Monetary Policy is a macroeconomic concept and act by which the central bank, the Reserve Bank of India (RBI), controls the supply of money and credit in the economy. The RBI was established on April 1, 1935, under the Reserve Bank of India Act, 1934, with the original objective of regulating the issue of banknotes and securing monetary stability in India. The policy's primary purpose is to maintain price stability while keeping in mind the objective of economic growth.
The mechanism was significantly reformed with the amendment of the RBI Act, 1934, in May 2016, which provided a statutory basis for the Flexible Inflation Targeting (FIT) framework. This amendment introduced Chapter IIIF to the Act, which includes Section 45ZB for the constitution of the Monetary Policy Committee (MPC). The MPC, a six-member statutory body, is tasked with fixing the benchmark policy interest rate, the Repo Rate, to achieve the inflation target. The Government of India, in consultation with the RBI, sets the inflation target, which is currently 4% with a tolerance band of +/- 2%. The MPC's decisions are made by a majority vote, with the RBI Governor having a casting vote in case of a tie.
This framework replaced the earlier system where the RBI Governor alone took key interest rate decisions. The MPC's decisions are implemented through various instruments, including the Repo Rate, Cash Reserve Ratio (CRR), Statutory Liquidity Ratio (SLR), and the Marginal Standing Facility (MSF). The policy connects directly to the Banking system, as changes in the Repo Rate influence the interest rates banks offer on loans and deposits, thereby affecting the flow of credit and liquidity in the market. The current inflation target of 4% with the +/- 2% tolerance band has been retained by the government, extending the mandate through March 2031.