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.

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).

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.

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.

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.

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.

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

Tool Current Rate (2025) Purpose Impact
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.

Additional Resources