves have burgeoned to significantly higher levels and the country has achieved new heights in the overall socio-economic development. The money market mechanism has played a significant role in rapid development of the country during the post-reforms era.
On the flip side, the post-reforms period has witnessed relatively lesser growth of the social sector. Money market mechanism has kept the markets upbeat, yet the social sector needs more focused attention. With the base of the economy now strengthened, the money market mechanism must also focus on ensuring that proper direction is provided to the credit flows so that the poorest sections of the society also gain.
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