The Reserve Bank of India (RBI) is entrusted with the responsibility of keeping inflation under control as it pursues the goal of maintaining a healthy economic growth. Maintaining inflation is an important prerequisite to sustainable growth. The target inflation for RBI is 4 percent per annum and the upper tolerance limit is 6 percent while the lower tolerance limit is 2 percent.
The monetary policy is formulated by the six-member Monetary Policy Committee (MPC) which has three members from the RBI, and the three experts nominated by the Government of India. The Central bank’s Monetary Policy Department (MPD) offers its assistance to the RBI in formulating the policy. Under the monetary policy, RBI has several tools at its disposal that are used to contain inflation. These include the following:
Repo Rate: The rate of interest at which the RBI lends overnight loans to banks against the government securities.
Reverse Repo Rate: This is the rate of interest at which the RBI sucks liquidity from commercial banks on a short term (overnight basis) against the guarantee of government securities.
Statutory Liquidity Ratio (SLR): This is part of total NDTL (Net Demand and Term Liabilities) with a bank that it needs to maintain in liquid assets such as gold, cash and government securities. Since the banks are not permitted to lend these assets to borrowers, any change in SLR changes the availability of money that the bank can use for lending.
Marginal Standing Facility: It is a facility wherein a bank can take additional short-term loans from the RBI by dipping into the statutory liquidity ratio. But this is available up to a limit at a high rate of interest.
Bank Rate: This is the rate at which the RBI can buy or rediscount bills of exchange. It is linked to the SLR. So, whenever the bank rate changes, the SLR also changes as well as the repo rate.
Cash Reserve Ratio: This is the portion of deposits that the commercial bank is supposed to maintain with the RBI as a percentage of Net Demand and Time Liabilities (NDTL).
Open Market Operations (OMO): The open market operations entail buying and selling of government securities for infusing and absorbing liquidity, as the case may be.
The banking regulator tends to raise these rates (e.g. repo rate, cash reserve ratio and bank rate) to rein in the inflation and to bring the growth on track. However, it does not use all these instruments available in its arsenal in one go. At times, it uses some of them, and on other occasions — it uses them in a staggered way to roll out non-disruptive change.