Monetary policy committee - Background, Composition, Functions

The government has moved to give statutory backing to the monetary policy committee (MPC). In this regard, the centre has notified the changes made to the Reserve Bank of India (RBI) Act. This paves the way for a resetting of the monetary policy framework that will shift the responsibility of maintaining inflation targets on a six-member panel, with the Reserve Bank of India (RBI) governor getting a casting vote in case of a tie.

The Central Government, in consultation with RBI, has fixed the inflation target for the period beginning from the date of publication of the Gazette Notification (August 5, 2016) and ending on the March 31, 2021, as under: 

• Inflation Target: Four per cent.
• Upper tolerance level: Six per cent.
• Lower tolerance level: Two per cent.

Background:

The idea of setting up an MPC was mooted by an RBI-appointed committee led by deputy governor Urjit Patel in February 2014 though that committee had recommended a five-member committee where three members would be from RBI and two external members would be appointed by the RBI governor and the deputy governor in-charge.

• It suggested that RBI abandon the ‘multiple indicator’ approach and make inflation targeting the primary objective of its monetary policy. It also mooted having an MPC so that these decisions could be made through majority vote. Having both Government and RBI members on the MPC was suggested for accountability. The Government would have to keep its deficit under check and RBI would owe an explanation for runaway inflation.

Monetary Policy Committee:

It is a six member panel which will have the responsibility of maintaining inflation targets. The MPC will set interest rates to keep retail inflation within targets. Inflation targets will be set once every five years.

• The Committee is to meet four times a year and make public its decisions following each meeting.

Composition:

• 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.
• The other three members would be from the RBI with the governor being the ex-officio chairperson. Deputy governor of RBI in charge of the monetary policy will be a member, as also an executive director of the central bank. Decisions will be taken by majority vote with each member having a vote.
• The government nominees to the MPC will be selected by a Search-cum-Selection Committee under Cabinet Secretary with RBI Governor and Economic Affairs Secretary and three experts in the field of economics or banking or finance or monetary policy as its members.
• Members of the MPC will be appointed for a period of four years and shall not be eligible for reappointment.

Other details:

As per rules, no member of MPC should have any financial or other interest that prejudicially affects his functions as a member. Also, 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.

Why is it important?

Until recently, 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.

• As you can see, this is a tall order. Thus, RBI (with the Governor as the focal point) 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. RBI ended up juggling all these objectives and focussing on different indicators at different points in time.
• The MPC will ensure that decisions on interest rates are made through debate by a panel of experts. The many-heads-are-better-than-one approach may also help ensure that the decision isn’t easily 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. The public disclosure of MPC deliberations will also tell you why its members batted for higher or lower rates.
• The MPC may put a stop to the public skirmishes between the Government and the RBI. But with the RBI governor holding the casting vote, don’t expect controversies to die down.