Monetary Policy History India

Monetary policy evolution, focus & planning

Monetary Policy over the years

Monetary Policy History India - planning:

  1. The honour of being the first true central bank goes to Sweden based riksbank, which was a joint stock company bank, mandated to lend to the government along with its commercial functions. Riksbank later gave up commercial lending and was granted a monopoly for issuing banknotes in 1897.
  2. In later years France and England created their own central banks.
  3. Reserve bank of India (RBI) was set up in 1935, under Reserve Bank of India Act 1934; its mandate is defined as follows.

“it is expedient to constitute a Reserve Bank for India to regulate the issue of Bank notes and keeping of reserves with a view to securing monetary stability in India and generally, to operate the currency and credit system of the country to its advantage”.

  1. RBI nationalized in 1949. Even though its traditional functions remained unchanged, evolution of global economy and integration of Indian economy with global markets has led to evolution of monetary policy over the years.
  2. Till independence, focus was on maintaining exchange rate stability of pound sterling by maintaining liquidity by using tools such as bank rate and cash reserve ratio.

From 1947 up to 1969 –

  1. Advent of socialism marked the beginning of tight credit control.
  2. The policy instruments used in regulating the credit availability were bank rate, reserve requirements and open market operations (OMOs). The enactment of the Banking Regulation Act in 1949, statutory liquidity ratio (SLR) requirement prescribed for banks emerged as a secured source for government borrowings and also served as an additional instrument of monetary and liquidity management.

From 1969 to 1985(Balancing credit growth and inflation),

  1. In the backdrop of bank nationalization, global financial instability & Bangladesh war – govt. resorted to deficit financing leading to banks flooded with excessive cash.
  2. In above circumstances, traditional monetary policy instruments, viz., the Bank Rate and OMOs were found inadequate to address the implications of money supply for price stability.

Beyond 1985(years of tight monetary policy, monetary targeting framework)

  1. Automatic monetisation of budget deficit through ad hoc treasury bills meant that inflation control needed ever high dependence on both the CRR and Bank Rate, which were raised significantly.
  2. CRR was used as the primary instrument for monetary control. Nonetheless, due to continued fiscal dominance, both SLR and CRR reached their peak levels by 1990.
  • Worsening of fiscal situation in late 1980s led to deterioration of external balance position.
    1. There was a shift from fixed exchange rate regime to a market determined exchange rate system in 1993.
    2. Automatic monetization through ad hoc treasury bills from SLR was abolished in 1997 and replaced with a system of ways and means advances (WMAs).


Monetary targeting as a formal monetary policy framework in 1985 on the recommendations of the Chakravarty Committee. In this framework, with the objective of controlling inflation through limiting monetary expansion, reserve money was used as operating target and broad money as intermediate target.

Multiple Indicators Approach

  1. Opening up of the economy exposed the limitations of the prevalent monetary targeting framework and it was replaced by multiple indicators approach in April 1998 in April 1998.
  2. In order to stabilize short-term interest rates, the Reserve Bank placed greater emphasis on the integration of money market with other market segments. It modulated market liquidity to steer monetary conditions to the desired trajectory by using a mix of policy instruments. Some of these instruments including changes in reserve requirements, standing facilities and OMOs were meant to affect the quantum of marginal liquidity, while changes in policy rates, such as the Bank Rate and reverse repo/repo rates were the instruments for changing the price of liquidity.

Monetary Policy History India

Multiple indicators approach - Under this approach, besides monetary aggregates, a host of forward looking indicators such as credit, output, inflation, trade, capital flows, exchange rate, returns in different markets and fiscal performance constituted the basis of information set used for monetary policy formulation. The enactment of the Fiscal Responsibility and Budget Management (FRBM) Act in 2003, by introducing fiscal discipline, provided flexibility to monetary policy.

2013-2016: Preconditions Set for Inflation Targeting

  1. In the post-global financial crisis period (i.e., post-2008), however, the credibility of multiple indicators approach came into question as persistently high inflation and weakening growth began to co-exist. It was criticized for being a confused approach and it was changed in favour of inflation targeting approach.

2015 and after - amendment of the RBI Act in May 2016:

  1. Monetary Policy Framework Agreement (MPFA) was signed between the Government of India and the Reserve Bank on February 20, 2015.
  2. RBI adopted a flexible inflation targeting (FIT) framework under which primacy is accorded to the objective of price stability, defined numerically by a target of 4 per cent for consumer price headline inflation with a tolerance band of +/- 2 per cent around it, while simultaneously focusing on growth when inflation is under control.
  3. The monetary policy framework in India has also been guided by developments in theory and international best practices.
  4. Since early 1990s, beginning with New Zealand in 1990, many advanced and emerging market economies (EMEs) have switched to inflation targeting as the preferred policy framework.



Monetary policy key challenges

Monetary policy key challenges:

Financial markets are expected to seamlessly transmit key monetary decisions to real functioning economy, India before 1991 was a not so much a connected economy because of too few participants in borrowing and lending, but digitalization & development of markets and products, RBI or any central bank has to insure that in a more connected global economy, Indian economy is efficient not only in reaping the benefits, particularly allocation of resources but should also be able to control harmful effect of increasingly unified global markets.

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