Monetary Policy Agreement in India

Monetary Policy Agreement

What is Monetary Policy Agreement?

  • In 2015 The Government of India and Reserve Bank of India signed a Monetary Policy Framework Agreement. The new monetary policy framework was formed following the recommendations of a committee headed by RBI Deputy Governor Urjit Patel.
  • The objective of monetary policy framework is to primarily maintain price stability while keeping in mind the objective of growth.
  • As per the agreement, RBI would set the policy interest rates and would aim to bring inflation below 6 per cent by January 2016 and within 4 per cent with a band of (+/-) 2 per cent for 2016-17 and all subsequent years.
  • The central bank will be deemed to have missed its target if consumer inflation is at more than 6 percent or at less than 2 percent for three consecutive quarters starting in the 2015/16 fiscal year.
  • If the central bank misses the inflation target, it will send a report to the government citing reasons and remedial actions.
  • The central bank will also need to give an estimated time-period within which it expects to return to the target level.

Significance of Monetary Policy Agreement 

  • While the agreement gives a free hand to the RBI Governor to decide on the monetary policy measures to achieve the inflation target, it also requires the RBI to give out to the Central Government a report in case the target is missed for a period of time. Thus, it is a fine balance between autonomy and accountability.
  • The World over, the Central banks are moving towards an inflation targeting based criteria for managing monetary policy. The MPA is a step in that direction.
  • The MPA will put India into the League of Nations that followed a rule based monetary policy mechanism.

Monetary policy committee

What is the MPC?

  • The monetary policy committee framework will replace the current system where the RBI governor and his internal team have complete control over monetary policy decisions. While a technical advisory committee advises the RBI on monetary policy decisions, the central bank is under no obligation to accept its recommendations.
  • The committee will have six members, with three appointed by the Reserve Bank of India (RBI) and the remaining nominated by an external selection committee. The RBI governor will have the casting vote in case of a tie.
  • According to the Finance Bill, the committee will consist of the RBI governor, the deputy governor in charge of monetary policy and one official nominated by the central bank.
  • The other three members will be appointed by the central government through a search committee.
  • This search committee will comprise of the cabinet secretary, the secretary of the Department of Economic Affairs, the RBI governor and three experts in the field of economics or banking as nominated by the central government.
  • The members of the MPC appointed by the search committee shall hold office for a period of four years and shall not be eligible for re-appointment.
  • The idea to set up a monetary policy committee was mooted by a RBI-appointed committee led by deputy governor Urjit Patel in 2014.
  • The current members of the MPC are:
    1. Governor: DR Urijit Patel
    2. DY Governor RBI: DR Viral Acharya
    3. Executive Director RBI: Michael Patra
    4. External Member: Prof. Pami Dua
    5. External Member: Prof. Chetan Ghate
    6. External Member: Prof Ravindra Dholakia

Analysis of the MPC

  • There is very little to disagree about the desirability of transitioning from the current decision process to that of an MPC, imparting as it does a greater diversity of views, specialized experience and independence of opinion.
  • With the introduction of the monetary policy committee, the RBI will follow a system similar to the one followed by most global central banks. The US Federal Reserve sets its benchmark rate—the Fed funds rate—through the Federal Open Market Committee (FOMC). The Bank of England’s monetary policy committee is made up of nine members.
  • Setting up of MPC would make monetary policy making more democratic since currently, the RBI governor alone decides key interest rates. The committee will take a decision based on the majority vote. Each member will have one vote.
  • The final composition of MPC announced by the government seems to tread the middle path as it tries to address concerns over excessive government influence over monetary policy in the country Which the draft MPC invoked since under it proposed to strip the Governor of veto vote on the monetary policy besides powers for the government to appoint four of the six members.. The government, however, has reserved the right to send its views to the monetary policy committee, if needed.
  • Communicating the rationale of monetary policy actions is central to both the credibility of the central bank and to enable the incidence targets of the policy to adjust behavior appropriately.

By
Himanshu Arora
Doctoral Scholar in Economics & Senior Research Fellow, CDS, Jawaharlal Nehru University

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