Fiscal and Monetary Policy — UPSC Mains Model Answer

The LAF corridor is bounded above by the Marginal Standing Facility (MSF) rate and below by the Standing Deposit Facility (SDF) rate, both set at a fixed spread around the repo rate. After the introduction of the SDF in April 2022, the corridor became symmetric: MSF sits 25 basis points above the repo rate, while SDF sits 25 basis points below it, making the total corridor width 50 basis points.

The SDF replaced the fixed-rate reverse repo as the floor of the corridor, giving the RBI a tool to absorb surplus liquidity without providing collateral in return. This strengthens the central bank's ability to manage excess systemic liquidity, particularly relevant in post-pandemic conditions when the banking system was flooded with durable surplus.

A well-calibrated corridor ensures that the weighted average call money rate — the operating target — remains anchored close to the repo rate. A narrow, symmetric corridor reduces rate volatility in overnight markets, improving the predictability of borrowing costs across the yield curve and reinforcing the credibility of the Monetary Policy Committee's stance.

The RBI retains discretion to conduct variable-rate repo and reverse repo auctions within the corridor, allowing fine-tuning of liquidity conditions. This layered design balances rule-based predictability with operational flexibility, a critical feature when the monetary stance shifts between accommodation and withdrawal.