India[₹]

Institutional framework

The RBI Act, 1934 provides the legislative mandate to the Reserve Bank of India (RBI) to operate a modern monetary policy framework and it has adopted flexible inflation targeting (FIT) as the framework of monetary policy. The primary objective of monetary policy is to maintain price stability while keeping in mind the objective of growth. The Government of India, in consultation with RBI, has set the inflation target in terms of the Consumer Price Index (CPI), for five years (from August 2016 to March 2021).

To achieve the objectives of monetary policy, the RBI uses an interest rate framework with the overnight call money market rate, measured by the weighted average call money rate (WACR), as the operating target. A Monetary Policy Committee (MPC), with the Governor of the RBI as its chairperson, determines the policy rate, ie, the repo rate required to achieve the mandated inflation target. The RBI endeavours to anchor the operating target, ie, WACR, to the policy repo rate through the instruments available under monetary policy implementation framework.

A bi-annual Monetary Policy Report (MPR) is issued by the RBI, elucidating the macroeconomic framework, analysis of developments along with forecasts of inflation and output, liquidity conditions and financial market developments along with global environment and outlook.

Key features of the monetary policy implementation framework

The monetary policy framework aims at setting the policy repo rate at an appropriate level to achieve the monetary policy objectives based on an assessment of the current and evolving macroeconomic situation. Once the repo rate is announced, the operating framework envisages modulation of liquidity conditions on a day-to-day basis, aimed at anchoring the WACR to the policy repo rate. Within its implementation framework, the RBI undertakes Open Market Operations in both forms, ie, repurchase operations under Liquidity Adjustment Facility (LAF) as well as outright sale and purchase of eligible securities, offers standing facilities and requires banks to hold minimum reserves in their current accounts with it.

The current minimum reserve requirement has been set at 4 per cent of the net demand and time liabilities (NDTL) of banks and the reserves are held in the form of Cash Reserve Ratio (CRR) by banks in their current account with the RBI. These reserves are not remunerated. RBI allows limited averaging of reserves within the maintenance period, ie, a fortnight, to allow banks to absorb liquidity shocks at their discretion and to help in stabilising short-term interest rates in the money markets.

All the liquidity management operations of the RBI are collateralised by the eligible collateral notified by the RBI from time to time. Under the LAF, the Reserve Bank conducts daily fixed rate overnight repo and reverse-repo operation. The interest rate for the daily overnight fixed-rate repo operation is the policy rate set by the MPC. The interest rate on the daily overnight fixed-rate reverse-repo operation sets the lower-end of the policy corridor (currently 25 bps below the repo-rate). Reverse-repo is a standing facility for deposit of funds by the eligible entities with the RBI. In addition, the RBI has provided standing lending facility viz, Marginal Standing Facility (MSF), which eligible entities can access to meet their overnight reserve requirements arising out of unforeseen frictional factors. The interest rate on the MSF sets the upper-end of the corridor (currently 25 bps above the repo-rate). Thus, the MSF together with the fixed-rate reverse-repo rate constitute the corridor for overnight money market rates. To further strengthen the operating framework, a Standing Deposit Facility (SDF) has been notified but this is yet to be operationalised. The RBI also conducts 14-day variable-rate repo operations twice a week to supply reserves covering the whole reserve maintenance period. Apart from the daily fixed-rate operations and the twice-weekly 14-day variable rate repo auction, the RBI conducts variable-rate repo and reverse-repo auctions of varying tenors, as and when needed, to steer liquidity conditions consistent with the monetary policy objective. Outright Open Market Operations (OMOs) and long-term FX swap auctions are conducted for supplying/withdrawing liquidity for longer duration.

The operating framework is fine-tuned and revised as and when required to achieve the monetary policy objectives.