Rameshwar's IAS

Tools of Monetary Policy in India

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The MPC or, the Monetary Policy Committee and the Central Bank are authorities that control inflation through multiple monetary policies in order to maintain the economic balance. Given below are the key tools used by the MPC to do so:

1. Repo Rate - The rate at which the RBI provides overnight liquidity to banks against the G-SECs and other approved securities under the Liquidity Adjustment Facility (“LAF”). The Repo Rate is a tool used to limit and regulate the inflation in the economy. The RBI, in times of high inflation, hikes the Repo Rate in order to absorb the liquidity from the market and vice versa.

2. Reverse Repo Rate - It is a concept inverse of the Repo Rate. It indicates a rate at which the RBI provides a return on the money deposited by the banks with the RBI. In addition to Repo Rate, Reverse Repo Rate also assists in controlling the liquidity available in the market/economy.

3. Liquidity Adjustment Facility (“LAF”) - The LAF is a policy mechanism of RBI which allows the banks and RBI to enter into contractual arrangements with respect to lending and borrowing of monies with a reciprocal future commitment of buying (Repos) or selling (Reverse Repos). It is a tool that helps in maintaining liquidity demands and ensuring fundamental stability in the financial market.

4. Marginal Standing Facility (“MSF”) - MSF is a provision made by the RBI through which scheduled commercial banks can obtain liquidity overnight if inter-bank liquidity completely dries up.

5. Bank Rate - Published under Section 49 of the RBI Act, 1934, it is the rate at which the banks avail the facility of rediscounting of bills of exchange and/or other negotiable instruments. This rate is directly proportional to the rate of MSF.

6. Cash Reserve Ratio (“CRR”) - It is the rate at which the banks have to maintain cash balance with RBI. It needs to be maintained on an average daily basis and calculated on the sum of total time and demand liabilities of the respective banks. A raise in CRR necessarily implies lesser amount of liquid assets available with the bank which such bank can use to grant loans and vice versa. Hence, such a rate aids the RBI in maintaining the cash availability with the banks and regulates credit creation in the economy.

7. Statutory Liquidity Ratio (“SLR”) - This rate depicts the amount which the banks have to maintain in form of government securities, bullion and liquid cash as a share of the sum of net time and demand liabilities of banks. The SLR regulates credit growth and inflation in the Indian economy. An increase in SLR results into a decrease in the lending power of the banks and vice versa.

8. Open Market Operations (“OMO”) - OMO refers to transacting and dealing in G-SECs in the open market by the RBI. In open market operation, in order to target inflation, short-term interest rate securities in debt markets are earmarked and dealt.

9. Market Stabilisation Scheme (“MSS”) - MSS entails an intervention by the RBI in order to suck out the liquidity from the market by offering G-SECs. The scheme was used to withdraw excess liquidity created during the demonetisation in 2016.

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