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Monetary Policy Committee in India

Published on Monday, September 26, 2016
In the recent past anyone who has been abreast with the happenings in the banking and financial sector of India knows that the Government and the RBI have not been on the same page when it comes to determining the Monetary Policy of India.

All over the world in most developed and developing countries it is a norm that the Monetary Policy of the country or economy is the sole area of responsibility of the Central Banks. Looking from that end, the government interfering in the framing of Monetary Policy does not seem to be suitable. But the government is responsible for the macroeconomic aspects of the economy such as generation of employment opportunities, controlling inflation, larger benefit of the society and the growth of the economy. Considering these aspects the interest of the government to shape the monetary policy and thus controlling the flow of money into the economy is quite understandable. After all in democratic nations like India the Government is given a mandate to serve the nation by the people. Failing to effectively manage the economy might result in reversal of mandate.

To avoid such problems and circumvent differences the Reserve Bank of India and Government of India together has agreed to setup a Monetary Policy Committee (MPC). This model has been followed by the developed world for quite some time now. The idea of a monetary policy committee was proposed by an RBI-appointed committee to Revise and Strengthen the Monetary Policy Framework led by Urjit R. Patel (then a Deputy Governor), which submitted its report on January, 2014. (The panel then recommended a 5-member committee in which 3 members were to be from RBI and 2 external members to be appointed by the Government. The issue later took a very controversial turn when the government in 2015 put out a draft Indian Financial Code, suggesting a 7-member committee with 4 members appointed by the Government and 3 members from RBI.).

The Monetary Policy Committee will be taking decisions on setting of interest rate or repo rate in future and is being formed under the RBI. MPC will be a 6-member committee and will be bringing significantly change the powers of the RBI governor while also deciding the policy rates. The RBI governor will now be free from facing the brunt of criticism from the government, which historically has held contradictory views and demands on lending costs as well as how to rein in inflation.

With 3-members being from RBI and 3-members being appointed by the Government the MPC paves the way for India's first collective interest-rate decision. The panel will be guided by the inflation targeting law that demands a retail inflation target of 4%, plus/minus 2 percentage points on either side, till 31 March 2021. The first such MPC is scheduled conduct its first monetary policy review on 4 October, header by Urjit Patel, the new RBI governor.

Structure of Monetary Policy Committee (MPC)

MPC is formed under the RBI with 6 members. Three of those members are from the RBI itself, while the other three members are appointed by the government. The RBI Governor is the chairman of the MPC. Other two members from RBI include a Deputy Governor and one officer of the RBI. The three members appointed by the government will be selected by the Centre on the recommendations of a search-cum-selection committee, to be headed by the Cabinet Secretary.

Presently for the 3 members appointed by the Government, the Appointments Committee of the Cabinet has approved the names of Professor Chetan Ghate, faculty at Indian Statistical Institute, Director at Delhi School of Economics (DSE) Pami Dua, and Ravindra Dholakia, professor at Indian Institute of Management, Ahmedabad, as MPC members. Experts in different fields these 3 members will serve for a period of four years and are not eligible for re-appointment.

The 3 memebers from RBI are Governor Urjit Patel, Deputy Governor of RBI R. Gandhi (he is also in charge of the monetary policy), and Executive Director of RBI Michael Patra.

In the MPC, the RBI governor only enjoys a casting vote and does not have veto power. All the decisions regarding setting policy rates and other monetary policy initiatives will be taken on the basis of majority vote. It is the responsibility of the MPC to manage and maintain an inflation targeting monetary policy regime.

The Committee must meet at least four times a year and the decisions taken in those meeting must be made public. There will not be any reappointment of the same committee.

Functions of Monetary Policy Committee (MPC)

This new MPC framework replaces the earlier system in which the RBI governor and his team had complete control over monetary policy. Though there was a committee that advised the RBI on monetary policy decisions, the central bank had no obligation to accept its recommendations.

The main function of the MPC is Inflation Targeting and to form a suitable Monetary Policy for the continued and effective growth of the economy. The members of the panel are free to suggest reasons for their support or opposition for a change in policy. This will have to be published in the minutes of meeting of the MPC (public announcements of decision taken in a meeting).

Countries like USA and the United Kingdom have similar panels to form their monetary policies, with representation from both the government and the central bank. The preamble of the RBI Act has been amended by the Finance Act, 2016 which now proclaims that the primary objective of India’s monetary policy is to “maintain price stability, while keeping in mind the objective of growth”.

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