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Monetary Policy Committee – Structure and Functioning

Monetary Policy Committee – Structure and Functioning

UPSC CSE Mains Syllabus: GS-3- Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment.

Monetary Policy Committee – Structure and Functioning

On October 1, the Reserve Bank of India’s Monetary Policy Committee (MPC) was supposed to announce the country’s key interest rates and the monetary policy for the next two months. This will have to wait as the government is yet to appoint three new members at a time when the pandemic is raging, GDP growth is floundering and borrowers are bracing for a mega loan restructuring process.

What is MPC:

  • The Monetary Policy Committee (MPC) is a committee of the Central Bank in India (Reserve Bank of India), headed by its Governor, which is entrusted with the task of fixing the benchmark policy interest rate (repo rate) to contain inflation within the specified target level.
  • Monetary Policy Committee is defined in Section 2(iii)(cci) of the Reserve Bank of India Act, 1934and is constituted under Sub-section (1) of Section 45ZB of the same Act.
  • The MPC replaces the current system where the RBI governor, with the aid and advice of his internal team and a technical advisory committee, has complete control over monetary policy decisions.
  • A Committee-based approach will add lot of value and transparency to monetary policy decisions.
  • MPC was set up consequent to the agreement reached between Government and RBI to task RBI with the responsibility for price stability and inflation targeting.
  • The Reserve Bank of India and Government of India signed the Monetary Policy Framework Agreementon 20 February 2015.

Functions of the MPC:

  • Under the Monetary Policy Framework Agreement, the RBI will be responsible for containing inflation targets at 4% (with a standard deviation of 2%) in the medium term.
  • Under Section 45ZA(1) of the RBI Act, 1934, the Central Government determines the inflation target in terms of the Consumer Price Index, once in every five years in consultation with the RBI.
  • This target would be notified in the Official Gazette.
  • Though the central bank already had a monetary framework and was implementing the monetary policy, the newly designed statutory framework would mean that 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 as well as estimated time within which the inflation target shall be achieved. (The factors that constitute failure shall be such as may be notified by the Central Government in the Official Gazette.)
  • 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 policy rate (repo rate) so as to contain the inflation within the target level specified to it by the Central Government.  
  • Each Member of the Monetary Policy Committee has to write a statement specifying the reasons for voting in favour of, or against the proposed resolution, and the same alongwith the resolution adopted by the MPC is published as minutes of the meeting by RBI after 14 days of the said meeting.
  • In addition, subsequent to the MPC meeting, RBI has to publish a document explaining the steps to be taken by it to implement the decisions of the Monetary Policy Committee, including any changes thereto.
  • Constitution of the MPC
  • The Central Government constitutes the MPC through a notification in the Official Gazette.
  • Altogether, the MPC will have six members, – the RBI Governor (Chairperson), the RBI Deputy Governor in charge of monetary policy, one official nominated by the RBI Board and the remaining three members would represent the Government of India.
  • These Government of India nominees are appointed by the Central Government based on the recommendations of a  search cum selection committee consisting of the cabinet secretary (Chairperson), the RBI Governor,  the secretary of the Department of Economic Affairs, Ministry of Finance, and three experts in the field of economics or banking as nominated by the central government.

Assessment of its functioning so far:

  • The bi-monthly MPC meeting discusses the domestic and international scenario before finalising the repo and reverse repo rates.
  • If there is no consensus on the rate or policy, there will be voting process.
  • MPC members differed on a couple of occasions on the quantum of repo rate changes but eventually went by the majority decision.
  • Although the MPC slashed the key policy rate — repo rate — by 250 basis points to four per cent, the rate cut transmission has been rather slow with banks taking their time to pass on the benefits.
  • The first MPC meeting was held on October 4, 2016 when Urjit Patel was the RBI Governor.
  • The MPC has since then slashed the repo rate by 250 basis points to 4% in the last four years with 115 bps reduction in the last nine months.
  • With retail inflation picking up in recent months, the MPC in its last policy review in August kept the repo rate unchanged at 4% while deciding to continue with the accommodative stance.
  • The current inflation target is 4% — within a band of 2-6% — which the RBI is expected to maintain.
  • The retail inflation level is now above the target of 6% with the August reading at 6.69%, and it has been above the medium-term target of 4% for nearly a year now.
  • The amended RBI Act defines failure as average inflation breaching the tolerance band for three consecutive quarters, not instantly.

Delay and its impacts:

  • Interest rates play a crucial role in the economy.
  • Any delay in changing the rates will impact the economy as MPC sets the repo rate (the rate at which RBI lends funds to banks) and reverse repo rate (the rate at which the RBI borrows funds from banks).
  • The pandemic is still evolving and credit offtake has been sluggish.
  • The economy is facing a serious challenge and the RBI has been leading from the front with quick responses through rate cuts, injecting liquidity through open market operations and long-term repo operations and a variety of innovative tools to manage and ensure financial stability.
  • In this hour of economic emergency, the MPC has to be in place to formulate policy. This delay could have been avoided.

POSSIBLE UPSC MAINS EXAMINATION:

What are the objectives of the Monetary Policy Committee (MPC)? Give an assessment of the functioning of the MPC.