Monetary Policy is a macroeconomic concept and process by which the central bank, the Reserve Bank of India (RBI), manages the supply of money and credit in the economy. Its primary objective is to maintain price stability while keeping in mind the objective of growth. The framework for central banking policy in India is rooted in the Reserve Bank of India Act, 1934.
The modern framework was created to solve the problem of a non-transparent, single-person decision-making process for setting interest rates. The most significant recent change was the establishment of the Monetary Policy Committee (MPC) in 2016, which replaced the system where the RBI Governor alone set the rates. This change was formalized by amending the RBI Act, 1934, through the Finance Act, 2016, to provide a statutory basis for the policy.
The mechanism works through the Monetary Policy Committee (MPC), a six-member statutory body constituted under Section 45ZB of the RBI Act, 1934. The MPC is entrusted with fixing the benchmark policy rate, the repo rate, to contain inflation within the specified target level. This institutionalized the Flexible Inflation Targeting (FIT) framework, formally adopted in February 2015. The Government of India sets the inflation target, which is currently 4% with a tolerance band of ±2%. The MPC meets at least four times a year. Key tools connected to this policy include the Cash Reserve Ratio (CRR), governed by Section 42 of the RBI Act, 1934, and the Statutory Liquidity Ratio (SLR), governed by Section 24 of the Banking Regulation Act, 1949. Furthermore, the fixed reverse repo rate was replaced by the Standing Deposit Facility (SDF) rate as the floor of the Liquidity Adjustment Facility (LAF) corridor in April 2022.