Levers of RBI Monetary Policy

RBI influences the economy through several monetary policy tools. Each tool has a distinct role in controlling liquidity, interest rates, and credit in the financial system:

• Repo Rate: The repo (repurchase) rate is the RBI’s main policy interest rate – the rate at which commercial banks borrow funds from the RBI against government securities as collateral​. Changes in the repo rate signal the stance of policy. Lowering the repo makes bank credit cheaper and more abundant, boosting lending and growth; raising it makes credit costlier, cooling demand. For example, when inflation rose persistently, the RBI hiked the repo rate to discourage borrowing and slow money growth; conversely, facing a growth slump (such as after the 2008 crisis or during COVID-19), the RBI slashed the repo rate to stimulate economic activity.
• Reverse Repo Rate: The reverse repo rate is the mirror image of the repo – it is the interest rate at which banks park their excess funds with the RBI, typically overnight. In essence, it’s the rate the RBI pays banks for these deposits​. The reverse repo is used to absorb surplus liquidity from the banking system. An increase in the reverse repo encourages banks to deposit funds with the RBI (earning interest risk-free) rather than lend out, thereby tightening liquidity. A cut in reverse repo has the opposite effect, pushing banks to lend more since parking funds yields less. The repo and reverse repo rates form the upper and lower bounds of the RBI’s liquidity adjustment facility (LAF) corridor, guiding short-term market interest rates.
• Cash Reserve Ratio (CRR): The CRR is a regulatory reserve requirement – the proportion of a bank’s deposits that must be kept as cash with the RBI at all times (on which banks earn no interest). By altering the CRR, the RBI can directly change the amount of funds banks have available to lend. A higher CRR means banks have to set aside more cash with RBI (reducing loanable funds), whereas a lower CRR frees up deposits for lending. For instance, in late 2008 the RBI cut the CRR sharply – from a peak of 9% in August 2008 down to 5% by January 2009 – to inject liquidity during the global financial crisis​. Conversely, during boom times with excess money growth, RBI has raised the CRR (e.g. hiking it to 9% in 2008 to suck out liquidity). The CRR remains a blunt but powerful tool to modulate banking system liquidity​.
• Statutory Liquidity Ratio (SLR): In addition to cash reserves, banks in India must invest a stipulated percentage of their net deposits in safe and liquid assets, primarily central and state government securities. This ratio is the SLR. It functions as a buffer and a liquidity tool: raising the SLR forces banks to hold more government bonds (constraining their ability to extend credit), while lowering it can free up funds for lending. Over the last 20 years, the SLR has generally been reduced in line with financial liberalization. It was statutorily floored at 25% of deposits until 2007; thereafter, RBI steadily brought it down. From 25% in 2008, SLR was cut to 24% and then 23% by 2012​. Further calibrated cuts in the late 2010s brought SLR to 18% of deposits by 2020​. These reductions were aimed at freeing bank resources for credit growth and aligning with global liquidity coverage standards. The RBI only rarely increases SLR; one instance was an emergency hike from 24% to 25% in late 2009 to constrain credit growth amid inflation concerns​, but since then the trend has been downward.
• Open Market Operations (OMO): OMOs refer to the RBI’s buying or selling of government securities in the open market to regulate liquidity and influence interest rates. When the RBI buys government bonds from banks, it injects rupee liquidity into the system (as payment to the sellers), thereby easing monetary conditions and typically lowering short-term interest rates. Selling bonds has the opposite effect – withdrawing liquidity and tightening conditions. Over the past two decades, RBI has actively used OMOs to manage liquidity swings, especially those driven by capital flows or changes in currency demand. For example, in periods of heavy capital inflows (mid-2000s and again in the late 2010s), the RBI conducted OMO sales (and issued special Market Stabilisation Scheme (MSS) bonds) to absorb the excess rupee liquidity that resulted from its intervention in the forex market. During downturns, it undertook large OMO purchases to inject cash – notably in late 2008, RBI bought government securities to complement CRR cuts and ensure ample liquidity for banks. In recent years, RBI also deployed unconventional OMOs: in 2019 it initiated “Operation Twist” (simultaneous buying of long-term bonds and selling of short-term bonds) to flatten the yield curve and reduce long-term borrowing costs. In 2020–21, as part of the pandemic response, RBI committed to a massive government bond purchase program (G-SAP) to keep yields low amid heavy government borrowing.
• Other Instruments: The RBI’s toolkit includes a few other significant instruments and facilities:
  • The Bank Rate, an older benchmark rate (now largely symbolic) which historically was the standard lending rate of RBI. In modern practice, the bank rate is typically aligned to the Marginal Standing Facility rate and used for calculating penalty rates on certain defaults.
  • The Marginal Standing Facility (MSF), introduced in 2011, is an emergency overnight window for banks to borrow from RBI against government securities above their LAF quota. The MSF rate is set slightly higher than the repo rate (by 25 basis points in normal times). Banks tap MSF when liquidity is very tight. By adjusting the MSF rate, RBI can widen or narrow the interest rate corridor. For instance, during the 2013 currency crisis, RBI temporarily raised the MSF rate steeply (to 10.25%) even as repo was lower, to aggressively tighten overnight rates and defend the rupee – a signal of how MSF can be used as a crisis tool.
  • The Standing Deposit Facility (SDF) is a relatively new addition (2022) that allows RBI to absorb surplus liquidity from banks without the need for collateral (unlike reverse repo which requires government securities). SDF effectively replaced the reverse repo as the floor of the policy corridor in April 2022, giving RBI more flexibility in liquidity absorption operations.
  • RBI also employs macroprudential measures as part of the broad monetary-policy toolkit. These include things like varying risk weights and provisioning requirements for bank loans to certain sectors, or imposing credit growth caps – all intended to curb excessive lending to risky areas without altering overall interest rates. For example, in the mid-2000s, RBI increased risk weights on housing and consumer loans to rein in a potential credit bubble. Such measures often work in tandem with interest rate policy to maintain financial stability.
  • Finally, while not a traditional “instrument,” RBI’s foreign exchange interventions influence monetary conditions. When RBI buys dollars (to prevent rupee appreciation during capital inflows), it releases rupees into the system (increasing liquidity); when it sells dollars (to support the rupee during outflows), it sucks out rupee liquidity. The RBI offsets these effects through tools like OMOs or MSS bonds to ensure that domestic liquidity and interest rate targets remain on track. In episodes like 2013, RBI even introduced special schemes (e.g. a facility for banks to swap foreign currency deposits) to attract dollars and bolster foreign reserves, thereby easing pressure on the external account and the currency. Such measures, while aimed at external stability, had direct monetary impacts and were coordinated with domestic policy tools.