Explained: Monetary Policy in India
Monetary policy is the activities governed by the central bank that aim to influence the management of the money supply and the interest rates in the country.
Monetary policy refers to the activities governed by the central bank of a country that aim to influence the management of the money supply and the interest rates in an economy. The ultimate goal of monetary policy is to achieve sustainable economic growth while also controlling inflation. To achieve its goals, the central bank mainly uses three strategies for monetary policies including revising interest rates, changing the reserve requirements of the banks and open market operations.
In India, the Reserve Bank of India (RBI) has the responsibility of conducting monetary policy with the primary objective of maintaining price stability while keeping in mind the objective of growth. RBI, along with the central government is also responsible for setting the inflation target in India.
The inflation target in the economy is determined in terms of the Consumer Price Index (CPI) once every five years. Currently, the inflation target in India is 4 per cent with an upper tolerance level of 6 per cent and a lower tolerance level of 2 per cent for the five years period of April 1, 2021, to March 31, 2026.
The key instruments that RBI uses for implementing its monetary policy are:
- Repo Rate: The repo rate is the interest rate at which the Reserve Bank provides liquidity to the banking system against the collateral of government and other approved securities. In simple terms, the repo rate is the rate at which the RBI lends to commercial banks. The current repo rate in India is 6.25 per cent.
- Cash Reserve Ratio (CRR): The Cash Reserve Ratio (CRR) is the minimum percentage of the total deposits that a bank must maintain with RBI in order to operate risk-free. The bank cannot use this money for lending or investing, and it receives no interest from the RBI. The current CRR in India stands at 4.50 per cent.
- Statutory Liquidity Ratio (SLR): The Statutory Liquidity Ratio (SLR) is the minimum percentage of deposits that a commercial bank must keep in liquid cash, gold, or other securities. It is essentially the reserve requirement that banks must meet before offering credit to their customers. The current SLR that banks have to maintain is 18 per cent.
- Bank Rate: The rate at which the Reserve Bank is ready to buy or rediscount bills of exchange or other commercial papers. The Bank Rate acts as the penal rate charged on banks for shortfalls in meeting their reserve requirements (cash reserve ratio and statutory liquidity ratio). The current bank rate in India is 6.50 per cent
- Open Market Operations (OMOs): These include the outright purchase/sale of government securities by the Reserve Bank for injection/absorption of durable liquidity in the banking system.