Expert Committee Submits its Report on Determining Methodology for Fixing National Minimum Wage, Ministry of Labour and Employment Click here

Monetary Policy Committee (MPC)

From Arthapedia
Jump to: navigation, search

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, 1934 and 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.

 

Background
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 Agreement on 20 February 2015.

Subsequently, the government, while unveiling the Union Budget for 2016-17 in the Parliament, proposed to amend the Reserve Bank of India (RBI) Act, 1934 for giving a statutory backing to the aforementioned Monetary Policy Framework Agreement and for setting up a Monetary Policy Committee (MPC). Vide this amendment, it was written into the preamble of the RBI Act that the primary objective of the monetary policy is to maintain price stability, while keeping in mind the objective of growth, and to meet the challenge of an increasingly complex economy, RBI would operate a Monetary Policy Framework. Thus the amendment provides a statutory basis for a Monetary Policy Framework (MPF) and the MPC. This amendment to RBI Act was carried out through the Finance Bill, 2016 presented along with the Union Budget documents. A new Chapter (Chapter IIIF, Section 45Z) was introduced in the RBI Act, through this Finance Bill, 2016, detailing the operation of MPC. The provisions in the Bill become effective once it is passed and notified as an Act of Parliament.

Government decided to bring the provisions of amended RBI Act regarding constitution of MPC into force on 27 June, 2016 so that statutory basis of MPC is made effective. Rules governing the procedure for Selection of Members of Monetary Policy Committee and Terms and Conditions of their Appointment and factors constituting failure to meet inflation target under the MPC Framework were also notified on 27 June, 2016.

The history of suggestions for setting up a MPC is not new and traces back to 2002 when the Y. V. Reddy Committee recommended for a MPC to decide policy actions. Subsequently, suggestions were made to set up a MPC in 2006 by the Tarapore Committee, in 2007 by the Percy Mistry Committee, in 2009 by the Raghuram Rajan Committee and then in 2013, both in the report of the Financial Sector Legislative Reforms Commission (FSLRC) and the Dr. Urjit R. Patel (URP) Committee.  According to the URP Committee, "Heightened public interest and scrutiny of monetary policy decisions and outcomes has propelled a worldwide movement towards a committee based approach to decision making with a view to bringing in greater transparency and accountability in India."

 

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 (For more details see here). 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.

The three central government nominees of the MPC appointed by the search cum selection committee will hold office for a period of four years and will not be eligible for re-appointment. These three central government nominees in MPC are mandated to be persons of ability, integrity and standing, having knowledge and experience in the field of economics or banking or finance or monetary policy. RBI Act prohibits appointing any Member of Parliament or Legislature or public servant, or any employee / Board / committee member of RBI or anyone with a conflict of interest with RBI or anybody above the age of 70 to the MPC. Further, central government also retains powers to remove any of its nominated members from MPC subject to certain conditions and if the situation warrants the same.

 

Decision Making at MPC
The proceedings of MPC are confidential and the quorum for a meeting shall be four Members, at least one of whom shall be the Governor and in his absence, the Deputy Governor who is the Member of the MPC.

The MPC takes decisions based on majority vote (by those who are present and voting). In case of a tie, the RBI governor will have the second or casting vote. The decision of the Committee would be binding on the RBI.

No act or proceeding of the Monetary Policy Committee shall be invalid merely by reason of—

As per the Act, RBI has to organise at least four meetings of the MPC in a year. (More meetings can be held if the RBI Governor is of that opinion)

The government may, if it considers necessary, convey its views, in writing, to the MPC from time to time.
RBI is mandated to furnish necessary information to the MPC to facilitate their decision making and if any Member of the MPC, at any time, requests the RBI for additional information, including any data, models or analysis, the same have to be provided, not just to that member but to all members.


International Comparison
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 fund rate through the Federal Open Market Committee (FOMC). The federal funds rate is the interest rate at which depository institutions lend balances at the Federal Reserve to other depository institutions overnight. The Board of Governors of the Federal Reserve System is responsible for the discount rate and reserve requirements, and the Federal Open Market Committee is responsible for open market operations. The Federal Open Market Committee (FOMC) consists of twelve members--the seven members of the Board of Governors of the Federal Reserve System; the president of the Federal Reserve Bank of New York; and four of the remaining eleven Reserve Bank presidents, who serve one-year terms on a rotating basis. The FOMC holds eight regularly scheduled meetings per year.

The Bank of England also has a MPC to decide the official interest rate in the United Kingdom . The MPC meets every month to set the interest rate and meets over three days.  The Bank's Monetary Policy Committee (MPC) is made up of nine members – the Governor, the three Deputy Governors for Monetary Policy, Financial Stability and Markets & Banking, the Bank's Chief Economist and four external members appointed directly by the Chancellor. The MPC sets an interest rate it judges will enable the inflation target to be met. A representative from the Treasury also sits with the Committee at its meetings. The Treasury representative can discuss policy issues but is not allowed to vote. The purpose is to ensure that the MPC is fully briefed on fiscal policy developments and other aspects of the Government's economic policies, and that the Chancellor is kept fully informed about monetary policy. In addition to the monthly MPC minutes, the Bank publishes its Inflation Report every quarter. 

The transitioning from the current decision process to that of an MPC will impart diversity of views, specialised experience and independence of opinion in the monetary policy decisions which could help in improving the representativeness in the overall decision-making process.


Also See


Contributed by

Personal tools
Variants
Actions
Navigation
Concepts
Share Tools
Toolbox
Translate