Monetary policy is one of the determinants of economic performance. This is because monetary policy influences the level of money supply in the economy, which, in turn, determines the level of economic activities. Central banks are important institutions that are tasked to regulate money supply in the economy. Monetary policies tend to change over time and may differ by country and the state of the economy. Therefore, this paper compares India’s and Canada’s monetary policies with the aim of identifying similarities and differences in the use of monetary policy instruments. The Reserve Bank of India (RBI) and Bank of Canada (BC) regulate monetary policies in India and Canada, respectively.
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Monetary Policy in India
The repo rate is the main monetary policy instrument in India. The RBI also uses the reverse repo rate to encourage liquidity absorption by commercial banks on an overnight basis (RBI, 2019a). Liquidity adjustment and marginal standing facilities are also used to regulate liquidity injection into the economy, which provides resilience to unpredicted shocks to the financial system. Other policy instruments used by the RBI include open market operations, cash reserve ratio, market stabilization schemes, and statutory liquidity ratio (RBI, 2019a).
Since the mid-1980s, the RBI maintained a flexible monetary targeting approach. Financial market reforms were instituted by the RBI in the 1990s, which focused on fixing the instability in money demand and the weakened relationship between inflation and money supply (Inoue & Hamori, 2015). The RBI switched to multiple indicator approach (MIA) in 1998, but maintained money supply as an intermediate target (Inoue & Hamori, 2015). MIA was used to by the RBI to monitor different macroeconomic variables until 2014 when the bank experienced challenges in fulfilling multiple objectives.
India’s monetary policy has changed significantly since 2013. The Urjit Patel Committee recommendations of 2014 had shifted the focus of India’s monetary policy from MIA to inflation targeting (Khilar, 2017). The focus of inflation targeting is to stabilize prices and contribute to economic growth. Secondly, the RBI replaced wholesale price index (WPI) with the consumer price index (CPI) as an indicator of inflation. The implementation of the new policy regime reduced CPI inflation from an average of 10.9% in 2013 to about 6.7% in 2014 (World Bank, 2019). Thirdly, the RBI maintained a tight monetary policy which kept in check the inflation and reduced the volatility of the rupee. The repo rate reduced to 8% between 2013 and 2014.
The easing of inflation in early 2015 prompted the RBI to reduce the repo rate by 25 bps, setting it at 7.25% (RBI, 2015). Additionally, the RBI reduced the statutory liquid ratio to 21.5%, down from 22% (Khilar, 2017). Upon adoption of CPI as an indicator of inflation in 2014-15, inflation reduced to 4.9% in 2015. The RBI reduced repo rate to 6.75% in 2015, and maintained it at the same level until early 2016.
The government amended the RBI Act of 1934 in the 2016-17 financial year establishing the Monetary Policy Committee (MPC). The MPC’s mandate is to maintain price stability and achieve government’s economic growth objective. The MPC fixes the repo rate to curb inflation within pre-specified target levels. The MPC is required to set the repo rate at 4% with tolerance levels of ± 2 (RBI, 2017). Consequently, the MPC reduced the repo to 6.25% from 6.5%, resulting in CPI inflation of 4.9% in 2016 and 3.3% in 2017 (RBI, 2016; World Bank, 2019).
The repo rate is currently reviewed on a bi-monthly basis. The most recent bi-monthly policy report indicates that the RBI reduced the policy rate from 6.25% to 6% (RBI, 2019b). The April 4 repo cut is the second cut in two months. The latest repo cut is expected to spur economic growth and maintain inflation within RBI’s target of 4%. The RBI is expecting to further revise the repo rate in 2019 in order to achieve growth projection of 7.2% in 2019-20.
Monetary Policy in Canada
The target of the Canadian monetary policy is to promote financial and economic wellbeing of Canadians. Canada started implementing inflation targeting monetary policy in 1991. The BC identified inflation targeting as the best solution to enhancing the value of the Canadian dollar and sustaining economic growth. The policy stabilizes and keeps inflation low. Thus, the Bank has maintained inflation-control target at 2% since 1995, which it renews every five years (BC, 2016).
