Monetary Policy Committee (MPC)

Monetary Policy Committee (MPC)

Subject: Economy

Context: As widely expected, the RBI’s Monetary Policy Committee (MPC) maintained status quo on the policy repo rate with economic recovery still nascent and even as it assessed that the recent inflation pressures are transitory.

Concept

• The MPC is a statutory and institutionalized framework under the RBI Act, 1934, for maintaining price stability, while keeping in mind the objective of growth.
• The MPC determines the policy interest rate (repo rate) required to achieve the inflation target (4%).
• The Governor of RBI is ex-officio Chairman of the MPC.
• The Monetary Policy Report is published by the Monetary Policy Committee (MPC) of RBI.

Monetary Policy Committee (MPC)

• The Monetary Policy Committee (MPC) is a committee of the RBI, which is entrusted with the task of fixing the benchmark policy interest rate (repo rate)to contain inflation within the specified target level.
• The RBI Act, 1934 was amended by Finance Act (India), 2016to constitute MPC to bring more transparency and accountability in fixing India’s Monetary Policy.
• The policy is published after every meeting with each member explaining his opinions.
• The committee is answerable to the Government of India if the inflation exceeds the range prescribed for three consecutive months.
• Suggestions for setting up a Monetary policy committee is not new and goes back to 2002 when YV Reddy committee proposed to establish an MPC, then Tarapore committee in 2006, Percy Ministry committee in 2007, Raghuram Rajan committee in 2009 and then Urjit Patel Committee in 2013.

Composition and Working

• The committee comprises six members – three officials of the RBI and three external members nominated by the Government of India.
• The meetings of the Monetary Policy Committee are held at least 4 times a year and it publishes its decisions after each such meeting.
• The Governor of RBI is the chairperson ex officio of the committee.
• Decisions are taken by a majority with the Governor having the casting vote in case of a tie.
• They need to observe a “silent period” seven days before and after the rate decision for “utmost confidentiality”.

Instruments of monetary policy are of two types:

• Quantitative Instruments: General or indirect (Cash Reserve Ratio, Statutory Liquidity Ratio, Open Market Operations, Bank Rate, Repo Rate, Reverse Repo Rate, Marginal standing facility and Liquidity Adjustment Facility (LAF))
• Qualitative Instruments: Selective or direct (change in the margin money, direct action, moral suasion)

Monetary Policy decisions and projection

• The Reserve Bank of India’s Monetary Policy Committee raised the inflation target for fiscal 2001-22 but maintained the growth forecast at 9.5 per cent
• The RBI’s Monetary Policy Committee (MPC) maintained status quo on the policy repo rate with economic recovery still nascent and even as it assessed that the recent inflation pressures are transitory
• The repo rate despite the retail inflation projection for FY22 being upped to 5.7 per cent from 5.1 per cent. The revised projection is only 30 basis points below the RBI’s upper tolerance level of 6 per cent.
• Elevated inflation level and delayed recovery in the economy would have prompted the panel to keep rates steady. Interest rates in the banking system are expected to remain stable in the next couple of months.
• The RBI panel has hiked the inflation target for fiscal 2021-22 to 5.7 per cent from 5.1 per cent projected earlier. Although the target is below the RBI’s upper band of inflation target of six per cent, input prices are rising across manufacturing and services sectors and weak demand and efforts towards cost cutting are tempering the pass-through to output prices

Reasons for increase in retail inflation cited by RBI

• The combination of elevated prices of industrial raw materials, high pump prices of petrol and diesel with their second-round effects, and logistics costs continue to impinge adversely on cost conditions for manufacturing and services, although weak demand conditions are tempering the pass-through to output prices and core inflation.

Link between Growth, Inflation and Interest rates:

• In a fast-growing economy, in comes go up quickly and more and more people have the money to buy the existing bunch of goods.
• As more and more money chases the existing set of goods, prices of such goods rise. In other words, inflation (which is nothing but the rate of increase in prices) increases.
• To contain inflation, a country’s central bank typically increases the interest rates in the economy. By doing so, it incentivises people to spend less and save more because saving becomes more profitable as interest rates go up.
• However, when growth contracts, people’s incomes hit. As a result, less and less money is chasing the same quantity of goods. This results in either the inflation rate decelerating or it actually contracts (also called deflation).
• In such situations, a central bank decreases interest rates so as to incentivise pending and by that route boost economic activity in the economy.
• In the current Monetary Policy, RBI has not raised the interest rates even when retail inflation is high because RBI is facing an odd situation at present: GDP is contracting even as inflation is rising.
• This is happening because the pandemic has reduced demand, on the one hand, and disrupted supply on the other. As a result falling growth and rising inflation are happening at the same time.