Introduction to Monetary Policy Committee
The Reserve Bank of India’s (RBI) Monetary Policy Committee (MPC) meeting is scheduled to take place. The MPC was established in 2016 as part of the RBI’s formal adoption of flexible inflation targeting (FIT). Since its formation, the MPC has done a fine job of managing monetary policy. However, one issue remains – the MPC does not vote on all monetary instruments.
The Structure of MPC
The MPC’s structure was established by amending the RBI Act (1934). Chapter III-F was introduced, dedicated to inflation targets and the MPC. The RBI Act specifies that the MPC’s main job is to achieve the inflation target (4+/- 2%). The MPC will achieve this by determining the policy rate (repo rate). Other policy rates, such as the standing deposit facility and marginal standing facility, form a corridor with the repo rate and change automatically with changes in the repo rate.
Limitations of the Current System
Limiting the MPC vote to only the repo rate creates a problem, as the RBI uses other instruments to conduct monetary policy. Textbooks on Indian macroeconomics teach that apart from the repo rate, the RBI also deploys the cash reserve ratio (CRR) and statutory liquidity ratio (SLR) as monetary policy tools. In fact, both CRR and SLR were used as monetary policy tools much before the repo rate. Yet, the MPC only votes on the repo rate.
Why the MPC Only Votes on Repo
The committee established by the RBI in 2013 to revise and strengthen the monetary policy framework discussed how monetary policy has evolved in India. It recommended that the MPC vote on the policy rate. For SLR, it said that it should be reduced to levels of the liquidity coverage ratio, and there is no mention of CRR. Based on these recommendations, the RBI Act was amended, allowing for the constitution of the MPC.
Confusion in the Current Arrangement
Following legislative changes, the MPC resolution only votes on the repo rate, and the governor’s statement discusses other monetary policy instruments. However, this arrangement causes confusion. The MPC votes only on the repo rate, and the governor’s statement includes overall monetary policy instruments, but it is not clear who decides on the other instruments. This can lead to odd situations, such as the MPC keeping the repo rate unchanged but tweaking the CRR for liquidity.
Need for Reforms
The current MPC arrangement should be revisited and streamlined. It should vote on all monetary policy instruments, and the speeches/interviews of MPC members should be linked on the RBI website. This will help improve both transparency and communication from the central bank.
Conclusion
The Monetary Policy Committee has done a fine job of managing monetary policy since its formation. However, the limitation of voting only on the repo rate creates confusion and needs to be addressed. Reforms are necessary to streamline the current arrangement, ensuring that the MPC votes on all monetary policy instruments. This will lead to better transparency and communication, ultimately benefiting the country’s economic growth and development.
