Why in News: RBI kept rates steady as growth remains strong and inflation is expected to rise, with limited impact from US tariffs on India’s mostly domestic-driven economy.
RBI’s Monetary Policy Stance
No rate cut due to:
- Low real interest rate (~1%)
- Stable growth
- Likely inflation rise in 2026
Key Takeaways
1. Inflation Outlook
- CPI Inflation fell to ~2% in June 2025; expected to stay benign (~2.5%) in coming quarters.
- RBI projects CPI inflation to rise above 4% in 2026, averaging >4.5% in FY27 due to base effect reversal. Hence, limited room for further rate cuts.
2. Growth Projections
- RBI maintains FY26 GDP growth forecast at 6.5%.
- Supported by:
- Past rate cuts
- Strong agriculture, good monsoon
- Low inflation
- Lower income tax burden
- Urban consumption faces pressure due to weak income growth and IT sector slowdown.
External Sector and Trump Tariffs
- US tariffs may hurt merchandise exports (2% of GDP) but impact is limited due to India’s domestic demand-driven economy.
- Current Account Deficit (CAD) expected at 0.9% of GDP.
- Forex reserves at $689 billion – cover 11 months of imports.
- Capital flows may be volatile due to global uncertainties.
What is Monetary Policy?
- Monetary policy is a macroeconomic tool used by the central bank to control the money supply and credit availability in the economy. Its aim is to achieve key economic objectives by regulating interest rates and liquidity in the financial system.
Significance of Monetary Policy
1. Price Stability: Helps control inflation, ensuring a stable economic environment.
2. Economic Growth: Stimulates growth by influencing investment and capital formation.
3. Influence on Key Variables: Affects consumption, savings, and investment decisions.
4. Employment Generation: Increased money supply boosts business activity, creating jobs.
5. Exchange Rate Management: Regulates currency exchange rates by controlling liquidity.
Limitations of Monetary Policy in India
1. Unfavorable Banking Habits
- High preference for cash transactions reduces banks’ ability to create credit.
2. Underdeveloped Money Market
- Limits the reach and effectiveness of RBI’s policy tools.
3. Existence of Black Money
- Unaccounted money distorts true money supply and demand, reducing policy impact.
4. Conflicting Objectives
- Balancing growth (requires expansion) and inflation control (requires contraction) is challenging.
5. Limitations of Instruments
- Multiple interest rates and structural issues restrict the effectiveness of monetary tools.
Types of Monetary Policy
1. Expansionary Monetary Policy (Accommodative Policy)
- Objective: Increase money supply to boost growth and reduce unemployment.
Key Measures:
↓ Interest rates → Cheaper borrowing
↓ Reserve requirements → More lending capacity
RBI buys govt. securities → Injects liquidity
Risk: May lead to inflation or hyperinflation.
2. Contractionary Monetary Policy
Objective: Reduce money supply to control inflation.
Key Measures:
↑ Interest rates → Costlier borrowing
↑ Reserve requirements → Less money to lend
RBI sells govt. securities → Absorbs liquidity
UPSC Relevance –
- GS Paper III – Indian Economy
Mains Practice Question
Q. “Monetary policy is a critical instrument for ensuring macroeconomic stability in India, but it faces multiple challenges.” Discuss the objectives of monetary policy in India and critically analyse the constraints in achieving them. (250 words)