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  • Writer's picturePooja Ambala

Role of RBI in Indian economy

Updated: May 5, 2022

The Royal commission on Indian Currency and Finance, which was appointed on August 25, 1925, recommended the creation of a central bank in India, and the Indian Central Banking Enquiry Committee, which was established in 1931, emphasized the need for a central bank in India. The Reserve Bank of India Act, 1934, established the Reserve Bank of India on April 1, 1935. The Reserve Bank of India's primary goal is to "regulate the issue of banknotes and the keeping of reserves to ensure monetary stability and in India and, in general, to operate the country's currency and credit system to its benefit." The Reserve Bank of India was founded as a bank for private shareholders. The Reserve Bank of India's headquarters were initially in Calcutta but were later relocated to Bombay. In January 1938, the Reserve Bank of India issued its first currency notes in denominations of Rs.5 and Rs.10, followed by Rs.100, Rs.1000, and Rs.10000 later that year.

The Reserve Bank of India (RBI) is the country's central bank. Every country has a central bank of its own. The United States has the Federal Reserve Bank (FED), England has the Bank of England (BOE), and Europe as a whole has the European Central Bank (ECB) (ECB). Simply put, the role of a central bank is to monitor and stabilize a country's economy through various policies. A central bank serves as an advisor to the government on economic matters. The RBI, contrary to popular belief, is not controlled by the government and operates as a separate entity.

To understand the role of RBI in the Indian economy lets look at its structure:

The RBI's Organizational Structure

The RBI was established in 1935 to address the economic problems in British-ruled India following World War I. Its organizational structure has changed significantly since then. The RBI currently has a central board of directors that oversees its operations.

There are 21 members on the board of directors:

Governor – for a four-year term, the government appoints a governor.

Up to four Deputy Governors

Executive Directors – nominated from a variety of fields and regions and two government-nominated directors from the Ministry of Finance.

RBI's Function

The RBI has seven main functions. Each function has the goal of managing a specific sector of the economy.

1. Currency issuer

The RBI has sole authority over the issuance of new currency notes and coins and the exchange and destruction of currency that is no longer fit for circulation.

The goal is to provide a sufficient supply of high-quality currency notes and coins to the general public.

2. Financial Supervisory Authority

The Reserve Bank of India (RBI) is in charge of formulating, implementing, and monitoring monetary policy. The RBI's most crucial policy tool is this policy. RBI uses this policy to control the interest rates that banks charge on loans and deposits, which impacts inflation and deflation in the country. To put it another way, lower rates lead to higher inflation and vice versa.

Maintaining price stability while pursuing the goal of growth is the goal.

3. Foreign Exchange Manager

The RBI also enforces the Foreign Exchange Management Act, 1999, which regulates the flow of foreign currency in the Indian economy. The RBI performs this function by ensuring that the value of the Indian National Rupee is maintained in international markets.

The goal is to make international trade and payments more accessible and promote the orderly development and maintenance of India's foreign exchange market.

4. Financial System Regulator and Supervisor

The RBI establishes broad parameters for banking operations within which the banking and financial systems of the country operate. It oversees banks' financial operations to ensure that they follow the issued guidelines. In a bank failure, RBI steps in to protect depositors' money by bailing out the distressed bank.

The goal is to keep the public's faith in the system, protect depositors' interests, and provide cost-effective banking services.

5. Payment and Settlement Systems Regulator and Supervisor

To meet the needs of the general public, the RBI introduces and upgrades safe and efficient payment systems in the country. This includes implementing advanced technologies such as NEFT, RTGS, or the most recent Unified Payment Interface (UPI) and overseeing the National Financial Switch (NFS) operations, which are required for ATMs.

The goal is to keep the public's faith in the payment and settlement system.

6. Complementary Functions

Government banker: performs merchant banking services for the federal and state governments and acts as their banker. This includes dealing with government-issued financial securities such as Treasury bills, infrastructure bonds, and so on.

The banker's banker: To keep track of all scheduled banks' accounts. This includes maintaining the required minimum reserve capital balance with the RBI.

