India's Growth Outlook Improves as Inflation Risks Rise

India's monetary policy operates under a formal inflation-targeting framework, adopted through an amendment to the Reserve Bank of India Act, 1934 in 2016. The Monetary Policy Committee (MPC) is the statutory body that sets the policy repo rate. It has six members: three from the RBI, including the Governor who chairs it and holds a casting vote, and three external members appointed by the government. The MPC's mandate is to keep CPI inflation at 4%, within a band of plus or minus 2 percentage points. If inflation stays outside this band for three consecutive quarters, the RBI must explain the failure and the remedial path to the government in writing. This reporting duty keeps the framework accountable.

A simple money-market logic explains why the repo rate can manage inflation. When the demand for money rises while its supply stays constant, the equilibrium rate of interest rises to clear the market. A repo rate hike works the same way. It makes credit costlier, which can pull down money demand, cool consumption and investment, and slow price increases. The reverse also holds. A rate cut lowers borrowing costs and raises investment expenditure, which is why capital spending tends to move with interest rate cycles.