The RBI (Reserve Bank of India) holds significant influence over various aspects of the country’s economy and financial system. Its primary responsibility is ensuring both macroeconomic and financial stability. Macroeconomic stability focuses on maintaining steady prices and sustainable growth, while financial stability involves safeguarding the resilience of the financial system, including banks and non-banking financial institutions, to prevent crises. A key objective of the RBI’s policies is to foster stable growth and low, predictable inflation, a goal that has always been central to its operations.

To achieve macroeconomic stability, the RBI uses a range of tools, with monetary policy being one of the most important. The central bank aims to anchor inflation at a target of 4% annually, which serves as the core of its monetary policy. In addition to managing inflation, the RBI also ensures that adequate credit flows to productive sectors of the economy.

 

Tools to Control Inflation

Inflation is the sustained rise in the prices of goods and services over time, leading to a reduction in the purchasing power of money. It is commonly measured using the Consumer Price Index (CPI), which tracks the percentage change in the average price level of a basket of goods and services.

If inflation is not kept under control, it can lead to significant economic challenges, such as diminished purchasing power, which erodes consumers’ ability to afford goods and services. High inflation can also discourage savings, as the value of money erodes over time, and create uncertainty in the economy, which may deter investment and stifle growth.

Several factors can drive inflation, including rising production costs, increased demand for goods and services, or shifts in government policies and regulations.

1. Monetary Policy Framework: The Reserve Bank of India (RBI) is responsible for formulating and executing the country’s monetary policy, with a primary focus on ensuring price stability. The central bank utilizes several tools to manage inflation, including the repo rate, which is the interest rate at which it lends to commercial banks. By raising the repo rate, the RBI increases the cost of borrowing for banks, thereby limiting their lending capacity. This reduces the overall money supply in the economy and helps control inflation.
   
2. Cash Reserve Ratio (CRR): The RBI also sets the Cash Reserve Ratio (CRR), which is the percentage of a bank’s deposits that must be held in reserve with the central bank. When the RBI raises the CRR, banks have fewer funds available for lending. This limits the money supply, which helps in curbing inflationary pressures.
3. Open Market Operations (OMO): Open Market Operations involve the buying and selling of government securities in the open market by the RBI. Selling government securities helps absorb excess liquidity from the financial system, thereby reducing the money supply and alleviating inflation. On the other hand, purchasing government securities injects liquidity into the market, stimulating economic growth and addressing deflationary concerns.
4. Quantitative Tools: In addition to these measures, the RBI uses quantitative tools like the Statutory Liquidity Ratio (SLR) and the Liquidity Adjustment Facility (LAF) to manage inflation. The SLR mandates that banks maintain a specific percentage of their deposits in government securities. An increase in the SLR restricts banks’ ability to lend, curbing inflation by reducing money supply. The LAF allows banks to borrow or lend to the RBI on a short-term basis, helping manage liquidity and inflation.
5. Inflation Targeting: Since 2016, the RBI has adopted an inflation targeting framework, aiming to achieve a specific inflation target set by the government in consultation with the central bank. This approach enhances transparency and helps manage inflation expectations, which is essential for controlling inflation.
6. Supervision and Regulation: The RBI plays a crucial role in overseeing and regulating the banking sector to ensure sound lending practices. It ensures that banks maintain adequate capital reserves and liquidity buffers, preventing excessive credit growth that could contribute to inflationary pressures.
7. Exchange Rate Policy: The RBI also manages the exchange rate of the Indian rupee against foreign currencies. A falling rupee can lead to imported inflation, as the cost of imported goods rises. To prevent this, the RBI intervenes in the foreign exchange market, stabilizing the rupee and mitigating inflation driven by external factors.

 

Challenges in Controlling Inflation in India

1. Dependence on Imported Oil: India imports over 80% of its oil requirements, making the country vulnerable to global oil price fluctuations, which are influenced by geopolitical and economic events worldwide.
2. Supply-Side Constraints: The need for long-overdue supply-side reforms remains a critical issue. Without improvements in infrastructure, production, and distribution, inflationary pressures can persist.
3. Inefficiencies in Monetary Policy Transmission: There are challenges in effectively transmitting monetary policy measures, which can limit the effectiveness of RBI’s actions in controlling inflation.
4. Limited Control Over Currency Depreciation: The government and RBI have limited influence over the depreciation of the rupee, which can contribute to higher import costs and inflation.
5. Fiscal Pressures: Political pressures to reduce government expenditure and maintain a manageable fiscal deficit often hinder the implementation of necessary economic adjustments, impacting inflation control.
6. Populist Policies: Government measures aimed at appeasing voters, such as subsidies or price controls, can sometimes exacerbate inflation by distorting market dynamics.

 

RBI Monetary Policy Committee Meeting February 2025 Key Highlights & Outcomes:

Here are the key highlights from the bi-monthly monetary policy announced by RBI Governor Sanjay Malhotra on February 7, 2025:

• A 25-basis point rate cut to 6.25% aimed at stimulating growth.
• GDP growth for 2025-26 is projected at 6.7%, driven by consumption and investment.
• Inflation is expected to be around 4.2% for 2025-26, barring any major shocks.
• Global risks such as geopolitical tensions, trade policies, and financial volatility continue to be major concerns.
• A neutral stance has been maintained to provide flexibility in responding to changing economic conditions.

Additional adjustments include:

• Standing Deposit Facility (SDF) rate: 6.00%
• Marginal Standing Facility (MSF) rate & Bank Rate: 6.50%

India’s Economic Outlook for 2024-25:

• GDP growth is estimated at 6.4% YoY, primarily supported by a recovery in private consumption. Quarterly estimates: Q1 – 6.7%, Q2 – 7.0%, Q3 & Q4 – 6.5% each.
• Headline inflation decreased from 6.2% in October 2024 to lower levels in November-December 2024, mainly due to falling food inflation.

Inflation Projections:

• For 2024-25: CPI Inflation projected at 4.8% (Q4: 4.4%).
• For 2025-26: CPI Inflation projected at 4.2%.

 

India’s Economic Outlook: Recovery Supported by Domestic Demand, but Risks Persist

India’s economic growth is set to recover as domestic demand strengthens, though the Reserve Bank of India’s (RBI) State of the Economy report, highlighted the need to closely monitor the impact of persistent food inflation. Banks are becoming more cautious about lending in the money market due to tight liquidity conditions. Rural demand continues to show growth, driven by strong agricultural prospects, which is supporting consumption.

India’s GDP growth fell to a seven-quarter low of 5.4% during the July-September period of the current fiscal year. For FY25, GDP growth is projected to dip to a four-year low of 6.4%, based on the first advance estimates from the National Statistics Office (NSO). However, the RBI’s report suggests that an increase in public capital spending on infrastructure could boost growth in key sectors. At the same time, rising manufacturing input costs, weather-related disruptions, and global economic challenges could pose risks to this forecast.

 

Conclusion

In summary, the RBI’s tasks go beyond just setting interest rates. It is central to maintaining both price and financial stability, adjusting its monetary policies to safeguard the economy from both inflationary and deflationary pressures, while fostering sustainable growth.

The RBI’s responsibility in managing inflation will remain crucial as India navigates both global economic challenges and internal pressures. Controlling inflation is essential not only for fostering economic growth but also for preserving public confidence in the financial system. As the economy progresses, the RBI is expected to continuously adapt its strategies and tools to maintain stability and support growth in an increasingly dynamic landscape.