What is Monetary Policy? Meaning, objectives, and impact in India
The monetary policy is RBI’s key tool to manage inflation and growth in India. Learn the meaning of monetary policy, and its impact on loans and deposits.
Monetary policy is one of the most important tools available to a central bank for managing an economy. In India, it is conducted by the Reserve Bank of India (RBI), and every two months, the RBI’s Monetary Policy Committee (MPC) announces its decision on interest rates, liquidity, and other measures. These announcements make headlines because they affect everything from loan EMIs and deposit rates to inflation and GDP growth.
But what exactly is monetary policy, how does it work, and why does it matter to households, businesses, and investors?
Meaning of Monetary Policy
Monetary policy refers to the process by which a country’s central bank controls the supply of money, interest rates, and credit availability in the economy. Its ultimate aim is to ensure price stability, support economic growth, and maintain financial stability.
In India, the RBI is tasked with conducting the monetary policy, guided by the Monetary Policy Framework Agreement with the Government of India. The RBI currently targets an inflation rate of 4%—with a tolerance band of 2% on either side—while also supporting growth.
Types of Monetary Policy
1. Expansionary Monetary Policy: An expansionary monetary policy is adopted when the economy is slowing down. RBI cuts the repo rate and injects liquidity to encourage borrowing, investment, and consumption. For example, the RBI cut the repo rate by 115 basis points during the pandemic to support growth.
One basis point is one-hundredth of a percentage point.
2. Contractionary Monetary Policy: A contractionary policy is used when inflation is rising rapidly. The RBI raises interest rates and withdraws liquidity to curb demand and control prices. Shortly after the pandemic in 2022-23, the RBI was on a rate-hike cycle to bring back inflation within its tolerance band of 2% to 6%.
Tools of Monetary Policy in India
The RBI uses several instruments to implement monetary policy:
- Repo Rate: The rate at which RBI lends money to banks.
- Reverse Repo Rate: The rate at which banks park excess funds with RBI.
- Cash Reserve Ratio (CRR): The portion of deposits banks must maintain with RBI in cash.
- Statutory Liquidity Ratio (SLR): The portion of deposits banks must invest in government securities.
- Liquidity Adjustment Facility (LAF): Framework for repo and reverse repo operations.
- Open Market Operations (OMO): RBI buying/selling government securities to adjust liquidity.
- Standing Deposit Facility (SDF): Tool to absorb excess liquidity without providing collateral.
Objectives of Monetary Policy
The RBI’s monetary policy has several key objectives:
- Price Stability: Keeping inflation under control while ensuring essential goods remain affordable.
- Economic Growth: Ensuring that credit availability supports businesses and job creation.
- Financial Stability: Safeguarding the banking system and preventing liquidity crises.
- Exchange Rate Stability: Managing volatility in the rupee through capital flows and currency management.
Monetary Policy Committee (MPC)
The MPC is a six-member committee that decides India’s monetary policy. It meets bi-monthly to review inflation, growth, and economic conditions before announcing repo rate decisions. Three MPC members are from the RBI, including the governor who chairs it. The rest are external experts nominated by the Government of India. Each member has one vote, and in case of a tie, the RBI Governor has the casting vote.
Impact of Monetary Policy on You
Borrowers & Depositors: A repo rate hike leads to higher EMIs for home, auto, and personal loans. A repo rate cut makes borrowing cheaper. Higher rates often mean better returns on fixed deposits.
Investors: The stock and bond markets react sharply to monetary policy changes. Rate cuts usually boost markets, while hikes can slow them down.
Economy: Over time, the right monetary policy ensures a balance between controlling inflation and supporting growth.
Example Of Monetary Policy In Action
In 2020, during the pandemic, the RBI cut the repo rate sharply to stimulate growth and ensure liquidity in the financial system. In contrast, in 2022–23, when inflation rose above 6%, the RBI hiked the repo rate multiple times to bring inflation closer to its 4% target. These actions show how monetary policy adapts to changing economic conditions.
