Banking, Money & Fiscal Policy — RBI Tools, MPC & Deficits Made Simple

Q: To fight rising inflation, which combination of actions would the RBI most likely take?

To fight inflation, the RBI tightens money by making borrowing costlier and pulling cash out of the system, so it raises the repo rate and raises the CRR. Cutting rates (option A) would boost money and worsen inflation. Government spending (option D) is fiscal policy, not the RBI's tool.

Learn how RBI's monetary policy (repo rate, CRR, SLR, MPC) and the government's fiscal policy (deficits, FRBM) steer India's economy, as tested in UPSC Prelims.

By the PadhoDost Team · 📖 8 min read · Updated 4 August 2026

Part of UPSC Civil Services prep

Think of the Indian economy like a car on a highway. Money is the fuel, and someone has to control the speed. Press too hard and it overheats (high inflation). Go too slow and it stalls (recession, no jobs). Two different drivers share the controls: the Reserve Bank of India (RBI) handles monetary policy, and the Government handles fiscal policy. This chapter teaches you how each one steers, and the exact tools they use.

Two drivers, two toolkits

First, get this basic split clear, because UPSC loves to test it. Monetary policy is about the supply and cost of money in the economy. It is run by the RBI. Fiscal policy is about the government's taxes and spending. It is run by the Ministry of Finance (the Union Budget). Do not mix them up.

Point	Monetary Policy	Fiscal Policy
Who runs it	RBI (central bank)	Government (Ministry of Finance)
Main tools	Repo rate, CRR, SLR, OMO	Taxes and public spending
Shown in	RBI policy statements	Union Budget
Main goal	Control inflation, ensure growth	Growth, jobs, redistribution

The RBI: India's central bank

The RBI was established in 1935 on the recommendation of the Hilton Young Commission (the Royal Commission on Indian Currency and Finance). It was nationalised in 1949, so it is now owned by the government. The RBI is the banker to the government, the banker to other banks, the issuer of currency notes (except the one-rupee note and coins, which the Ministry of Finance issues), and the manager of monetary policy.

How RBI controls money: the key rates

The tools every aspirant must know

✓Repo rate: the rate at which RBI lends short-term money to banks against government securities. Raise it and loans become costlier, slowing the economy.
✓Reverse repo rate: the rate at which RBI borrows from banks (absorbs extra money).
✓CRR (Cash Reserve Ratio): the share of a bank's deposits it must keep with the RBI as cash. RBI pays no interest on it.
✓SLR (Statutory Liquidity Ratio): the share of deposits a bank must keep in safe liquid assets like cash, gold, or government securities, held by the bank itself.
✓MSF (Marginal Standing Facility): an emergency window where banks borrow overnight from RBI, at a rate slightly above the repo rate.
✓OMO (Open Market Operations): RBI buys or sells government securities in the market to add or remove money.

🧠 CRR vs SLR made simple

Imagine a bank must keep some savings aside for safety. CRR is the part it must park with the RBI as pure cash (like money locked in the RBI's vault). SLR is the part it keeps with itself but only in safe forms like cash, gold, or government bonds. CRR earns no interest; SLR assets can. Both reduce how much the bank can lend out.

Easy money vs tight money

When RBI wants to boost growth, it makes borrowing cheaper: it cuts the repo rate, CRR, and SLR. More money flows out, loans get cheaper. This is expansionary or easy monetary policy. When inflation is high, RBI does the opposite: it raises the repo rate, CRR, and SLR to pull money back. This is contractionary or tight monetary policy.

💡 Simple memory rule: Rates UP = money tighter = fights inflation. Rates DOWN = money cheaper = boosts growth. If a question mentions RBI cutting the repo rate, it is trying to encourage borrowing and spending.

Who decides the repo rate? The MPC

Since 2016, the repo rate is set by the Monetary Policy Committee (MPC), created by an amendment to the RBI Act. The MPC has six members: three from the RBI (including the Governor, who chairs it and has a casting vote in a tie) and three experts appointed by the central government. Its job is to keep retail inflation, measured by the Consumer Price Index (CPI), at a target of 4 percent, with a tolerance band of plus or minus 2 percent (that is, 2 to 6 percent).

ℹ️ Note the difference: CPI (Consumer Price Index) measures retail prices paid by consumers and is the target for monetary policy. WPI (Wholesale Price Index) measures wholesale prices. The MPC targets CPI inflation, not WPI.

Measuring money: M1 and M3

The RBI measures the total money in the economy using money-supply measures. The two most tested are M1 (narrow money) and M3 (broad money). M1 is the most liquid: currency held by the public, plus demand deposits (money you can withdraw anytime), plus other deposits with the RBI. M3 is broader: it is M1 plus time deposits (like fixed deposits). M3 is the figure most watched for policy.

Fiscal policy: the government's side

Fiscal policy is how the government uses taxes and spending to steer the economy, laid out every year in the Union Budget. When it spends more or cuts taxes to boost demand, that is expansionary fiscal policy. When it spends less or taxes more to cool the economy, that is contractionary. The gap between what the government earns and what it spends creates different types of deficits.

Type of Deficit	Simple meaning
Fiscal Deficit	Total expenditure minus total receipts (excluding borrowings). Shows how much the government must borrow.
Revenue Deficit	Revenue expenditure minus revenue receipts. Means the government borrows even for daily running costs.
Primary Deficit	Fiscal deficit minus interest payments. Shows this year's borrowing need excluding interest on past debt.

⚠️ To keep borrowing in check, Parliament passed the FRBM Act (Fiscal Responsibility and Budget Management Act) in 2003. It sets targets to limit the fiscal deficit and bring discipline to government finances.

Rapid revision must-knows

✓Monetary policy = RBI. Fiscal policy = Government (Budget).
✓RBI set up 1935 (Hilton Young Commission), nationalised 1949.
✓Repo up, CRR up, SLR up = tighter money, fights inflation.
✓MPC has 6 members, Governor chairs with a casting vote; targets CPI inflation at 4% (+/- 2%).
✓CRR is parked with RBI as cash (no interest); SLR is held by the bank in liquid assets.
✓Fiscal deficit shows government borrowing; FRBM Act (2003) limits it.

⚡ Quick check

To fight rising inflation, which combination of actions would the RBI most likely take?

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