Monetary policy of Reserve Bank of India is aimed to influence the nations financial condition in terms of liquidity, interest rates, inflation, exchange rates, etc. It is definitely a powerful instrument in the hands of central banks of any nation. It encompasses a variety of mechanisms aimed at managing the money supply and interest rates, thereby directly impacting inflation, currency stability, and overall economic growth. In India, the Reserve Bank of India (RBI) serves as the central bank, playing a pivotal role in formulating and implementing monetary policies. In this article, you will learn about the key monetary policy instruments and theirs impacts on overall economic growth and development.
Role of Central banks in monetary policy
In any nation, Central Bank is the apex authority to regulate, supervise and control the flow of money in the system. By using monetary policy instruments like SLR, bank rates, cash reserve ratio and repo rates, omo, central bank controls the money supply and inflation in the given economic system. In India Reserve Bank of India, in US the Federal Reserve Bank, in UK Bank of England, etc. are assigned powers and responsibilities to ensure equilibrium in the economic system in terms of liquidity or money supply.
Key measures of money supply in India
Money supply means total amount of money in circulation in nation at a specific time. Simply put, total money available with public for spending. In India, Reserve Bank of India uses M1, M2, M3 and M4 measures of money supply.
What does M1 money supply measure mean?
M1 is called narrow money that includes currency with public including currency notes and coins. It also includes demand deposits with the bank. Here, you must not get confused with cash in banks and demand deposits between banks or Inter-bank demand deposits. Because, I’m talking about money supply not money stock. Cash with bank and Inter-bank demand deposits are part of money stock and not money with public for instant spending.
M2 money supply measure
M2 measure of money supply is comparatively less liquid than M1 money supply. You know that M1 is the most liquid form of money. It extends beyond M1 and includes post office savings bank deposits. Because, post office savings bank deposits can be quickly accessible for liquidation.
M3 measure of money supply
It is a third measure of money supply and also called broad money because it includes M1 plus time deposits with commercial and cooperative banks. Time deposits are fixed deposits of money for a specific predetermined time period. In simple term, M1 indicates cash in hand, M2 includes small savings, and M3 includes larger less accessible time deposits.
M4 measures of money supply
Finally, M4 is more broader money supply than m3 and includes M3 plus all post office deposits that includes time and demand deposits. Particularly, in India, M3 is used to frame monetary policy by the Reserve Bank of India.
Adequate money supply means neither over supply nor too low is indispensable for smooth functioning of economic system in any nation. In case, if there is too much money supply, it may cause prices of commodities skyrocket resulting inflation and hyperinflation. In such situation, people may face difficulties in maintaining living standards with declined purchasing power.
On the other side, if there is shortage of supply of money, it may cause shortfall of investment for business activities. And, as a result, it may precipitate high unemployment, rise in poverty and decline in living standards. So policy instruments, especially cash reserve ratio and repo rates have strong bearing on the economic growth and living standards of citizens.
Monetary policy in India by RBI
The role of monetary policy in controlling inflation is well known. Obviously, it is a primary concern for every governments worldwide. High inflation can erode purchasing power and savings, while deflation can stifle economic activity. By adjusting interest rates and regulating the money supply, the RBI aims to maintain price stability.
Moreover, the stabilization of currency is another vital objective of monetary policy. A stable currency contributes to investor confidence and enhances economic transactions. Central banks utilize various tools, such as open market operations, the bank rate, and cash reserve ratios, to influence currency value and overall liquidity in the economy.
Understanding Key Monetary Policy Instruments: qualitative and quantitative
Central Bank of India have powers and responsibilities to interfere in the system of money supply by the means of monetary policy instruments. It employs several key monetary policy instruments to manage the nation’s economic stability and control inflation. Here, I’m going to explain the quantitative instruments of money supply.
- Repo rate and reverse repo rates
- Bank rates
- Open market operations
- Cash reserve ratios (CRR)
- SLR (statuatory liquidity ratio)
Repo rate and reverse repo rates
Repo Rate, which is the rate at which the RBI lends money to commercial banks. A reduction in the Repo Rate makes borrowing cheaper for banks. Conversely, an increase in the Repo Rate restricts money supply and can help contain inflation.
In contrast, the Reverse Repo Rate, which is the rate at which the RBI borrows money from banks, serves to absorb excess liquidity from the financial system, aiming to strike a balance between too much and too little money circulation. At the present, in December 2025, 5.25 percent is repo rate and reverse repo rate is 3.35 percent.
In simple terms, repo rate is a versatile policy instrument that control and manage liquidity, inflation and credit flow in the financial system.
The bank rate
The Bank Rate, which is the rate at which the RBI lends funds to commercial banks, supports long-term funding for development projects. It is a long term policy decisions of reserve Bank of India regarding long term developmental program.
Generally, bank rate doesn’t change. Reserve Bank of India adjusts repo rate to control inflation, liquidity and credit supply. Commercial Banks by selling government securities as buyback agreement borrow money from Reserve Bank of India.
The Cash Reserve Ratio (CRR)
The Cash Ceserve Ratio is one of the most fundamental instruments used to mandate commercial banks to hold a specific percentage of their total deposits in reserve with the RBI. Important to note that RBI doesn’t give any dividend and interest on such amount. By doing so, it controls how much money banks can lend out. In short, CRR used by RBI to control liquidity, inflation and lending activities.Today, the CRR rate in India is 3 percent by December 2025.
The Statutory Liquidity Ratio (SLR
The Statutory Liquidity Ratio (SLR) is another vital instrument. It requires banks to maintain a certain percentage of their net demand and time liabilities in liquid assets. Liquid assets may be cash, gold, government securities. SLR ensures that banks have adequate liquidity to meet demands. It acts like safty wall against any sudden credit challenge. Undoubtedly, it is useful in ensuring liquidity and financial stability in banking system. In India, SLR is around 18 percent.
The Open Market Operations (OMO)
Lastly, Open Market Operations (OMO) is a key tool of liquidity control in the hands of RBI. It involve the buying and selling of government securities to control the money supply,liquidity, and credit flow. In December 2025, RBI has decided conduct open market operations of 1 lakh crores to inject liquidity in financial system.
Collectively, these instruments are essential in shaping RBI’s monetary policy framework, influencing banks’ liquidity, credit availability, and overall economic growth. 4 types of market competitions
https://en.wikipedia.org/wiki/Monetary_policy_of_India
https://m.economictimes.com/news/economy/policy/rbi-mpc-meeting-at-a-glance-december-5-quick-summary-sanjay-malhotra-key-announcements/articleshow/125780082.cms