Monetary Policy Framework

Now, MPC will decide monetary policy instead of RBI Governor doing it single handily there by bringing more accountability and thought into it.

Amendment to RBI Act removed the governor’s powers to singularly set monetary policy vesting them in a six-member Monetary Policy Committee

Last year, the government and the Reserve Bank of India (RBI) had agreed to adopt a monetary policy framework, which will make taming inflation the primary priority of the central bank’s policy decisions.

The MPC will set interest rates to keep retail inflation within targets. Inflation targets will be set once every five years

The committee will have six members. Of the six members, the government will nominate three. The RBI Governor will chair the committee. The governor, however, will not enjoy a veto power to overrule the other panel members, but will have a casting vote in case of a tie. No government official will be nominated to the MPC.

At present, the RBI’s Monetary Policy Department (MPD) assists the governor in formulating the monetary policy. Views of all key stakeholders in the economy, advice of the Technical Advisory Committee (TAC) contribute to the process for arriving at the key decision on policy repo rate — the rate at which the central bank lends to banks. The governor, however, has overriding powers to decide on interest rates

For past few years, India has been fighting against price rise at monetary level, not with much success. This time addressing few structural constraints partially in budget,  government has strengthened its monetary front by entering into a pact with RBI. Key highlights are:

Importance to Indian economy:

Such institutionalized measure to battle inflation has given more confidence but government must do more to address the structural issues like supply chain constrains.

Based on Urijit Patel Committee recommendations, government and the Reserve Bank of India (RBI) agreeing over a new monetary policy framework with the primary objective of containing inflation.

Many people feel it will give more autonomy to RBI which is in sync with the central banks of many world big economies. The agreement says, once inflation reaches beyond the comfort zone, both at high and low levels, RBI should use whatever in its command to bring it to the comfort zone. This basically gives autonomy to RBI.

RBI act will be amended for the formation of a five-member monetary policy committee (MPC) headed by the RBI governor. Out of the five members, three were suggested to be from RBI (the deputy governor and the executive director in-charge of monetary policy). This composition of committee will reflect the independence of RBI, it should have  experts as members and should not have government nominee as members.

India in past has paid price for not having clear monetary policy. So this step should improve the situation and also ease pressure on RBI to pursue a particular course of

policy.

In general, this mechanism is welcome – since it brings to India the formal accountability and transparency about future actions that is the hallmark of modern central banking but there are still few areas where RBI cannot still do much.

As, RBI targets CPI where the weight of food items is around 50% but food inflation in India is mostly dependent on non-monetary factors such as production and supply chains, rains, harvest etc. In this case, RBI may signal intent but it will not have much impact on ground and RBI will find hard to achieve inflation target.

Also, RBI do not have any control over fiscal responsibility or debt control which government breach again and again. So again, RBI can’t do much here as well. This step is a much welcome step and will definitely improve the situation in India with respect to monetary policy but we need to be cautious and government also need to contain fiscal deficit and control its debit.