Syllabus: 

GS3: Indian Economy and issues relating to Planning, Mobilization of Resources, Growth, Development and Employment.

Context: 

Recently, the Monetary Policy Committee (MPC) has slashed the repo rate by 50 basis points to 5.50 percent. 

More on the News

• It marked the third consecutive reduction since February 2025. 
• The central bank also cut the cash reserve ratio of banks by 100 basis points to 3 percent.

Monetary Policy Instruments

Quantitative (General) Tools

Repo Rate: 

• The interest rate that the RBI charges when commercial banks borrow money from it. 
• To boost economic activity, the RBI cuts the repo rate, prompting banks to lower loan and deposit rates. This encourages spending over saving and makes borrowing cheaper for businesses.

Reverse Repo Rate: 

• The interest rate the central bank pays commercial banks when they park their excess cash. 
• To control inflation, the RBI raises the repo rate, making borrowing costlier for banks and, in turn, for consumers. This curbs spending and reduces money in circulation, helping to tame inflation.

Standing Deposit Facility (SDF) Rate: 

• It is the rate at which the RBI, on an overnight basis, accepts uncollateralized deposits from all liquidity adjustment facility (LAF) participants. 
• The SDF is also a financial stability tool in addition to its role in liquidity management. It was introduced in 2022 to replace the fixed rate reverse repo (FRRR) as the floor of the liquidity adjustment facility corridor.

Marginal Standing Facility (MSF) Rate: 

• It is the rate at which a bank can borrow, on an overnight basis, from the RBI in an emergency situation when inter-bank liquidity dries up completely. It is typically placed at 25 basis points above the policy repo rate.

Liquidity Adjustment Facility (LAF):

• LAF is an RBI facility that allows scheduled commercial banks (except RRBs) and Primary Dealers to borrow or park funds overnight using G-Secs and SDLs as collateral, depending on liquidity needs.

Main Liquidity Management Tool:

• To manage the frictional liquidity requirements, a 14-day term repo/reverse repo auction operation at a variable rate is conducted to coincide with the cash reserve ratio (CRR) maintenance cycle.

Bank Rate:

• In case of shortfalls in meeting the reserve requirements (cash reserve ratio and statutory liquidity ratio) by the banks, the Reserve Bank provides to buy or rediscount bills of exchange or other commercial papers at a rate which is called Bank rate.

Cash Reserve Ratio (CRR): 

• It is the percentage of a bank’s net demand and time liabilities (NDTL) that is required to be maintained in liquid cash with the RBI as a reserve. The RBI determines the CRR percentage from time to time.

Statutory Liquidity Ratio (SLR): 

• Banks must maintain a minimum percentage of their demand and time liabilities in India as liquid assets, like cash, gold, or government securities, based on figures from the last Friday of the second preceding fortnight.

Open Market Operations (OMOs): 

• These include outright purchase or sale of government securities by the Reserve Bank for injection or absorption of durable liquidity in the banking system.

Qualitative (Selective) Tools

• Credit Rationing – Limiting credit flow to certain industries or sectors.
• Margin Requirements – Changing initial collateral needed for loans against assets like securities.
• Moral Suasion – RBI’s informal persuasion of banks to follow desired lending behaviours.
• Directives & Selective Regulation – Such as controlling lending rates for certain sectors or capping bank exposures.

Monetary Policy Committee (MPC)

The Monetary Policy Committee (MPC) in India is a statutory body established under the Reserve Bank of India Act, 1934. 

Specifically, Section 45ZB of the Act empowers the Central Government to constitute this six-member committee, which determines the policy interest rate needed to achieve the inflation target set by the Government of India. 

The MPC comprises of six members where three members from the RBI and three appointed by the Central Government. 

• RBI officials: the Governor (Chairperson), the Deputy Governor in charge of monetary policy and an RBI-nominated officer
• External members: appointed by the Central Government for four-year terms

The Governor of the Reserve Bank of India acts as the ex officio Chairperson of the committee. 

Decision-making: By majority vote; the RBI Governor holds a casting vote in case of a tie.