Monetary Policy is a concept and mechanism by which the central bank, the Reserve Bank of India (RBI), controls the supply of money, interest rates, and credit availability to achieve macroeconomic objectives like price stability and growth. The statutory framework for the RBI and its functions, including conducting monetary policy, is provided by the Reserve Bank of India Act, 1934. The Act was passed by the British government based on the recommendations of the Hilton Young Commission (Royal Commission on Indian Currency & Finance) in 1926 to address scattered currency issues and widespread financial instability, and the RBI was constituted on April 1, 1935.
The mechanism is currently governed by the Flexible Inflation Targeting (FIT) framework, formally introduced in 2016 through amendments to the RBI Act, 1934. This framework replaced earlier approaches that lacked a clear nominal anchor. The key provision is the establishment of the Monetary Policy Committee (MPC), a six-member body mandated under Section 45-ZA of the RBI Act, 1934, to fix the benchmark policy rate (Repo Rate). The MPC's primary goal is to maintain the Consumer Price Index (CPI) inflation target, which the government sets every five years in consultation with the RBI.
The target was initially set at 4% with a tolerance band of +/- 2% (i.e., 2% to 6%) for the period 2016-2021. This framework has been extended twice, most recently for the period from April 1, 2026, to March 31, 2031, retaining the 4% target with the 2% to 6% band. The MPC is accountable to the government if inflation remains outside this band for three consecutive quarters. Monetary policy connects directly to the regulation of the banking system, which is also supervised by the RBI under the Banking Regulation Act, 1949, and uses tools like the Repo Rate, Reverse Repo Rate, and Cash Reserve Ratio (CRR) to manage liquidity and credit.