08 Jul 2016 17:05 IST

All you wanted to know about...Monetary Policy Committee

Monetary policy decisions by central banks can have far-reaching implications for the economy, investors, savers and borrowers. And if seen to be taken by an individual, these decisions can cause a lot of heartburn. Therefore, globally many governments have solved this problem by appointing a committee.

On June 27, 2016, the Government amended the RBI Act to hand over the job of monetary policy-making in India to a newly constituted Monetary Policy Committee (MPC).

What is it?

The new MPC is to be a six-member panel that is expected to bring “value and transparency” to rate-setting decisions. It will feature three members from the RBI — the Governor, a Deputy Governor and another official — and three independent members to be selected by the Government.

A search committee (yes, another committee!) will recommend three external members, experts in the field of economics, banking or finance, for the Government appointees. The MPC will meet four times a year to decide on monetary policy by a majority vote. And if there’s a tie between the ‘Ayes’ and the ‘Nays’, the RBI governor gets the deciding vote.

Why is it important?

Until recently, India’s central bank used to take its monetary policy decisions based on the multiple indicator approach. Its rate decisions were expected to take into account inflation, growth, employment, banking stability and the need for a stable exchange rate.

As you can see, this is a tall order. Thus, RBI (with the Governor as the focal point) would be subject to hectic lobbying ahead of each policy review and trenchant criticism after it. The Government would clamour for lower rates while consumers bemoaned high inflation. Bank chiefs would want rate cuts, but pensioners would want high rates. RBI ended up juggling all these objectives and focussing on different indicators at different points in time.

To resolve this, RBI set up an Expert Committee under Urijit Patel to revise the monetary policy framework, and it came up with its report in January 2014. It suggested that RBI abandon the ‘multiple indicator’ approach and make inflation targeting the primary objective of its monetary policy. It also mooted having an MPC so that these decisions could be made through majority vote. Having both Government and RBI members on the MPC was suggested for accountability. The Government would have to keep its deficit under check and RBI would owe an explanation for runaway inflation.

Why should I care?

What happens to interest rates in the country matters to you as a saver, investor, consumer and borrower. High rates can help savers earn more on debt options. Loan-takers may prefer lower retes. The MPC will ensure that decisions on interest rates are made through debate by a panel of experts. The many-heads-are-better-than-one approach may also help ensure that the decision isn’t easily influenced by bias or lobbying.

India’s shift to an MPC, driven by a clear inflation-targeting framework, if it succeeds, may also ensure that consumers and investors can look forward to lower inflation rates over the long-term. The public disclosure of MPC deliberations will also tell you why its members batted for higher or lower rates.

The bottomline

The MPC may put a stop to the public skirmishes between the Government and the RBI. But with the RBI governor holding the casting vote, don’t expect controversies to die down.

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