Monetary Policy of RBI

  • Monetary policy is the process by which monetary authority of a country (RBI) monitor the supply of money in the economy by its control over interest rates to maintain price stability and achieve high economic growth

Monetary Policy Objectives

Price Stability

  • Price Stability implies promoting economic development and controlling inflation or deflation and exchange rate

Controlled Expansion Of Bank Credit

  • One of the important functions of RBI is the controlled expansion of bank credit and money supply in the economy

Promotion of Fixed Investment

  • The aim here is to increase the productivity of investment by restraining non-essential fixed investment.

Restriction of Inventories and stocks

  • main objective of this policy is to avoid over-stocking and idle money in the organization.

To Promote Efficiency

  • To increase the efficiency in the financial system
  • Tries to incorporate structural changes such as deregulating interest rates, ease operational constraints in the credit delivery system etc.

Reducing the Rigidity

  • RBI tries to bring about the flexibility in the operations which provide a considerable autonomy.
  • It encourages more competitive environment and diversification.
  • It maintains its control over financial system wherever necessary to maintain the discipline

Monetary Policy Committee

  • The Reserve Bank of India Act, 1934 (RBI Act) was amended by the Finance Act, 2016, to provide for a statutory framework for a Monetary Policy Committee
  • It’s a statutory body, started in 2016
  • MPC is a 6 members body
    1. 3 officials of the RBI
    2. 3 external members nominated by GoI
  • Nominated members’ term is 4 years, no reappointment
  • They recommended by Search-cum-Selection Committee
    1. Cabinet Secretary
    2. Governor of RBI
    3. Secretary Department of Economic Affairs
    4. 3 experts in related fields
  • MPC is required to meet at least four times in a year.
  • The quorum for the meeting of the MPC is four members.
  • Each member of the MPC has one vote, and Governor has a second or casting vote.
  • Once in every six months, RBI will publish Monetary Policy Report to explain
    1. the sources of inflation
    2. the forecast of inflation for 6-18 months ahead
  • As per Section 45ZA, Govt. determine the inflation target in term of CPI one in every 5 years
  • Minutes of the meeting have to publish in 14th day

Types of Monetary Policy

  1. Exchange rate stability – Export oriented economics
  2. Multiple Indicators – Growth, Employment, Inflation, Exchange rate
  3. Inflation Targeting –

Flexible Inflation Targeting Framework 

  • Urjit Patel committee recommended it 2013-14
  • Target inflation is 4% +- 2%, min 2% and max 6%
  • So the main target of monetary policy is  inflation
  • If inflation > 4%, then RBI will go with tight monetary policy, high interest rate


  • Predictability of policy based on the prevailing inflation
  • More price stability and check inflation
  • Relatively less volatile economy, which will help for FDI and domestic business
  • Increases transparency in policy making (minutes of meeting)


  • Inflation in India depends on poor supply chain also
  • Growing economies are generally have high inflation, because of miss match of supply and demand
  • Inflation targeting may curtail liquidity flow, which can effect growth
  • Fiscal policy also cause of inflation
  • Oil and agri product has more price volatility, cause of less control on oil price and monsoon


  • It is the Core Banking Solution (CBS) of RBI
  • This site used by all the banks for transaction with RBI
  • E-Kuber provides a single current account for each bank across the country
  • Auction of Government securities is also done through e-kuber system
  • It has 4 windows
    1. OMO
    2. MSS
    3. LAF
    4. MSF
    5. SDF – Standing Deposit Facility ( not started yet)
Instruments of Monetary Policy
  • Quantitative or Indirect tool
  • Qualitative or Selective tool

Quantitative or Indirect tool

Repo Rate

  • Fixed interest rate at which the Reserve Bank provides overnight liquidity to banks against the collateral of government and other approved securities under the liquidity adjustment facility (LAF).
  • Its called policy rate
  • Banks can’t use SLR securities for this system
  • Minimum borrowing 5 Cr.

Reverse Repo Rate

  • Fixed interest rate at which the Reserve Bank absorbs liquidity, on an overnight basis, from banks against the collateral of eligible government securities under the LAF.

Liquidity Adjustment Facility (LAF)

  • It allows banks to borrow money through repurchase agreements.
  • LAF is used to aid banks in adjusting the day to day mismatches in liquidity.
  • LAF consists of repo and reverse repo operations.   

Marginal Standing Facility (MSF)

  • It is a new Liquidity Adjustment Facility (LAF) window created by RBI in its credit policy of May 2011.
  • MSF is the rate at which the banks are able to borrow overnight funds from RBI against the approved government securities.
  • Only scheduled commercial bank can use it (exclude RRB)
  • Min 1 Cr. Can be borrowed
  • Banks can use SLR securities


  • It is the difference between the reverse repo rate and the high cost MSF rate.
  • Ideally, the call rate should travel within the corridor showing a comfortable liquidity situation in the financial system and economy.

