CGPSCNotes
Economy Money, Banking and Inflation

Monetary Policy and the MPC

RBI monetary policy for CGPSC: inflation targeting, MPC composition and voting, repo, SDF, MSF, CRR, SLR, OMO, LAF corridor and 2026 policy rates.

14 min read Updated Oct 2026 #monetary policy#mpc#repo rate

Prerequisites

The Hook: Why Did the Home Loan EMI Change?

Connect

A schoolteacher in Bilaspur took a home loan in 2024 linked to an “external benchmark”. During 2025 her bank cut her interest rate several times without her asking. Her cousin, who had a fixed deposit, noticed that new FD rates went down over the same period.

Both changes came from a small committee in Mumbai that votes on a single number, the repo rate. Between February and December 2025 it cut that number from 6.50% to 5.25%. Who sits on that committee, how does it vote, and what else can the RBI change besides the repo rate?

Why it matters: “Which tool injects liquidity?”, “Who chairs the MPC?” and “CRR vs SLR” are among the most repeated economy MCQs. Mains asks you to evaluate inflation targeting and the limits of monetary policy against food and fuel price shocks.

What Monetary Policy (मौद्रिक नीति) Is

Monetary policy is the central bank’s use of interest rates and the quantity of money and credit to achieve macroeconomic goals. In India, the RBI Act (as amended in 2016) states that the primary objective is to maintain price stability while keeping in mind the objective of growth.

StanceMeaning
Accommodative (expansionary)Ready to cut rates or add liquidity to support growth
NeutralFree to move either way depending on data
Tight / withdrawal of accommodationReady to raise rates or absorb liquidity to fight inflation

The MPC’s stance was neutral at the August 2026 review.

Flexible Inflation Targeting (लचीला मुद्रास्फीति लक्ष्यीकरण)

timeline
    title How India adopted inflation targeting
    2014 : Urjit Patel Committee recommends CPI as the nominal anchor and a 4% ± 2% target
    2015 : Monetary Policy Framework Agreement between the Government and the RBI (February)
    2016 : Finance Act amends the RBI Act (Chapter IIIF); first target notified for 2016–21; first MPC meeting in October
    2021 : Same target retained for April 2021 – March 2026
    2026 : Same target retained again for April 2026 – March 2031 (notification of 25 March 2026)
  • Target-setter: the Central Government, in consultation with the RBI, fixes the target once every five years (Section 45ZA).
  • Current target (1 April 2026 – 31 March 2031): 4% CPI (combined) inflation, with an upper tolerance of 6% and a lower tolerance of 2%.
  • Accountability: If average inflation stays above 6% or below 2% for three consecutive quarters, the RBI has failed the target. It must then send a report to the Central Government explaining the reasons, the remedial action proposed and the time needed to bring inflation back. This happened for the first time for January–September 2022.
  • Why “flexible”: the target is a band, and growth is a stated secondary concern. The MPC can tolerate a temporary breach caused by a supply shock instead of crushing growth.

The Monetary Policy Committee (मौद्रिक नीति समिति)

FeatureDetail
Legal basisSection 45ZB, RBI Act, 1934 (inserted 2016)
MembersSix
From the RBI (3)Governor (ex officio chairperson); Deputy Governor in charge of monetary policy; one RBI officer nominated by the Central Board
External (3)Appointed by the Central Government on the recommendation of a search-cum-selection committee headed by the Cabinet Secretary; term of four years, not eligible for reappointment
QuorumFour members, including the Governor (or, in his absence, the Deputy Governor member)
VotingOne vote each; in a tie the Governor has a second (casting) vote
MeetingsAt least four a year by law; in practice six (bi-monthly)
TransparencyResolution published after each meeting; minutes on the 14th day, showing each member’s vote and statement
DecidesThe policy repo rate (and the stance). CRR, SLR and liquidity operations remain with the RBI

As of 2026: the MPC is chaired by Governor Sanjay Malhotra. The three external members appointed in October 2024 are Ram Singh, Saugata Bhattacharya and Nagesh Kumar.

