"Low Real Rates Risk NPA Recurrence; Digital Infrastructure Offers Structural Credit Fix"
Flexible Inflation Targeting (FIT)
RBI framework targeting 4% CPI ±2%, with MPC accountability if breached for three consecutive quarters.
Repo Rate
rate at which RBI lends overnight funds to commercial banks against government securities.
India's monetary policy framework underwent a structural transformation when the Flexible Inflation Targeting (FIT) regime was formally established through an amendment to the Reserve Bank of India Act, 1934, in 2016. Under FIT, the central government, in consultation with the RBI, sets a medium-term inflation target of 4% CPI with a tolerance band of ±2 percentage points (i.e., 2%–6% is acceptable). This replaced the earlier multiple-indicator approach, which lacked a clear nominal anchor and reduced policy credibility. A binding accountability mechanism was introduced: if inflation remains outside the 2–6% band for three consecutive quarters, the RBI must submit a formal report to the government explaining reasons and proposed remedial measures.
The institutional vehicle for achieving this target is the Monetary Policy Committee (MPC), a six-member body under the RBI Act. Three members are from the RBI — the Governor (who chairs and holds a casting vote), the Deputy Governor in charge of monetary policy, and one RBI officer nominated by the Central Board — while three external members are appointed by the central government. The MPC meets at least four times a year and sets the policy repo rate as its primary instrument. Between 2016 and 2018, during the credibility-building phase of FIT, India maintained real policy rates of over 2 per cent. The period before FIT — the early 2010s — was characterised by suppressed real rates, aggressive bank lending, and a subsequent Non-Performing Asset (NPA) crisis that required years of balance-sheet repair under the Insolvency and Bankruptcy Code (IBC), 2016 and the Asset Quality Review process.
A structural challenge compounding monetary policy in India is information asymmetry in credit markets — lenders cannot easily distinguish creditworthy borrowers from risky ones, especially in the SME and informal segments. This raises the cost of credit intermediation independently of the policy rate. The India Stack — Aadhaar, UPI, and account aggregators — along with the National Payments Corporation of India (NPCI), have begun addressing this by creating verifiable digital transaction trails that serve as proxy credit histories.
The repo rate is the rate at which the RBI lends overnight funds to commercial banks against government securities. Changes in the repo rate transmit through the financial system via the interest rate channel, affecting borrowing costs for households and firms, and through the credit channel, influencing bank lending volumes. The real interest rate — the nominal policy rate adjusted for expected inflation — is the more analytically significant variable: when the RBI holds the repo rate steady while inflation rises, real rates fall or turn negative, effectively making money cheap and potentially fuelling asset-price inflation or reckless lending.
India's CPI basket assigns approximately 46% weight to food and beverages, making headline inflation highly sensitive to food price shocks. This structural feature complicates the MPC's task of distinguishing transient supply-side pressures from durable demand-driven inflation. …
Consider the following statements:
Statement-I: In the post-pandemic recent past, many Central Banks worldwide had carried out interest rate hikes.
Statement-II: Central Banks generally assume that they have the ability to counteract the rising consumer prices via monetary policy means.
Which one of the following is correct in respect of the above statements?
Which among the following steps is most likely to be taken at the time of an economic recession?
When the Reserve Bank of India reduces the Statutory Liquidity Ratio by 50 basis points, which of the following is likely to happen?
Assertion (A): India's Non-Performing Asset (NPA) crisis of the mid-2010s was partly a consequence of the low real interest rate environment of the early 2010s.
Reason (R): Low real rates reduce banks' net interest margins, lowering their incentive to screen borrowers carefully, and simultaneously boost collateral values, encouraging greater risk-taking.
Which one of the following is correct?
Under India's flexible inflation targeting framework, the Monetary Policy Committee (MPC) is mandated to maintain CPI inflation at which of the following targets?
Want the full note, Prelims Facts & MCQ answers?
Create a free account — takes less than a minute.
Create free account