Bank Rate

  • It is the rate at which RBI buy or rediscount bills of exchange or other commercial papers.
  • This rate has been aligned to the MSF rate and, therefore, changes automatically as and when the MSF rate changes
  • It’s a long term system of borrowing by Banks

Cash Reserve Ratio (CRR)

  • The average daily balance that a bank is required to maintain with the Reserve Bank
  • It’s a per cent of bank’s Net demand and time liabilities (NDTL)

Statutory Liquidity Ratio (SLR)

  • The share of NDTL that a bank is required to maintain in safe and liquid assets
  • It can be government securities, T-Bill, cash and gold.
  • Changes in SLR often influence the availability of resources in the banking system for lending
  • Primary society Cooperative banks no need to keep SLR
  • RBI can prescribe different SLR for NBFCs

Open Market Operations (OMOs)

  • These include purchase and sale of government securities, for injection and absorption of durable liquidity, respectively.
  • It’s a part of Government borrowing

Market Stabilization Scheme (MSS)

  • This instrument was introduced in 2004.
  • Surplus liquidity is absorbed through sale of short-dated government securities and treasury bills.
  • The cash so mobilised is held in a separate government account with the Reserve Bank.
  • MSS doesn’t increase Govt. debt
  • Upto 2 years maturity G-securities, 365 days T-bill, 90 days Cash management Bill
  • RBI used it during demonetization to absorb extra liquidity from Banks
  • MSS limit is 6 lac Cr., before demonetization it was 30K Cr.

Standing Deposit Facility (SDF)

  • A strong tool to suck out the surplus liquidity
  • Recommended by the Urjit Patel committee report in 2014
  • Without collateral
  • Without limit
Dear money
Cheap money
To fight inflation
To fight deflation
Reserve Ratio (CRR, SLR)
Increase them.
Decrease them.
Open Market Operation (OMO)
RBI sell securities
RBI buy securities
Bank Rate
increase it
decrease it
Repo rate
increase it
decrease it
    1. Money supply decreases
    1. Money supply increases
    1. Interest rate rises
    1. Interest rate falls
    1. Investment expenditure declines
    1. Investment increases
    1. Demand declines
    1. Demand increases
    1. Price level falls
    1. Output and price increases

Qualitative tool

Credit Control

  • 1968: first time RBI used the word “priority sector – target 40% by 1985
  • 1968: Export credit interest subsidy
  • 1969 nationalization round 1, 14 banks nationalized
  • 1971: Credit Guarantee Corporation of India Ltd. established. To facilitate bank lending to the priority sectors.
  • 1972: Differential interest rate scheme in PSB: for low income groups
  • 1980: Bankers to give more loans to Indira’s 20-Point program for removing poverty & reviving economy
  • 2006: Interest subvention scheme for farmers (7-3=4%)
  • 2016: Interest subvention Home loans (post-demonetization)

Priority Sector Lending – PSL

  • Schedule commercial banks has to lend 40% to PSL
  • RRB, Local Area Banks, Small Finance Banks has to lend 75% to PSL
  • Other banks or NBFC no need to follow PSL
  • Banks need to give report on PSL every 4 months
  • Banks can give funds to Rural Infrastructure Development Fund (RIDF) and other funds of some organizations in case of short fall in target
  • Those organizations are
    1. NABARD
    2. NHB
    3. SIDBI
    4. MUDRA

Priority Sectors

  1. Agriculture – 18%
  2. Export related business
  3. Education
  4. Small Housing
  5. MSME
  6. Social Infra
  7. Renewable Energy
  8. Other ( personal loan to weaker section, SC/ST organizations etc.)

PSL Certificate – 2016

  • Bank can purchase this certificate to fulfill PSL target in case of short fall
  • Only loan amount is transferred not the risk
  • Buy via E-Kuber

Interest Subvention Scheme

  • It’s a type of subsidy by Govt. to priority sectors
  • NABARD maintain this process

Rural Infrastructure Development Fund (RIDF)

  • RIDF came into existence in FY 1996
  • Primary purpose of encouraging commercial banks to meet their PSL targets
  • lower interest on investment under RIDF as compared to net returns on priority sector advances.
  • Currently, the interest rate levied on RIDF varies from two per cent below bank rate to four per cent below bank rate depending on the extent of shortfall in PSL targets.

Consumer Credit Control

  • It’s a one type of qualitative tool
  • By this way also RBI can maintain the money supply in market
  • RBI can change the rules for minimum down payment, EMI
  • By this process market demand will be control

Margin or LTV

  • This is what people will get against mortgages as percentage
  • RBI can change the percentage of the loan


  • RBI uses media for the publicity of its views on the current market condition and its directions that will be required to be implemented by the commercial banks to control the unrest.

Moral Suasion

  • RBI give suggestion to states to control fiscal deficit
  • Suggestion to banks for purchasing more G-sec than SLR

Direct Action

  • As per Banking Regulation Act, 1949, RBI can impose penalty on any banks
  • No complain can be filed against it by banks in any court of law

Limitation of Monetary Policy

Low deposit growth in Banks & it’s reason

  • Inflation
  • Small saving schemes has more interest (Ex: kishan vikas patra)
  • Outward remittance & money laundering
  • Leakage or Black money
  • High Election expenditure
  • Low Financial inclusion or low deposit behavior in villages

Banks are increasing spread & it’s reason

  • Spread is the margin of banks or the difference of the interest rate of Depositor and lenders
  • Losses due to NPA
  • Less demand from corporates
  • Less demand from aam admi


Economy is not 100% monetized

  • Land resources – companies cant buy land or start mine as per wish
  • Labour – they are not paid in money always mainly agriculture
  • Unorganized sector – high credit doesn’t improve the productivity