Canada’s monetary policy instrument is the target overnight interest rate. The BC regulates money supply in the economy by making changes to the target overnight interest rate. This implies that the interest rate for interbank lending in Canada fluctuates daily (BC, 2019). The BC announces 25 bps interest rate that is above or below the overnight interest rate and maintains the rates within the announced operating band. Additionally, the very short-term changes in interest rates allow the bank to alter the rate at which commercial banks transact. A change in the target overnight interest rate influences market interest rates, demand for goods and services, exchange rate, and prices of domestic assets (BC, 2017).
The Canadian monetary policy is forward looking, that is, changes in the target overnight interest rate take between 6 and 8 quarters to affect inflation. The inflation targeting approach is symmetric and flexible. This implies that the BC’s concern is having inflation closer to the target rate. The BC uses CPI as an inflation indicator. The average inflation in Canada was about 2.9% in 2011 up from 1.8% in 2010 (World Bank, 2019).
The government and the BC renew inflation control target every five years. In 2011, the BC and the government maintained the target inflation at 2% with a control range of 1% to 3% (BC, 2014). The regulation of the money supply in the economy maintained inflation below 2% in the latter half of 2012. On average, inflation in Canada was about 1.5% in 2012 before averaging 0.9% in 2013 (BC, 2018; World Bank, 2019). The average inflation rate was 1.9%, 1.1%, and 1.4% in 2014, 2015, and 2016 respectively (BC, 2018; World Bank, 2019).
The government and the BC renewed the inflation-control target in 2016 for a five-year period. The inflation target was maintained at 2% with a control range of 1% to 3% (BC, 2016). The renewal of the inflation-control target as well as changes in the specific interest rates in subsequent years maintained inflation rate within the targeted range. The CPI inflation rate was 1.6% in 2017 (BC, 2018). However, the CPI inflation rate increased to 2.3% in 2018, which the bank attributed to a rise in gasoline prices.
Economic Growth
The effect of monetary policy on India’s economic growth is mixed. Under the MIA, India’s economy grew by 8.48%, 10.26%, and 6.64% in 2009, 2010, and 2011, respectively. However, the monetary policy was not able to significantly reduce the inflation. A shift from MIA to inflation targeting monetary policy in 2011 resulted in 5.46% growth in GDP in 2012. India’s low inflation between 2013 and 2015 was accompanied by a rise in GDP growth. The economy grew by 6.39%, 7.41%, and 8.15% in 2013, 2014, and 2015, respectively (World Bank, 2019). The MPC interventions resulted in a decline in GDP growth. The economy registered 7.11% growth in GDP in 2016 before declining to 6.68% in 2017 (World Bank, 2019).
In comparison, Canada’s economic growth was modest and below 5%. The Canadian economy grew by -2.95% in 2009 (World Bank, 2019). This is largely attributed to the 2008 global economic downturn. The economy recovered in 2010 and 2011, growing by about 3.1%. The Canadian economic growth was 1.75% in 2012, 2.48% in 2013, and 2.86% in 2014, coinciding with the BC’s inflation-control target renewal. Canada’s GDP declined to 1% in 2015 before rising to 1.41% in 2016 and 3.05% in 2017 (World Bank, 2019).
Conclusion
This paper compared monetary policies of India and Canada. Monetary policies in both the countries are targeted on inflation. The RBI and BC regulate money supply by adjusting interest rates. Monetary policies in the two countries focus on stabilizing and maintaining low inflation rate, and contributing to economic growth. Additionally, monetary policies in the two countries have accomplished the central banks’ objective of stabilizing and maintaining low inflation rates. The RBI and BC have managed to maintain inflation rates within the inflation-control targets. India’s monetary policy has maintained an economic growth rate of above 5%. Similarly, Canada’s monetary policy has, on average, maintained economic growth rate between 2% and 3%.
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