Instruments of Monetary Policy

graph TD
    A["Instruments of monetary policy"] --> B["Quantitative (general):
affect total money and credit"]
    A --> C["Qualitative (selective):
affect the direction of credit"]
    B --> B1["Rates: Repo, SDF,
MSF, Bank Rate"]
    B --> B2["Reserve ratios:
CRR, SLR"]
    B --> B3["Market operations:
OMO, MSS, VRR/VRRR, forex swaps"]
    C --> C1["Margin requirements,
credit rationing,
moral suasion, direct action"]

Policy rates and the LAF corridor

The Liquidity Adjustment Facility (LAF) is how the RBI adds or absorbs money day to day. Its rates form a corridor:

RateWhat it isLevel (as of August 2026)
MSF rate (ceiling)Marginal Standing Facility, introduced in 2011: banks borrow overnight from the RBI in an emergency, even by dipping into their SLR securities. Repo + 0.255.50%
Policy repo rate (centre)Rate at which the RBI lends to banks against Government securities. The main policy signal set by the MPC5.25%
SDF rate (floor)Standing Deposit Facility, introduced in April 2022: the RBI absorbs surplus funds from banks without giving collateral. Repo − 0.255.00%
Fixed-rate reverse repoThe old floor; kept at the RBI’s discretion after the SDF replaced it3.35%
Bank RateSection 49 of the RBI Act; now aligned with the MSF rate and used mainly for penal rates5.50%

Corridor width: 50 basis points (SDF 5.00% to MSF 5.50%), with the repo rate in the middle.

The 2025–26 rate cycle

ReviewRepo rateAction
Before February 20256.50%Unchanged since February 2023
February 20256.25%Cut 25 bps
April 20256.00%Cut 25 bps
June 20255.50%Cut 50 bps; CRR cut announced
August, October 20255.50%Hold
5 December 20255.25%Cut 25 bps (total 125 bps in 2025)
February, April, June, August 20265.25%Hold, neutral stance
Check before the exam
The figures above are as of the August 2026 review (3–5 August 2026). The MPC meets again in October 2026 and every two months after that. Write “as of” with the month in any answer that quotes a rate.

Reserve ratios

Cash Reserve Ratio (CRR)Statutory Liquidity Ratio (SLR)
Kept asCash balance with the RBILiquid assets with the bank itself: cash, gold, unencumbered approved (mainly Government) securities
LawSection 42, RBI Act, 1934Section 24, Banking Regulation Act, 1949
Interest earnedNoneYes (on securities)
LimitsNo statutory floor or ceiling since 2006Ceiling 40%
Level (2026)3.00% of NDTL18.00% of NDTL
Main purposeControls liquidity and the money multiplierEnsures solvency and creates a captive market for Government bonds

NDTL = Net Demand and Time Liabilities (mainly deposits). The CRR was cut from 4% to 3% in four steps of 25 bps between September and November 2025, releasing liquidity to banks.

Market operations

  • Open Market Operations (OMO, खुले बाजार की क्रियाएँ): the RBI buys Government securities to inject money and sells them to absorb money.
  • Market Stabilisation Scheme (MSS, 2004): special Government securities issued to sterilise (absorb) excess liquidity, typically from large foreign capital inflows.
  • Variable Rate Repo / Reverse Repo (VRR / VRRR): auctions for fine-tuning liquidity.
  • Forex swaps: the RBI buys or sells dollars for rupees with a promise to reverse the deal later. This adds or drains rupee liquidity.

Qualitative (selective) tools

  • Margin requirements: the gap between a loan and the value of the security pledged. A higher margin means less credit against, for example, commodities being hoarded.
  • Credit rationing / ceilings for particular sectors.
  • Moral suasion (नैतिक दबाव): persuasion and advice to banks.
  • Direct action against banks that ignore directions.
  • Regulation of consumer credit and publicity.

Which way does each tool move liquidity?

To inject liquidity (expansionary)To absorb liquidity (contractionary)
Cut repo, SDF, MSFRaise repo, SDF, MSF
Cut CRR or SLRRaise CRR or SLR
Buy G-secs (OMO purchase)Sell G-secs (OMO sale), MSS bonds
Lower margin requirementsRaise margin requirements

Transmission (मौद्रिक संचरण)

A repo cut helps only if banks pass it on to borrowers. India moved through several lending-rate systems to speed this up:

PLR → BPLR (2003) → Base Rate (2010) → MCLR (April 2016) → External Benchmark Lending Rate (from 1 October 2019)

Since 1 October 2019, new floating-rate loans to retail borrowers and MSMEs must be linked to an external benchmark such as the repo rate or a Treasury bill yield. So a repo change now reaches home and MSME loan rates faster.

