Monetary Policy Committee

Note4Students

Recently the Government amended the RBI Act to hand over the job of monetary policy-making in India to a newly constituted Monetary Policy Committee (MPC). The new MPC is to be a six-member panel that is expected to bring “value and transparency” to rate-setting decisions. It has started to function recently.

Background/ Introduction

  1. India’s central bank used to take its monetary policy decisions based on the multiple indicator approach. Its rate decisions were expected to take into account inflation, growth, employment, banking stability and the need for a stable exchange rate.
  2. RBI would be subject to hectic lobbying ahead of each policy review and trenchant criticism after it. The Government would clamour for lower rates while consumers bemoaned high inflation. Bank chiefs would want rate cuts, but pensioners would want high rates.
  3. The MPC is not new and traces back to 2002 when the Y. V. Reddy Committee recommended for a MPC to decide policy actions. Subsequently, suggestions were made to set up a MPC in 2006 by the Tarapore Committee, in 2007 by the Percy Mistry Committee, in 2009 by the Raghuram Rajan Committeeand then in 2013, both in the report of the Financial Sector Legislative Reforms Commission (FSLRC) and the  Urjit R. Patel (URP) Committee.
  4. According to the URP Committee, “Heightened public interest and scrutiny of monetary policy decisions and outcomes has propelled a worldwide movement towards a committee based approach to decision making with a view to bringing in greater transparency and accountability in India.”
  5. It suggested that RBI abandon the ‘multiple indicator’ approach and make inflation targeting the primary objective of its monetary policy.
  6. The erstwhile technical advisory committee (TAC) that earlier advised the RBI on interest rates. The TAC is made up of external academicians and members from within the RBI, including the governor, and it meets ahead of every monetary policy.
  7. The TAC has no voting rights, while the MPC have them. TAC is an advisory committee and the RBI can disregard its advice, which governors have done in several instances.The members of the TAC, which was first constituted in 2005, have had tenures of two years.

Newly Created MPC

  1. The Reserve Bank of India Act, 1934 (RBI Act) has been amended by the Finance Act, 2016,  to provide for a statutory and institutionalised framework for a Monetary Policy Committee, for maintaining price stability, while keeping in mind the objective of growth.
  2. The Monetary Policy Committee would be entrusted with the task of fixing the benchmark policy rate (repo rate) required to contain inflation within the specified target level.
  3. A Committee-based approach for determining the Monetary Policy will add lot of value and transparency to monetary policy decisions.
  4. The meetings of the Monetary Policy Committee shall be held at least 4 times a year and it shall publish its decisions after each such meeting

Composition

  1. Altogether, the MPC will have six members – the RBI Governor (Chairperson), the RBI Deputy Governor in charge of monetary policy, one official nominated by the RBI Board and the remaining three members would represent the Government of India.
  2. These Government of India nominees are appointed by the Central Government based on the recommendations of a  search cum selection committee consisting of the cabinet secretary (Chairperson), the RBI Governor,  the secretary of the Department of Economic Affairs, Ministry of Finance, and three experts in the field of economics or banking as nominated by the central government.
  3. The three central government nominees will hold office for a period of four years and will not be eligible for re-appointment. These three central government nominees in MPC are mandated to be persons of ability, integrity and standing, having knowledge and experience in the field of economics or banking or finance or monetary policy.
  4. RBI Act prohibits appointing any Member of Parliament or Legislature or public servant, or any employee / Board / committee member of RBI or anyone with a conflict of interest with RBI or anybody above the age of 70 to the MPC.
  5. The Central government also retains powers to remove any of its nominated members from MPC subject to certain conditions.

Working and Functions of MPC

  1. The proceedings of MPC are confidential and the quorum for a meeting shall be four Members, at least one of them shall be the Governor and in his/her absence, the Deputy Governor who is the Member of the MPC.
  2. The MPC takes decisions based on majority vote (by those who are present and voting). In case of a tie, the RBI governor will have the second or casting vote. The decision of the Committee would be binding on the RBI.
  3. As per the Act, RBI has to organise at least four meetings of the MPC in a year. (More meetings can be held if the RBI Governor is of that opinion)
  4. The government may, if it considers necessary, convey its views, in writing, to the MPC from time to time.
  5. RBI is mandated to furnish necessary information to the MPC to facilitate their decision making and if any Member of the MPC, at any time, requests the RBI for additional information, including any data, models or analysis, the same have to be provided, not just to that member but to all members.

International Comparisons:

  1. With the introduction of the monetary policy committee, the RBI will follow a system similar to the one followed by most global central banks.
  2. The US Federal Reserve sets its benchmark fund rate through the Federal Open Market Committee(FOMC). The federal funds rate is the interest rate at which depository institutions lend balances at the Federal Reserve to other depository institutions overnight. The Board of Governors of the Federal Reserve System is responsible for the discount rate and reserve requirements, and the Federal Open Market Committee is responsible for open market operations.
  3. Bank of England also has a MPCto decide the official interest rate in the United Kingdom . The MPC meets every month to set the interest rate and meets over three days.  A representative from the Treasury also sits with the Committee at its meetings. The purpose is to ensure that the MPC is fully briefed on fiscal policy developments and other aspects of the Government’s economic policies.

Conclusion

  1. Till now RBI was having complete autonomy over monetary policy rates. But now the same will be decided by MPC, in which RBI as half member including presiding officer.  Though to some extent autonomy of RBI reduced, but still RBI remains in charge of monetary policy decisions.
  2. Monetary policy of Reserve Bank of India will go under review in October. This is the first time monetary policy review will held under the new regime of a monetary policy committee.

MODEL QUESTIONS

Q. Why a new institution named Monetary Policy Commission was given with the responsibility of monetary policy?

Q. The Monetary Policy is one of the most important decision in a country. The new institution will collectively decide and implement the monetary policy in a better manner. Comment.

References:

 

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