Qualitative Tools of Monetary Policy - Indian Economy Notes
Qualitative Tools of Monetary Policy is a set of instruments used by the Reserve Bank of India (RBI) which discriminates the use and allocation of credit to different sectors of the economy. The qualitative tools are also known as Selective Tools of Monetary Policy. For instance, the RBI guidelines to incentivize lending to certain sectors like small businesses, the housing sector and the automotive sector is a kind of Qualitative tool.
In this article, let us see the meaning and types of qualitative tools and the difference between qualitative and quantitative tools.
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What are Qualitative Tools?
- Qualitative instruments are selective instruments of the RBI's monetary policy.
- These instruments are used to distinguish between different types of credit, such as preferring export over import or essential credit supply over non-essential credit supply.
- Both borrowers and lenders are affected by this strategy.
- These instruments have an impact on how credit is used in various sectors. For example, the RBI can set upper limits on how much money banks can lend to specific sectors of the economy.
- The amount of money in circulation is unaffected. The available funds are simply directed in a certain direction.
Types of Qualitative Tools
The following are the qualitative tools used by the RBI for credit control:
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Change in Marginal Requirement
- The term "margin" refers to the percentage of a loan that is not offered or financed by the bank.
- A change in the loan size can be caused by a change in the marginal requirement.
- This device is used to boost credit supply for necessary sectors while discouraging it for non-essential ones.
- This can be accomplished by raising the marginal of unneeded sectors while lowering the marginal of other sectors in need.
- If the RBI believes that additional credit should be available to the agricultural sector, the margin will be reduced, and 80-90 percent of the loan will be available.
- For instance, if the marginal requirement for the agricultural sector is 10% and if someone pledges collateral worth 10 crores for a loan of 10 crores, then the sanctioned loan would be a maximum of 9 crores.
- On the other hand, if the automotive sector has a marginal requirement of 20%, for the same collateral and loan the sanctioned amount will be 8 crores.
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Regulation of Consumer Credit
- Consumer credit supply is regulated by the installment of sale and hire purchase of consumer goods.
- Features such as installment amount, down payment, loan period, and so on are all pre-determined, which aids in the control of credit and inflation in the country.
- For instance, for a home loan, the RBI can set a minimum downpayment limit of 15%. Therefore for a home loan of 1 crore, Rs. 15 lakhs must be paid as a downpayment and avail 85 lakhs as a loan.
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Rationing of Credit
- The Reserve Bank of India sets a credit limit for commercial banks. The quantity of credit accessible to any commercial bank is limited.
- The higher credit limit might be set for certain objectives, and banks must adhere to it.
- This reduces the bank's credit exposure to unfavorable industries. This device also regulates bill rediscounting.
- For instance, the banks might be instructed by the RBI not to lend to traders of Onion and Potato in spite of having eligibility and collateral pledging capacity.
- This is to ensure there is no hoarding of essential commodities by using bank loans.
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Moral Suasion
- Moral suasion refers to the RBI's recommendations to commercial banks that aid in the restraint of credit during inflationary periods.
- The Reserve Bank of India (RBI) exerts pressure on the Indian banking system without taking any concrete steps to ensure compliance with the rules.
- Commercial banks are informed of the RBI's expectations through monetary policy.
- Under moral suasion, the RBI can offer orders, recommendations, and suggestions to commercial banks to reduce loan supply for speculative purposes.
- For instance, the Governor of RBI making a press statement that the reduction in repo rates have not been transferred to the consumers. This will nudge the banks to reduce their interest rates.
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Direct Action
- The central bank (RBI) can punish and impose sanctions on banks for not following the guidelines provided under the monetary policy.
- For instance, the imposition of the Prompt Corrective Action Framework is one such Direct Action measure.
Comparison between Quantitative Tools and Qualitative Tools
| Parameter | Quantitative Tools | Qualitative Tools |
|---|---|---|
| Tools |
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| Impact | Indirect in nature as any change in these tools may not be transmitted to the consumer immediately or directly. | Direct in nature as any changes are directly impacting the consumers as in the case of the requirement of a down payment. |
| Reach | The reach of Quantitative tools is general. They affect money supply in the entire economy and all sectors be it housing, automobile, manufacturing- everything. | The reach of Qualitative tools is selective. It can affect the money supply in a specific sector of the economy like automobile or agriculture. |
Conclusion
The RBI uses Qualitative tools to directly control the credit flow to any sector of the economy based on macroeconomic situations. The Qualitative tools don't increase or decrease the money supply or liquidity in the economy rather channel the available money to needed sectors of the economy.
| Other Relevant Links | |
|---|---|
| Indian Economics Notes | Monetary Policy |
| Monetary Policy Tools | Money Supply |
| RBI Act 1935 | Reserve Bank of India |
| Types of Monetary Policy | Monetary Policy Committee |
FAQs
Question: What are qualitative tools of monetary policy?
Answer: Qualitative tools of monetary policy are instruments used by the RBI to control the flow and direction of credit in the economy. These tools include moral suasion, margin requirements, direct action, and selective credit control.
Question: How does moral suasion work in monetary policy?
Answer: Moral suasion involves the RBI using persuasion and influence to encourage banks to follow specific credit policies, such as lending to priority sectors or curbing speculative lending.
Question: What is the purpose of margin requirements in monetary policy?
Answer: Margin requirements are used to regulate the percentage of collateral required for loans. By adjusting margins, the RBI can control speculative borrowing and stabilize credit expansion.
Question: What is the significance of selective credit control (SCC)?
