Monetary Policy
Monetary policy refers to the actions taken by a country's central bank — in India's case, the Reserve Bank of India — to control the supply of money, manage interest rates, and achieve macroeconomic objectives such as price stability and sustainable growth.
In India, monetary policy was conducted by the Reserve Bank of India (RBI) through its Monetary Policy Committee (MPC), a six-member body established under the RBI Act, 1934 as amended in 2016. The MPC comprised three RBI representatives — the Governor, a Deputy Governor, and one other official — and three external members appointed by the Government of India. All major policy rate decisions required an MPC vote, and the committee met at least four times a year, with six meetings typically held during each financial year.
The primary instrument of Indian monetary policy was the repo rate — the rate at which the RBI lent short-term funds to commercial banks. By raising the repo rate, the RBI made borrowing more expensive, which was intended to cool inflation by reducing credit growth and consumer spending. By cutting the repo rate, it made borrowing cheaper, stimulating economic activity during slowdowns. The reverse repo rate (the rate at which banks parked excess funds with the RBI) and the standing deposit facility (SDF) rate served as the floor for overnight money market rates, while the marginal standing facility (MSF) rate formed the ceiling.
Monetary policy operated through several transmission channels. The interest rate channel was the most direct: repo rate changes influenced lending rates charged by banks, which in turn affected home loan EMIs, corporate borrowing costs, and consumer credit. The credit channel influenced the availability of bank loans — a tighter policy tightened bank liquidity and reduced credit creation. The exchange rate channel worked through capital flows: higher interest rates attracted foreign capital, strengthening the rupee and reducing import inflation.
India formally adopted flexible inflation targeting (FIT) in 2016, with a medium-term CPI inflation target of 4 percent with a band of +/- 2 percent (i.e., between 2 and 6 percent). The MPC was legally required to explain in writing to the government if CPI inflation breached the band for three consecutive quarters, as happened in 2022 when headline CPI averaged well above 6 percent due to supply-side shocks from the Russia-Ukraine war and food price pressures.
Between 2020 and 2022, the MPC maintained an accommodative stance — keeping rates low to support the economy through the COVID-19 shock. From May 2022, the committee initiated a sharp tightening cycle, raising the repo rate cumulatively by 250 basis points to 6.5 percent by February 2023 in response to rising inflation. The RBI then held rates steady through 2023 and 2024 as inflation gradually moderated toward the 4 percent target.
Monetary policy was distinct from fiscal policy (government spending and taxation) but operated in conjunction with it. When the government ran a large fiscal deficit, the RBI's task of managing inflation became more complex, because deficit financing could add to money supply growth. The coordination — and occasional tension — between the RBI and the Ministry of Finance formed one of the central dynamics of Indian macroeconomic management.