Limits of monetary policy in India

  1. Supply shocks: a poor monsoon or a jump in fuel prices raises inflation, and interest rates cannot grow more tomatoes or lower crude prices.
  2. Fiscal dominance: large Government borrowing can keep bond yields high whatever the policy rate.
  3. Informal credit: a share of rural borrowers use moneylenders and are untouched by the repo rate.
  4. Lags: policy changes take several quarters to affect inflation.
  5. Global spillovers: US interest rates and capital flows constrain the RBI’s choices.
Chhattisgarh angle
Food has a larger weight in the budgets of rural and tribal households in Chhattisgarh, so food inflation hurts them most. But food prices respond mainly to supply-side measures: procurement and the PDS, storage, and market reforms. Monetary policy anchors expectations, but the state’s own food security system does much of the work of protecting the poor. See Chhattisgarh Economy and Schemes.

Memory Tricks

The corridor: 'Floor SDF, Middle Repo, Ceiling MSF'
Think of a three-storey house: the SDF is the floor (−25), Repo the middle storey, the MSF the roof (+25). The Bank Rate sits on the roof with the MSF.
CRR = Cash with RBI, SLR = Securities with the bank
CRR → Cash → Central bank (RBI Act, Sec 42). SLR → Securities → Self (bank keeps them; BR Act, Sec 24).
MPC in numbers: 6-3-3-4-4
6 members, 3 RBI + 3 external, quorum 4, external term 4 years. Tie → Governor’s casting vote.

Don’t Confuse

ThisvsThat
Repo: RBI lends, takes collateralvsSDF: RBI borrows, gives no collateral
MSF: emergency overnight borrowing, can use SLR securities, repo + 25 bpsvsBank Rate: Section 49, long-term / penal rate, now equal to MSF
Target fixed by the Government (in consultation with the RBI)vsRepo rate fixed by the MPC
CRR: cash with the RBI, no interestvsSLR: liquid assets with the bank, earns interest
OMO purchase: injects moneyvsOMO sale / MSS: absorbs money

Common Mistakes

MCQ traps
  • “The MPC decides the CRR.” No. The MPC decides only the policy repo rate (and stance). CRR and SLR are set by the RBI.
  • “The RBI fixes the inflation target.” No. The Central Government does, in consultation with the RBI, every five years.
  • “The Finance Ministry nominates a member to the MPC.” No. The three external members are appointed by the Government, but no Government official sits on the MPC.
  • “The reverse repo rate is the floor of the corridor.” Not since April 2022. The SDF rate is the floor.
  • “External MPC members can be reappointed.” No. They serve one four-year term.
  • “Selling G-secs adds money to the system.” Selling absorbs money. Buying injects it.

Practice

All questions below are original practice questions written in CGPSC style. They are not previous-year questions.

Level 1: Foundation

  1. The Monetary Policy Committee was given statutory backing by amending the RBI Act through the Finance Act of ______.
  2. The floor of the RBI’s liquidity corridor is the ______ rate.
  3. The SLR is prescribed under Section ______ of the Banking Regulation Act, 1949.
Answers
  1. 2016.
  2. Standing Deposit Facility (SDF) rate.
  3. 24.

Level 2: Prelims MCQs

Q1. Consider the following statements about the Monetary Policy Committee (MPC) of the RBI:

  1. It has six members, three of whom are appointed by the Central Government.
  2. The quorum for a meeting is three members.
  3. In case of a tie, the Governor has a second or casting vote.

Which of the statements given above is/are correct?

  • (a) 1 only
  • (b) 1 and 3 only
  • (c) 2 and 3 only
  • (d) 1, 2 and 3
Answer and explanation
(b) 1 and 3 only. The quorum is four, not three, so statement 2 is wrong. The six members are three from the RBI and three external members appointed by the Government. The Governor chairs the MPC and has a casting vote in a tie.

Q2. Which one of the following actions by the RBI would reduce liquidity in the banking system?

  • (a) Purchase of Government securities through open market operations
  • (b) Reduction in the cash reserve ratio
  • (c) Issue of securities under the Market Stabilisation Scheme
  • (d) Reduction in the policy repo rate
Answer and explanation
(c) Issue of securities under the Market Stabilisation Scheme. MSS securities are sold to absorb (sterilise) excess money. The other three options are all expansionary: OMO purchases pay money into the system, a lower CRR frees bank funds, and a lower repo rate makes borrowing cheaper.

Q3. Match List I (Instrument) with List II (Feature):

List IList II
A. Standing Deposit Facility1. Section 42, RBI Act
B. Marginal Standing Facility2. Absorbs liquidity without collateral
C. Cash Reserve Ratio3. Section 24, Banking Regulation Act
D. Statutory Liquidity Ratio4. Overnight borrowing even against SLR securities
  • (a) A-2, B-4, C-3, D-1
  • (b) A-4, B-2, C-1, D-3
  • (c) A-2, B-4, C-1, D-3
  • (d) A-3, B-4, C-1, D-2
Answer and explanation
(c) A-2, B-4, C-1, D-3. The SDF (2022) absorbs funds without collateral. The MSF (2011) lets banks borrow overnight, even by dipping into SLR holdings. CRR comes from Section 42 of the RBI Act and SLR from Section 24 of the Banking Regulation Act.

