MPC tasked with deciding benchmark interest rates

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Last week, the government notified the six-member Monetary Policy Committee (MPC), paving the way for it to decide key interest rates from the October 4 policy meeting onwards. The MPC has been tasked with deciding benchmark interest rates, which the RBI governor did so far. Here are the five key things you should know about the MPC.

1.What is a Monetary Policy Committee (MPC)?

It is an executive body of six members that will decide on policy rate for the Reserve Bank of India (RBI). It replaces the existing system of letting the RBI governor alone decide on the rate. Three members are from the central bank and three others are nominated by the government. All members will have a vote each, but in case of a tie, the RBI governor has a casting vote to break the tie. The MPC will meet for two days before deciding on rates. The first-ever meeting of the MPC is taking place today (3 October) and it will continue till tomorrow before the final decision is communicated on RBI website at 2.30 pm on that day.
2.Who are the members of the MPC?

Three members are from the central bank — RBI governor (Urjit Patel), deputy governor in charge of monetary policy (R. Gandhi) and an RBI-nominated executive (Michael Patra, RBI Executive Director). The other three members are nominated by the government. Currently, the three external members are well esteemed academicians — Chetan Ghate, professor, India Statistical Institute; Pami Dua, director, Delhi School of Economics; and Ravindra H Dholakia, professor, Indian Institute of Management (Ahmedabad). These external members will hold office for four years.

3. What is the mandate?

To keep inflation within the central point of 4 per cent for the next five years, while keeping growth considerations in mind. The tolerance band for inflation is 2 per cent on both sides of the central point. This means inflation reading could go up to 6 per cent or drop to 2 per cent. If the targets are not met for three consecutive readings, then the MPC will have to give in writing to the government why it failed to meet the objective.

4.So, what is left with RBI?

Everything else. It is a standard practice for countries where the central banks have inflation targeting mandate to have a monetary policy committee and India is no different. RBI still gets to decide on the other tools, for example on issues like liquidity, cash reserve ratio, statutory liquidity ratio, everything related to government bonds, foreign exchange market intervention and, of course, the whole of banking regulations.

5.How does the MPC make a difference?

The MPC improves transparency and brings a collective approach to the inflation problem. Even though the RBI governor has always been guided by his team as well as outside advisors, the final decision on rates was always of the governor alone. But in a world where people are asking more transparency from the central bank, an MPC was inevitable. As per the mandate, the MPC will have to release the minutes of the meetings after 14 days of the meet, which are expected to reveal how a member voted and why. Besides, the MPC is now accountable to the government and the people of India to keep inflation within a fixed target (to be fixed every five years). This will eventually bring about stability in the country’s financial system and attract more investors. Since half of the members are academicians, the deliberations in the meetings are expected to be of very high quality and the policy rate can be surmised to be a just prescription for the economy. Also, the data dependent methodical approach improves predictability of the policy and the markets are unlikely to get surprised on policy outcomes. This stabilises the market and is good for the country.

However, one point to be noted here is that surprising the market is also considered a potent weapon in the arsenal of the central bank (used, for example, when speculation threatens to destabilise the financial markets). But this approach is very rarely used and in any case, the RBI is left with enough means to surprise and even shock the market if it really wants to.

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