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Monetary policy and inflation

How the Reserve Bank of India sets interest rates to keep inflation near its target, and how inflation is measured.

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Monetary policy in an oil shock

Prelims and Mains

LeadMonetary policy in an oil shock: why the Reserve Bank heldJune 2026

Why in news

On 5 June 2026 the Monetary Policy Committee kept the repo rate at 5.25 per cent with a neutral stance. It cut its growth forecast for 2026-27 and raised its inflation forecast, as the conflict in West Asia pushed up the price of crude oil.

Background

Since 2016 the Reserve Bank of India has followed flexible inflation targeting: consumer price inflation of 4 per cent, within a band of 2 to 6 per cent.
A committee of six sets the repo rate, the rate at which the Reserve Bank lends to banks overnight.

The committee had cut the rate through 2025 to 5.25 per cent, and then held it.
In spring 2026 the conflict in West Asia and the disruption in the Strait of Hormuz took the Indian crude basket to about 110 dollars a barrel.

A supply shock, not a demand surge

Inflation in May was still below 4 per cent. Yet the committee raised its forecast for the year to 5.1 per cent, because it assumed dearer crude.
A rise in prices caused by costlier oil is a supply shock. Raising interest rates does not produce more oil; it only cuts demand.
So a central bank looks through the first round of such a shock.
It acts if the shock spreads into wages and into what people expect prices to be. These are the second round effects.

Why not cut, and why not raise

Growth was slowing: the forecast fell to 6.6 per cent, with a weak monsoon expected. That argued for a cut.
The rupee was falling and foreign investors were leaving. A cut would have narrowed India's interest advantage over rates abroad and added to the outflow.
A rise would have hurt a slowing economy to fight an inflation that money cannot cure.
So the committee held, and the Reserve Bank used other tools to draw in foreign money (see the lead on defending the rupee).

The limits of inflation targeting

Food and fuel make up a large part of the consumer price basket, and both are driven by supply.
This revives an old question: should the target be headline inflation or core inflation, which leaves out food and fuel?

The first line of defence against a fuel shock is often fiscal: a cut in fuel taxes acts on the price directly.

The way forward

Keep the stance neutral until the paths of oil and the monsoon are clear.
Use fuel tax and buffer stocks against the first round, and monetary policy against the second.
Communicate clearly, since expectations are anchored by what the central bank is believed to do.

Prelims facts

The committee has six members: three from the Reserve Bank and three appointed by the Centre. The Governor has a casting vote.
The target is set by the Centre in consultation with the Reserve Bank, for five years at a time.
The corridor: Standing Deposit Facility 5.00, repo 5.25, Marginal Standing Facility 5.50 per cent.
The Bank Rate moves with the Marginal Standing Facility rate.
The Standing Deposit Facility was introduced in 2022.

Open the lead on its own page

Since 2016 the Reserve Bank of India has followed flexible inflation targeting: consumer price inflation of 4 per cent, within a band of 2 to 6 per cent.

What changed

5 Aug 2026newly added
- At its August meeting the Monetary Policy Committee kept the repo rate at 5.25 per cent with a neutral stance, its fourth pause in a row.
- The Reserve Bank raised its growth forecast for 2026-27 to 6.7 per cent and trimmed its inflation forecast to 5.0 per cent.
The Hindu, 5 Aug 2026: Sensex gains as RBI keeps policy rates unchanged (opens in a new tab) · Reserve Bank of India, 5 Aug 2026: Statement on Developmental and Regulatory Policies (opens in a new tab)

Show history (1 other update)

5 Jun 2026LeadMonetary policy in an oil shock: why the Reserve Bank held

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