Monetary Policy Tools
Monetary Policy, managed by the Reserve Bank of India (RBI), regulates money supply and credit to achieve economic stability, growth, and price control. This chapter explores key tools like CRR, SLR, Repo Rate, Reverse Repo Rate, and their impacts, crucial for UPSC Prelims preparation.
Cash Reserve Ratio (CRR)
CRR is the percentage of a bank's total deposits that must be maintained as cash with the RBI. It controls liquidity in the banking system.
Current Rate (2025): 4.5% (unchanged since May 2022).
Impact of Increase: Reduces lendable funds, decreases money supply, controls inflation.
Impact of Decrease: Increases lendable funds, boosts money supply, stimulates growth.
Example: If a bank has ₹100 crore in deposits and CRR is 4.5%, it must keep ₹4.5 crore with RBI, reducing funds available for lending.
Statutory Liquidity Ratio (SLR)
SLR is the percentage of net demand and time liabilities (NDTL) that banks must invest in government-approved securities (e.g., G-Secs).
Current Rate (2025): 18% (reduced from 18.25% in 2024).
Impact of Increase: Limits credit availability, reduces liquidity, curbs inflation.
Impact of Decrease: Increases credit availability, enhances liquidity, supports economic activity.
Example: With ₹100 crore NDTL and 18% SLR, a bank must invest ₹18 crore in securities, reducing funds for loans.
Repo Rate
Repo Rate is the rate at which RBI lends short-term funds to commercial banks against government securities.
Current Rate (2025): 6.5% (as per latest RBI MPC meeting, February 2025).
Impact of Increase: Raises borrowing costs, reduces money supply, controls inflation.
Impact of Decrease: Lowers borrowing costs, increases money supply, promotes growth.
Example: In 2022-23, RBI raised Repo Rate by 250 basis points to 6.5% to tackle inflation, increasing loan EMIs for consumers.
Reverse Repo Rate
Reverse Repo Rate is the rate at which RBI borrows from commercial banks by accepting their surplus funds.
Current Rate (2025): 3.35% (typically 100-150 basis points below Repo Rate).
Impact of Increase: Encourages banks to park funds with RBI, reduces liquidity, controls inflation.
Impact of Decrease: Discourages banks from parking funds, increases liquidity, supports growth.
Example: During 2020-21, a low Reverse Repo Rate of 3.35% encouraged banks to lend rather than park funds with RBI, boosting credit during the pandemic.
Other Monetary Policy Tools
Besides quantitative tools (CRR, SLR, Repo, Reverse Repo), RBI uses qualitative tools to regulate credit.
Open Market Operations (OMO): RBI buys/sells government securities to adjust liquidity. Buying increases money supply; selling reduces it.
Marginal Standing Facility (MSF): Banks borrow from RBI at a higher rate (6.75% in 2025) against securities, used in emergencies.
Credit Rationing: Direct controls like priority sector lending targets or restrictions on specific sectors.
Example: In 2023, RBI conducted OMO sales to absorb excess liquidity, stabilizing the rupee during global volatility.
Key Concepts for Prelims
Understanding related terms and impacts is vital for UPSC Prelims.
Monetary Policy Committee (MPC): Established under RBI Act, 1934 (amended 2016), MPC sets Repo Rate. It has 6 members (3 RBI, 3 external).
Liquidity Adjustment Facility (LAF): Framework for Repo and Reverse Repo operations to manage short-term liquidity.
Inflation Targeting: RBI targets 4% CPI inflation (±2%) as per the 2016 agreement with the government.
Key Points for Prelims
RBI, established in 1935, conducts monetary policy under RBI Act, 1934.
CRR and SLR are mandatory reserves; Repo and Reverse Repo are voluntary.
Current MPC stance (2025): Neutral, balancing inflation and growth.
Repo Rate hikes increase loan interest rates, affecting EMIs and investment.
Section 42 (CRR) and Section 24 (SLR) of RBI Act govern reserve requirements.
Summary of Monetary Policy Tools
CRR
4.5%
Control liquidity
Affects lendable funds
SLR
18%
Ensure bank solvency
Limits credit availability
Repo Rate
6.5%
Regulate borrowing costs
Affects inflation, growth
Reverse Repo Rate
3.35%
Absorb surplus liquidity
Controls money supply
Frequently Asked Questions (FAQs)
Q1: How does an increase in Repo Rate control inflation?
Ans: Higher Repo Rate increases borrowing costs for banks, which raises loan interest rates, reducing credit demand and money supply, thus curbing inflation.
Q2: What is the difference between CRR and SLR?
Ans: CRR is cash held with RBI, directly reducing liquidity, while SLR is invested in securities, ensuring bank solvency and government borrowing.
Q3: What is the role of the Monetary Policy Committee?
Ans: MPC sets the Repo Rate and monetary policy stance to achieve 4% CPI inflation (±2%) while supporting growth.
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