Answer: Selective Credit Control (SCC) is used to limit credit to speculative sectors, such as commodity trading, to prevent excessive price volatility and speculative activities in the economy.
Question: How does the RBI use direct action as a qualitative tool?
Answer: The RBI uses direct action to penalize banks that do not comply with its monetary policies. This may involve restrictions on their lending practices or other punitive measures.
MCQs
- Which of the following is a qualitative tool of monetary policy?
A. Repo rate
B. Cash Reserve Ratio
C. Selective Credit Control
D. Statutory Liquidity Ratio
Answer: (C) See the Explanation
Selective Credit Control (SCC) is a qualitative tool of monetary policy, while repo rate, Cash Reserve Ratio (CRR), and Statutory Liquidity Ratio (SLR) are quantitative tools.
- What is the objective of imposing margin requirements by the RBI?
A. To increase inflation
B. To regulate speculative borrowing
C. To increase government revenue
D. To decrease money supply
Answer: (B) See the Explanation
The RBI imposes margin requirements to regulate speculative borrowing and stabilize credit in the economy, ensuring that loans are backed by adequate collateral.
- Moral suasion as a qualitative tool of monetary policy involves:
A. Forcefully imposing rules on banks
B. Penalties on banks for non-compliance
C. Persuasion and influence by the RBI
D. Setting statutory reserve ratios
Answer: (C) See the Explanation
Moral suasion involves the RBI persuading banks to follow specific practices without the use of force or penalties. It relies on influencing banks to adopt desired credit policies.
- Which of the following actions can be taken under direct action by the RBI?
A. Reducing the interest rate
B. Penalizing non-compliant banks
C. Introducing new government bonds
D. Adjusting foreign exchange reserves
Answer: (B) See the Explanation
Under direct action, the RBI can impose penalties or restrict the lending practices of banks that do not comply with its policies.
- What is the primary goal of selective credit control (SCC) as a qualitative tool?
A. To promote lending to all sectors
B. To regulate credit flow to specific sectors
C. To increase government taxation
D. To stabilize currency exchange rates
Answer: (B) See the Explanation
The goal of Selective Credit Control (SCC) is to regulate the flow of credit to specific sectors of the economy, particularly to control speculation and price volatility in areas such as commodity trading.
GS Mains Questions and Model Answers
Q1: Discuss the role of qualitative tools of monetary policy in controlling credit flow in the Indian economy.
Answer: The qualitative tools of monetary policy, such as moral suasion, margin requirements, selective credit control, and direct action, play a critical role in controlling the flow of credit to specific sectors of the Indian economy. While quantitative tools regulate the overall volume of credit, qualitative tools ensure that credit is directed towards productive and priority sectors, avoiding speculative or unproductive uses. For instance, margin requirements prevent excessive borrowing for speculative purposes, while Selective Credit Control (SCC) limits lending to speculative sectors like commodity trading. These tools help in maintaining financial stability and support the government's economic priorities, including inclusive growth and price stability.
Q2: Explain how moral suasion and selective credit control help the Reserve Bank of India in achieving its monetary policy objectives.
Answer: Moral suasion and Selective Credit Control (SCC) are key qualitative tools used by the RBI to achieve its monetary policy objectives. Through moral suasion, the RBI persuades banks to follow specific practices, such as lending more to priority sectors or curbing loans to speculative sectors. This non-coercive method encourages banks to align with the broader goals of economic stability and growth. On the other hand, Selective Credit Control directly regulates credit flow to specific sectors, particularly those prone to speculation, such as commodities. By controlling credit to speculative sectors, the RBI prevents asset bubbles and maintains price stability, which are crucial for overall economic stability.
Q3: Analyze the effectiveness of qualitative tools of monetary policy in promoting inclusive growth in India.
Answer: The qualitative tools of monetary policy are effective in promoting inclusive growth in India by ensuring that credit flows to priority sectors, such as agriculture, small industries, and housing. By using tools like Selective Credit Control (SCC) and moral suasion, the RBI can direct banks to lend to sectors that are crucial for social and economic development. For example, margin requirements ensure that speculative borrowing is curtailed, and credit is available for productive uses. Moreover, these tools complement quantitative measures by focusing on the quality of credit allocation, making them instrumental in promoting financial inclusion and addressing regional imbalances in credit access.
Previous Year Questions on Qualitative Tools of Monetary Policy
1. UPSC CSE Prelims 2019
Question: Which of the following is a qualitative tool of monetary policy?
A. Repo rate
B. Selective Credit Control
C. Open Market Operations
D. Cash Reserve Ratio
Answer: B
Explanation: Selective Credit Control (SCC) is a qualitative tool, while the repo rate, Open Market Operations (OMO), and Cash Reserve Ratio (CRR) are quantitative tools of monetary policy.
2. UPSC CSE 2019
Question. Explain the role of qualitative tools in regulating the monetary policy of India.
Answer: Qualitative tools of monetary policy refer to selective credit control methods used by the Reserve Bank of India (RBI) to regulate the distribution and use of credit within the economy. Unlike quantitative tools that control the overall supply of money, qualitative tools influence specific sectors or types of loans. Some of the key qualitative tools include:
- Credit Rationing: Limiting the amount of credit available to certain sectors.
- Moral Suasion: Persuading financial institutions to follow the central bank's guidelines.
- Margin Requirements: Setting minimum margin limits to control speculative activities.
These tools are crucial in curbing inflationary trends and ensuring the flow of credit towards productive sectors, such as agriculture or small industries, while discouraging speculative investments. They complement quantitative instruments like repo rates to achieve macroeconomic stability.
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