Monetary policy: RBI tools, the MPC and transmission

What is monetary policy?

Monetary policy is the set of steps the Reserve Bank of India (RBI) takes to change how much money is in the economy and how costly it is to borrow. Fiscal policy, by contrast, is the government’s taxing and spending. When prices rise too fast, the RBI makes money costlier. When growth is weak, it makes money cheaper.

Think of the RBI as the main water tank of a housing society. Banks are the pipes to each flat. If the tank lets out more water at low cost, every flat gets plenty, and people use it freely. If the tank charges more, people use less. The repo rate is the price at the tank.

Who decides: the MPC and inflation targeting

The Urjit Patel Committee (2014) suggested that the RBI should aim at a clear inflation number. The Finance Act, 2016 amended the RBI Act, 1934. Section 45ZA lets the government, with the RBI, set the inflation target. Section 45ZB creates the Monetary Policy Committee (MPC). This system is called flexible inflation targeting, which means the RBI aims at inflation but can also keep growth in mind.

• Members: six. The RBI Governor (chair, with a casting vote if votes tie), the Deputy Governor in charge of monetary policy, one RBI officer nominated by the Central Board, and three outside experts named by the government for four years.
• Meetings: at least four a year. The next meeting is on 2–4 December 2026.
• Target: 4% CPI inflation, band 2–6%, for 2026–31. If inflation stays outside the band for three quarters in a row, the RBI must write to the government explaining why.

The tools of monetary policy

Quantitative tools change the total amount of money:

Open Market Operations (OMOs) are the RBI buying or selling government bonds. Buying puts money into the system; selling pulls it out. The Liquidity Adjustment Facility (LAF) is the daily window of repo and SDF operations that keeps the overnight rate inside the corridor, which is 50 basis points wide (one basis point is 0.01%). The old fixed-rate reverse repo still exists but is used only at the RBI’s discretion. The Market Stabilisation Scheme (MSS) lets the RBI issue special bonds to soak up very large inflows of money.

Qualitative tools guide where credit goes: margin requirements on loans, selective credit controls on certain goods, and moral suasion, which means the RBI simply persuading banks.

What UPSC asks: Prelims: which steps are expansionary and which are tight. An expansionist policy cuts repo, Bank Rate, CRR or SLR; it does not raise MSF.

Transmission: from RBI rate to your loan

Transmission means how fast a repo cut actually lowers the rate a family pays on a home loan. In the past, banks were slow to pass on cuts. From 1 October 2019, the RBI made banks link new floating-rate loans to retail borrowers and small businesses (MSEs) to an external benchmark, such as the repo rate. This is the External Benchmark Lending Rate (EBLR), and it made transmission faster.

What UPSC asks: Mains: limits of monetary policy when inflation comes from food or fuel supply shocks, and why fiscal and monetary policy must work together.