- Until recently, to decide the monetary policy, a technical advisory committee constituted by the RBI, which consisted of RBI’s top brass including the Deputy Governor and the Governor and external advisors, gave their opinions and suggestions on what the RBI should do.
- But the Governor’s word was final on the rates and the advice of the technical advisors was not binding on the RBI.
- RBI used to take monetary policy decisions taking into account inflation, growth, employment, banking stability and the need for a stable exchange rate.
- This would make RBI subject to intense lobbying ahead of each policy review and criticism later on.
- The government would clamour for lower rates while consumers complained about higher inflation.
- Bank chiefs would want rate cuts, but pensioners would want high rates.
- To resolve this, RBI set up an expert committee under Urijit Patel to revise and strengthen the monetary policy framework
- The history of suggestions for setting up an MPC traces back to 2002. A number of committees since then have advised in favor of setting up an MPC.
- 2002- Y.V Reddy Committee
- 2006- Tarapore Committee
- 2007- Percy Mistry Committee
- 2009- Raghuram Rajan Committee
- 2013- Financial Sector Legislative Reforms Commission
- 2013- Urijit Patel Committee
Urijit Patel Committee Recommendations
- The committee came up with it’s report in January, 2014.
- It suggested that RBI abandon the ‘multiple indicator’ approach and make inflation targeting the main objective of it’s monetary policy.
- It also mooted a Monetary Policy Committee (MPC) so that these decisions could be made through a majority vote.
- To ensure accountability in it’s functioning, it was suggested to have both Government and RBI members on the MPC.
Monetary Policy Framework
- The RBI and the Government signed the Monetary Policy Framework Agreement in February, 2015.
- On June 27, 2016, the government amended the RBI Act, 1934 to hand over the job of monetary policy -making in India to a newly constituted MPC.
- According to the Monetary Policy Framework, the central bank will look to contain inflation within a band of 4% plus/minus 2% points from the next year.
- It will be considered that the panel failed in achieving the inflation target if the lower or the upper range of the target is breached for three consecutive quarters.
- The RBI would have to give an explanation in the form of a report to the Central Government, if it failed to reach the specified inflation targets.
- It shall, in the report, give reasons for failure, remedial actions and estimated time within which the inflation target shall be achieved.
- Further, RBI is mandated to publish a Monetary Policy Report every six months, explaining the sources of inflation and the forecasts of inflation for the coming period of six to eighteen months.
- Given this backdrop, MPC decides the changes to be made to the repo rate so as to contain inflation within the target level specified to it by the Central Government
- It will publicize it’s decisions after each meeting.
- After the MPC meeting, RBI has to publish a document explaining the steps to be taken by it to implement the decisions of the MPC, including any changes thereto.
What is the structure of MPC?
- It is to be a six-member panel that is expected to bring “value and transparency” to rate-setting decisions.
- It will have three members from the RBI- the Governor, a Deputy Governor and another official. Three others will be independent members selected by the Government.
- The three external members will be recommended to the government by a search-cum-selection committee. They will be experts in the field of economics or banking or finance or monetary policy and will be appointed for a period of four years and shall not be eligible for reappointment.
- No member of the MPC should have any financial or other interest that prejudicially affects his functions as a member.
- The search-cum-selection committee will be headed by the cabinet secretary.
- The RBI Governor will be the ex-officio chairperson of the MPC.
- The MPC will meet four times a year to decide on monetary policy by a majority vote.
- In case of a tie, the RBI Governor will have a deciding vote.
Mandate of the MPC
- It is entrusted with the task of fixing the benchmark policy interest rate (repo rate) to contain inflation within the target level.
- The Government may, if it considers necessary, convey its views, in writing, to the MPC from time to time.
- RBI is mandated to furnish necessary information to the MPC to facilitate their decision making.
- Monetary policy decisions by Central Banks can have far reaching consequences for the economy, investors, savers and borrowers. And if taken by an individual, these decisions can cause a lot of problems. Therefore, world over many governments have addressed this problem by appointing a committee.
- The MPC will ensure that decisions on interest rates are made through debate by a panel of experts.
- The MPC approach will also ensure that the decision is not influenced by bias or lobbying.
- India’s shift to an MPC, driven by a clear inflation-targeting framework, if it succeeds, may also ensure that consumers and investors can look forward to lower inflation rates over the long term.
- Other benefits include a stable currency and a higher real interest rate.
- The public disclosure of MPC deliberations will inform why it’s members opted for higher or lower rates.
- It may also put an end to public skirmishes between the Government and the RBI.
- Research has found that inflation, in general, had come down to a much acceptable level in many countries after adopting inflation targeting than before.
- There will be greater accountability on all the members of the committee, which has a legal backing.
Disadvantages of MPC
- It will impact the RBI’s mandate in setting interest rates, it would not only take away autonomy but also downgrade powers of the Central Bank.
- Government representatives with links to the ruling party are likely to accelerate the growth of money, to reduce poverty in India, without considering the importance of financial stability. They tend to take a biased view- biased towards the government’s objective of growth rather than the RBI’s objective of inflation.
- Will the Centre’s appointees on the MPC be able to handle the complexities of achieving growth without inflation?