What are the advantages of Bank Rate Policy in Under-developed Countries ?

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The necessary conditions for the success of bank rate policy are more satisfied in the developed countries than in underdeveloped countries. In the underdeveloped countries, the bank rate policy has been called into question due to the following reasons:

(i) In the underdeveloped countries, the money market is divided into two sectors:

(a) the modern banking sector: and

(b) the indigenous banking sector. While the bank rate policy may be effective in the mo4ern banking sector, comprising commercial banks, it has no effect on the indigenous bankers (e.g., sahukars, money lenders, etc) who are not dependent on the central bank for financial accommodation.

(ii) The modern banking sector in the underdeveloped countries lack coordination among its constituent units so that the bank rate policy does not become fully effective.

(iii) Most of the commercial banks in the underdeveloped countries are in the habit of keeping excess cash reserves over and above the minimum requirements. This reduces their dependence on the central bank for financial accommodation.

(iv) In the underdeveloped countries, there is no availability of eligible securities in large quantity to be rediscounted from the centre banks.

(v) The presence of substantial non-monetized sector (i.e., barter transactions) also render bank rate policy ineffective in the underdeveloped countries.

(vi) The, economies of the underdeveloped countries are far from elastic in the sense that wages, costs and prices do not respond readily to changes in the volume of credit.

(vii) The empirical evidence suggests that investment expenditure in the underdeveloped countries is generally interest-inelastic. This is mainly because of the fact that interest cost forms a very low proportion of total cost of investment in these countries.

(viii) In planned developing economies where the public sector accounts for the larger part of the nation's investment and is equipped with a set of more direct and powerful instruments of controlling the level of economic activity, the bank rate loses much of its importance.


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