Last Updated: 11 May 2026
UPSC GS Paper 3 Economy has carried at least one Mains question on monetary policy in every year since 2015. With CPI inflation hitting 4.83% in March 2026 — the lower band of RBI’s 4±2% target — and the MPC voting 5-1 to hold the repo rate at 6.50%, this topic is must-cover for CSE 2027.
Monetary Policy Framework — Constitutional Backing
- RBI Act 1934 (as amended in 2016): Establishes the Monetary Policy Committee.
- Section 45ZA-ZF: MPC composition, voting, accountability framework.
- Inflation Target: Set every 5 years by Central Government in consultation with RBI. Current target: 4% CPI inflation with ±2% tolerance band (2021-2026; review pending).
MPC Composition (6 Members)
- RBI Governor — Chairperson (1 vote + casting vote).
- Deputy Governor in charge of monetary policy (1).
- One officer of the Bank nominated by the Central Board (1).
- Three external members appointed by Central Government (3-year non-renewable terms).
Quantitative Tools of RBI
| Tool | Apr 2026 Value | Purpose |
|---|---|---|
| Repo Rate | 6.50% | Short-term liquidity injection (banks borrow from RBI) |
| Reverse Repo | 3.35% (discontinued as main rate) | Liquidity absorption |
| SDF (Standing Deposit Facility) | 6.25% | Replaced reverse repo as floor (since 2022) |
| MSF | 6.75% | Ceiling — emergency overnight borrowing |
| Bank Rate | 6.75% | Long-term lending rate |
| CRR | 4.50% | % of NDTL banks keep with RBI |
| SLR | 18.00% | % of NDTL in approved securities |
LAF Corridor
SDF (floor) – Repo (policy rate) – MSF (ceiling). The 25 bps gap from policy rate to SDF and MSF defines the liquidity adjustment facility band.
Monetary Policy Transmission
- Policy rate change → Bank’s MCLR (Marginal Cost of Lending Rate) changes.
- Since Oct 2019, all floating rate loans linked to external benchmark (mostly repo rate).
- Transmission to deposit rates is slower than lending rates.
- Concerns: weak transmission to MSME and rural credit due to bank-specific lending margins.
CPI Basket 2026 (NSO Re-Base from 2024)
| Group | Old (2012) | New (2024) |
|---|---|---|
| Food & Beverages | 45.86% | 39.06% |
| Housing | 10.07% | 13.05% |
| Fuel & Light | 6.84% | 6.97% |
| Clothing & Footwear | 6.53% | 5.88% |
| Miscellaneous | 28.32% | 32.21% |
Inflation Outlook (RBI Apr 2026 MPC)
- CPI inflation projection FY26: 4.5%
- Q1 2027: 5.1%, Q2: 4.5%, Q3: 4.3%, Q4: 4.1%
- GDP growth FY26: 7.0%; FY27: 6.8%
Mains Answer Templates
Q. ‘Inflation targeting framework has succeeded in stabilising prices but at the cost of growth.’ Examine. (250 words)
Intro: Define inflation targeting (Patel Committee 2014); 2016 amendment.
Successes: CPI variance ↓ from 9.5% in 2010-14 to 4.5% post-2017; anchored expectations; rupee credibility.
Trade-offs: 2022-23 hike cycle slowed credit growth; MSME pain; rural inflation lag.
Way Forward: Flexible inflation targeting; review target band; coordinate with fiscal stance.
Internal Links
FAQ
How is the MPC inflation target reviewed?
Every 5 years by Central Government with RBI; due for review in 2026.
What replaced reverse repo as the LAF floor?
Standing Deposit Facility (SDF), introduced April 2022.
Most-asked Mains question type?
Critical evaluation of inflation-targeting framework — appeared in 2017, 2020, 2023.
Practice Quiz
Practice Quiz — 10 UPSC-Style Questions
Click an option to reveal the answer and explanation.
