a) Achievement and Maintenance of Price Stability in the Medium and Longer Term is the Central Function
In view of the close economic and financial ties between Bhutan and India, an Exchange Rate Target was chosen, i.e., the one-to-one Peg between the BTN and the INR. Monetary Policy, which is aimed at achieving Price Stability, is confined to the support of the Peg, which involves making available sufficient INR on demand, providing at least 100% reserve backing for all BTN issued, the avoidance of a large BTN liquidity build-up, together with additional confidence-building measures for the BTN, implying, for example, credible RMA and Government policies. All the other Subsidiary Functions, which are also very important, and which complement the Central Function, are outlined below [b) through h)].

b) The Bank of Issue
The RMA has the sole right to issue notes and coins for the purpose of directly influencing the amount of currency in circulation outside banks, thereby providing the economy with sufficient, but if possible, non-inflationary liquidity.

c) The Bankers' Bank
This function includes the acceptance of deposits as prudential reserves for banks (e.g., Minimum Reserves), the willingness to Discount commercial and Government paper, and the
commitment to act as “lender of last resort” to banks in the case of short-term liquidity shortages. It also involves the provision of central clearance facilities for interbank transactions.

d) The Government's Bank
The RMA is the banker and the fiscal agent for the Government, and may be the depository of the Government. The Central Bank may also make temporary advances to the Government.

e) The Advisor to the Government
The RMA may advise the Government on any matter relating to its functions, powers, and duties. The RMA may also be requested to advise the Government on any matter related to its functions, powers, and duties, the credit conditions in the country, or any proposal, measures, and transactions relating thereto.

f) The Guardian of the Countrie's External Reserves
The RMA is the depository of the official external assets of the country, including gold and foreign currency reserves. Guarding international reserves usually implies also the responsibility for the Exchange Rate Policy (in Bhutan the external value of the BTN is declared by the Government on recommendation of the RMA’s Board, while the RMA has to implement and support it), Reserve Management (with a view to the prudential management of the funds, with due regard to liquidity, safety, and profitability, in that order), and External Debt Management on behalf of the Ministry of Finance. In Bhutan, as in various other developing countries (e.g., in India), Reserve Management also includes the formulation, implementation, monitoring, and enforcement of Foreign Exchange Regulations.

g) Promotion of Financial Sector Development
This refers to the establishment of an effective financial system, with the aid of which financial transactions necessary for the smooth functioning of the economy can be carried out with a minimum amount of cost and time involved. In this connection, the RMA has to be a facilitator of advanced clearing and transfer systems. It also implies that the necessary banking services, as, for example, deposit facilities and loan facilities, are made available. Of importance is also the establishment of a deposit insurance system and the availability of certain specialised institutions, which could be represented, for example, by an industrial development bank, an agricultural development bank, and microfinance institutions, and the facilitation of a money market, primary and secondary markets for securities, a foreign exchange market, and a capital market. In other words, the RMA should be heavily involved in Financial Sector Development, which already is the case.

3. MONETARY POLICY FRAMEWORK

The RMA’s Monetary Policy Framework is implicit. According to the RMA Act, Section 6 b), one of the purposes of the RMA is “to promote monetary stability”, which can be interpreted as the promotion of “Price Stability”. In some Central Bank Acts, Price Stability is quantified, e.g., in the case of the European Central Bank; Price Stability is equivalent to a year-to-year rate of change of the Consumer Price Index below, but close to, 2 percent, to be maintained over the medium term. The Intermediate Target for achieving and maintaining Price Stability in Bhutan is the one-to-one peg between the INR and the BTN. In other words, an Independent Monetary Policy in Bhutan is, more or less, precluded. As a consequence, Monetary Policy is confined to the support of the peg, including the following basic measures (for a schematic overview, please see Attachment II):

a) Ensuring the sustainability of the exchange rate arrangement, i.e., always making available sufficient INR on demand for exchange with the BTN for payments in India and provision of at least 100 percent reserve backing for all BTN issued (elements of a Currency Board). b) Confidence-building measures for the BTN (e.g., credible RMA and Government policies).

c) Sterilising any persistent growth in liquidity to forestall a possible build-up of inflationary pressures, a weakening of the balance of payments, and a contingent effect on the financial market.

The following are the main supporting factors for the present system:
a) Close economic and financial relationships exist between India and Bhutan.

b) There is a dual currency system, with the BTN and the INR circulating freely side by side in Bhutan. This system can be described as an informal monetary (currency) union with India.

c) Inflation and interest rates in the two countries are closely related.

d) The arrangement maintains confidence and ties Bhutan to the relatively stable monetary conditions in India.

e) The peg has also clear benefits for trade with India, since there is no uncertainty about exchange rate developments between the two trading partners.

On the basis of the above factors, the Monetary Policy Decisions made in Bhutan are generally viewed as prudent and appropriate (e.g., by the International Monetary Fund).

While ensuring the sustainability of the exchange rate arrangement, the Monetary Authority is also required to play an important role in Monetary and Credit Management, largely owing to the build-up of excess liquidity in recent years. With the elimination of Quantitative Credit Controls, it has developed and increasingly relied upon more Indirect Instruments of Monetary Management. In particular, for the purpose of liquidity management in the banking system, the RMA has resorted to variations in Reserve Requirements, the sale of Central Bank Bills, and the sale of Foreign Exchange to banks. Through the sale of the short-term Central Bank Bills, the RMA also aims to establish a modest money market and to set a frame of reference for interest rates.

According to the Act, the RMA has also at its disposal various Liquidity Support Facilities (e.g., discount of bills and secured loans), which, however, are not being used at present due to the relatively large surplus liquidity of commercial banks.