7. Developmental Function

To support national objectives, perform a wide range of promotional functions. This includes providing timely credit to the productive sectors of the economy, establishing institutions to build financial infrastructure such as UPI, NEFT, and other similar systems, expanding access to affordable financial services, and promoting financial inclusion for all socioeconomic groups.

India's central bank is the Reserve Bank of India (RBI). The RBI is responsible for various tasks, including monetary policy implementation and currency issuance. India's gross domestic product (GDP) growth rates are among the best globally. It is also known as one of the four most potent emerging market countries, collectively known as the BRIC nations (Brazil, Russia, India, and China). The bank had $5.93 billion in assets and was headquartered in Mumbai, India's financial capital.

As in all economies, the central bank is responsible for managing and monitoring monetary policies that affect both commercial and personal finance and the banking system.

The Reserve Bank is also involved in a variety of other development projects. These responsibilities include clearinghouse functions such as arranging credit for agriculture (which has been transferred to NABARD), collecting and publishing economic data, buying and selling government securities (gilt edge, treasury bills, etc.) and trade bills, lending to the government, buying and selling valuable commodities, and so on. It also serves as the government's representative at the International Monetary Fund (IMF) and represents India's membership.

The RBI has established a new department:

- For financial market surveillance, the Reserve Bank of India established a new department called the Financial Market Department on July 6, 2005.

This newly formed department will separate debt management and monetary operations in the future. This department will also be responsible for developing and monitoring money market instruments, government securities, and foreign markets.

As a result, it can be concluded that as our country develops, the role of the RBI will become increasingly important in the coming years.

In 2016, the bank demonetized the Indian rupee (INR), removing Rs. 500 and Rs. One thousand notes from circulation and removing nearly 86 percent of the country's money overnight. Counterfeiting, hoarding, and terrorism-related activities were all targets of the move. Another primary driver was the desire to combat tax evasion in a country where only 1% of citizens paid income taxes in 2013. 5

Following this decision, the analysis reveals some wins and losses. The demonetization of the specified currencies resulted in cash shortages and chaos and an increase in RBI spending to print more money. On the other hand, tax collection increased as a result of increased consumer reporting transparency.

In addition, the central bank must deal with a somewhat volatile inflation rate. The RBI Act of 1934 mandates that the bank and the federal government consult to determine an appropriate inflation target. The RBI reported a target rate of 4% as of April 2021, with the highest level reaching 6% and the lowest hovering around 2%. This goal will be maintained for the five years beginning April 1, 2021, and ending March 31, 2026. 7

The policy repo rate in India remained unchanged at 4%. This is the rate at which the central bank lends money to the country's commercial banks. The Reserve Bank of India (RBI) took swift action to address the economic and financial consequences of the COVID-19 pandemic. The rate has dropped by 2% since April 2019, when the bank set it at 6%. 8 Before that time, credit rates in India remained relatively high, despite the central bank's policy of limiting borrowing across the economy.

In 2018, the Reserve Bank of India (RBI) prohibited virtual currencies by the financial agencies and banks that it regulates.

India's Development

Since the early 2000s, India's economy has experienced significant growth. Between 2011 and 2015, the country implemented policies to help more than 90 million people escape poverty, according to the World Bank.

The Indian economy has weakened, despite its rapid growth rate, both before and during the global COIVD-19 pandemic. Between 2017 and 2020, growth fell from 8.3 percent to 4% due to a weak financial sector and a drop in private consumption. 9 According to the World Bank, India's GDP will be more than $2.62 billion in 2020, making it the world's sixth-largest economy after the United States, China, Japan, Germany, and the United Kingdom. 10

This figure is expected to rise, with the most significant impact expected in 2022. By that time, the World Bank expects growth to have stabilized at around 7%. This will most likely be due to a greater focus on fiscal and monetary policy to help struggling individuals and businesses and increased spending on health and welfare—all of which are expected to mitigate the crisis' impact.

As one of the world's fastest-growing emerging market countries, India faces several unique challenges that will necessitate quick thinking from the RBI, not to mention dealing with the global coronavirus pandemic. Shaktikanta Das will be in charge of guiding the country's monetary policy as it continues to be a focal point for GDP growth, which is expected to pick up by 2022.

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