Story Of The Week

The Monetary Policy Committee: India’s New Architecture for Interest Rate and Inflation Control

The last few days witnessed the emergence of a new framework in the form of the Monetary Policy Committee (MPC) which grants the Reserve Bank of India (RBI), independence from government pressure and interference. India will now fall in the list of those countries where interest rates are set by a committee rather than an individual.

The government appointed three members to the Monetary Policy Committee (MPC), thereby ending the RBI governor’s role as the sole arbiter. The next bi-monthly monetary policy update of the RBI, scheduled on October 4, is expected to follow the recommendations of this newly formed panel, that includes taking a call on the interest rates.

mpc

Structure of the MPC

The Monetary Policy Committee (MPC) will consist of six members, wherein the members appointed by the Central Government shall hold office for a period of four years.

The government has named three academics from the country’s top institutions as its nominee members to the 6-member MPC: Chetan Ghate, Professor at the Indian Statistical Institute; Pami Dua, Director at Delhi School of Economics; and Ravindra Dholakia, Professor at the Indian Institute of Management, Ahmedabad. The RBI, on its part, has put forth its set of three representatives: Governor Urjit Patel, who holds the casting vote, Deputy Governor R. Gandhi and Executive Director Michael Patra.

Objective of the MPC

The Reserve Bank of India Act, 1934, was amended by the Finance Act, 2016, to provide for a statutory and institutionalised framework for a Monetary Policy, for maintaining price stability, while keeping in mind the objective of growth.

The Monetary Policy Committee would be assigned the task of fixing the benchmark policy rate (repo rate), required to contain inflation within the specified target level. The said target level, that the government arrived at in consensus with the RBI, has been set at 4% with a margin of two percentage points for the five years ending March, 2021.

Working Principle

  • The meetings of the Monetary Policy Committee will be held at least four times a year and it will publish its decisions after each such meeting.
  • The committee will decide on the interest rates through a majority vote, with each member having one vote.
  • In the case of a tie, the Governor has a casting vote.
  • At least four members will have to be present for the quorum to be complete.

Challenges and the Way Forward

The shift to the new framework, for setting up India’s monetary policy, is laden with a few potential roadblocks that need to be taken care of:

  • It has been observed that the members of the old technical advisory committee have often, in private, complained about the lack of adequate data before meetings. Hence, it becomes imperative that all members of the MPC should have access to the same amount of information that includes open access to the research done by central bank economists.
  • Further, the group dynamics play a very crucial role. The onus would be on Governor Urjit Patel to ensure that the discussions are open in nature.It would be especially welcome if the RBI members do not habitually vote as a block in the meetings. And the Governor should try not to use his casting vote at least in the initial years.
  • Lastly, a robust channel of communication needs to be put in place so that other stakeholders in the economy are abreast with the thought process and decision making criteria of the MPC members.

With the dawn of the new era in the Indian Monetary Policy, the effectiveness of this transition would be under constant scrutiny. A lot would depend on the new Governor and his ability to nurture the first Monetary Policy Committee in India. With all eyes set on October 4, the first verdict by the new MPC would be out, in deciding interest rate to control inflation without compromising on growth.

REFERENCES:

Advertisements

Categories: Story Of The Week