Q4. Under India’s flexible inflation targeting framework, the inflation target is fixed by:

  • (a) the Monetary Policy Committee
  • (b) the Central Board of the RBI
  • (c) the Central Government in consultation with the RBI
  • (d) Parliament by a resolution
Answer and explanation
(c) the Central Government in consultation with the RBI, under Section 45ZA of the RBI Act, once every five years. The current target (4% ± 2%) covers 1 April 2026 to 31 March 2031. The MPC sets the policy rate to achieve it.

Q5. Consider the following statements:

  1. The Marginal Cost of Funds based Lending Rate (MCLR) replaced the Base Rate system in April 2016.
  2. Since October 2019, new floating-rate retail loans must be linked to an external benchmark.
  3. The external benchmark can only be the policy repo rate.

Which of the statements given above is/are correct?

  • (a) 1 and 2 only
  • (b) 2 only
  • (c) 1 and 3 only
  • (d) 1, 2 and 3
Answer and explanation
(a) 1 and 2 only. The external benchmark may be the repo rate or certain Treasury bill yields and other benchmarks published by the benchmark administrator, not only the repo rate. So statement 3 is wrong.

Level 3: Mains Answer Writing

Q1. (150–200 words) Evaluate the flexible inflation targeting framework adopted by India in 2016.

Model answer outline
  • Intro: Following the Urjit Patel Committee (2014), the RBI Act was amended in 2016 to make price stability the primary objective, with a 4% ± 2% CPI target set by the Government and a six-member MPC.
  • Achievements:
    1. Inflation expectations became better anchored than in the high-inflation years of 2009–13.
    2. Transparency: published resolutions, minutes and individual votes.
    3. Accountability: the 2022 breach produced a formal report to the Government.
    4. The target has been retained twice (2021, 2026), which signals credibility.
  • Concerns:
    1. CPI has a large food component driven by supply shocks that rates cannot control (the 2024-base CPI has reduced the food weight to about 37%).
    2. The growth cost of high real interest rates.
    3. Fiscal dominance and weak transmission in the informal sector.
  • Chhattisgarh angle: Rural households in the state spend more on food. Stable prices protect them, but the PDS and procurement matter more against food shocks.
  • Conclusion: The framework has worked broadly, but it needs supply-side reforms and fiscal discipline alongside it.

Q2. (60 words) Distinguish between CRR and SLR.

Model answer outline
  • CRR: share of NDTL kept as cash with the RBI (Sec 42, RBI Act); earns no interest; 3% as of 2026.
  • SLR: share of NDTL kept by the bank in liquid assets (cash, gold, approved securities) (Sec 24, BR Act); earns interest; 18% as of 2026.
  • Conclusion: CRR mainly controls liquidity. SLR also ensures bank solvency and finances Government borrowing.

Quick Revision Table

FactDetail
Primary objectivePrice stability, keeping growth in mind
Urjit Patel Committee2014; CPI as anchor, 4% ± 2%
Framework agreementFebruary 2015
Statutory frameworkFinance Act 2016; Sec 45ZA (target), 45ZB (MPC)
Target (2026–31)4% CPI, band 2–6%; notified 25 March 2026
FailureOutside 2–6% for 3 consecutive quarters → report to Government
MPC6 members; quorum 4; Governor’s casting vote; external term 4 years, no reappointment
Repo / SDF / MSF / Bank Rate5.25 / 5.00 / 5.50 / 5.50% (as of August 2026)
CRR / SLR3% / 18% of NDTL (as of 2026)
SDF introducedApril 2022
MSF introduced2011
External benchmark lendingFrom 1 October 2019 (retail, MSME floating loans)

Key Takeaways

Key Takeaways
  1. The Government sets the inflation target (4% ± 2%, now to March 2031). The MPC sets the repo rate to meet it.
  2. The MPC has 6 members, quorum 4, and the Governor has a casting vote.
  3. The LAF corridor runs from the SDF (floor) through the repo to the MSF (ceiling), 25 bps each side.
  4. CRR is cash with the RBI under the RBI Act. SLR is liquid assets with the bank under the BR Act.
  5. Monetary policy works poorly against supply shocks. That is the core of any Mains evaluation.

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