Topic 02 of 6 · Chapter 05 · Indian Economy
Monetary Policy Tools — CRR, SLR, Repo Rate Explained
CRR, SLR, Repo Rate, Reverse Repo Rate, MSF, Bank Rate — all explained with simple examples of how they control inflation.
📋 In This Article
1. What is Monetary Policy?
Monetary policy is the process by which RBI controls the money supply and credit in the economy to achieve macroeconomic objectives — primarily price stability (controlling inflation) and economic growth.
⭐ RBI’s Inflation Target: Since 2016, RBI follows flexible inflation targeting. The target is CPI inflation at 4% (±2%) — i.e., between 2% and 6%. If inflation goes above 6% for 3 consecutive quarters, RBI must explain to the government.
2. Quantitative Tools (Most Important)
CRR
Cash Reserve Ratio
% of deposits that banks must keep as cash with RBI. Banks earn NO interest on CRR. Higher CRR = less money for lending = less inflation.
SLR
Statutory Liquidity Ratio
% of deposits that banks must maintain in liquid assets (gold, government securities). Banks earn interest on SLR. Higher SLR = less money for lending.
Repo Rate
Repurchase Rate
Rate at which RBI lends to commercial banks (short-term). Higher repo rate = costlier loans for banks = higher interest rates for customers = less borrowing = less inflation.
Reverse Repo Rate
Reverse Repurchase Rate
Rate at which RBI borrows from commercial banks. Higher reverse repo rate = banks prefer to park money with RBI = less money in economy = less inflation.
MSF
Marginal Standing Facility
Emergency borrowing facility for banks from RBI at a rate higher than repo rate. Banks can borrow up to 1% of their NDTL (Net Demand and Time Liabilities).
Bank Rate
Bank Rate
Rate at which RBI provides long-term loans to commercial banks. Currently aligned with MSF rate. Used for penal purposes.
3. How Monetary Policy Controls Inflation
💡 Simple Example — How Repo Rate Controls Inflation
Scenario: Inflation is high (say 8%). RBI wants to reduce it.
Step 1: RBI raises Repo Rate from 6% to 6.5%
Step 2: Banks now pay more to borrow from RBI
Step 3: Banks raise their lending rates (home loans, car loans become costlier)
Step 4: People borrow less → spend less → demand falls
Step 5: With less demand, prices stop rising → inflation falls
This is called contractionary monetary policy — tightening money supply to reduce inflation.
| Tool | To Control Inflation (Raise) | To Boost Growth (Lower) |
|---|---|---|
| CRR | Increase CRR → banks have less money to lend | Decrease CRR → banks have more money to lend |
| SLR | Increase SLR → banks have less money to lend | Decrease SLR → banks have more money to lend |
| Repo Rate | Increase Repo Rate → borrowing becomes costlier | Decrease Repo Rate → borrowing becomes cheaper |
| Reverse Repo Rate | Increase → banks park more with RBI → less money in economy | Decrease → banks lend more → more money in economy |
4. Key Points for Exam
🔑 Must-Remember Facts
- CRR = % of deposits kept as cash with RBI (no interest earned)
- SLR = % of deposits in liquid assets (gold, govt securities)
- Repo Rate = rate at which RBI lends to banks
- Reverse Repo Rate = rate at which RBI borrows from banks
- MSF = emergency borrowing at rate higher than repo rate
- Higher CRR/SLR/Repo Rate → less money in economy → lower inflation
- RBI’s inflation target: 4% (±2%) CPI inflation
- Flexible inflation targeting adopted: 2016
- MPC decides repo rate by majority vote
- Reverse Repo Rate is always lower than Repo Rate