RBI’s MPC Meet

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Context: The Reserve Bank of India (RBI) released its monetary policy statement on June 8, in which it stated that it has decided to keep the policy repo rate under the liquidity adjustment facility (LAF) unchanged at 6.50%. The policy repo rate is the rate at which the RBI lends money to commercial banks in case of any shortfall of funds.

Details

• The decision was taken by the Monetary Policy Committee (MPC) headed by the RBI Governor and comprising three external experts and three RBI officials. The MPC meets every two months to review the macroeconomic situation and decide on the monetary policy stance.
• This is the second time in a row that the MPC has paused the policy rate, after raising it by a total of 250 basis points between June 2018 and February 2020 to curb inflationary pressures.

Key Highlights of the MPSC Meet

The RBI Governor said that the other key policy rates also remain unchanged.

• The standing deposit facility (SDF) rate, which is the rate at which the RBI pays interest on excess liquidity parked by banks with it, is kept at 6.25%.
• The marginal standing facility (MSF) rate and the Bank Rate, which are the rates at which the RBI provides emergency liquidity support to banks, are kept at 6.75%.
• These rates form a corridor around the policy repo rate and help in maintaining stability in the money market.

Accommodative stance

• The MPC also decided to continue with an accommodative stance as long as necessary to revive growth on a durable basis and mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target range of 4% +/- 2%, as mandated by the government.
• The MPC noted that inflation has moderated in recent months, but remains above the upper bound of the target range due to supply-side factors such as high food and fuel prices.

The RBI Governor gave an outlook on economic activity and inflation.

• He said that the headline inflation trajectory would be influenced by food price dynamics, which are subject to both upside and downside risks.
• He said that wheat prices may soften due to robust arrivals and procurement in the mandis, while milk prices may remain elevated due to supply shortfalls and high fodder costs.
• He expressed optimism about the prospects for agricultural production, given the forecast of a normal southwest monsoon by the India Meteorological Department (IMD). However, he cautioned that the spatial and temporal distribution of rainfall would be crucial for crop sowing and harvesting.
• He said “Crude oil prices have softened but the outlook is still unclear. Based on the preliminary data from the Reserve Bank’s surveys, firms in manufacturing, services and infrastructure sectors reported higher expectations for input costs and output prices”.
• He said higher rabi crop output in 2022-23, the anticipated normal monsoon, and the continued momentum in services should boost private consumption and overall economic activity in the current year.
• The government’s focus on capital expenditure, moderation in commodity prices and strong credit growth are expected to stimulate investment activity. Weak external demand, geoeconomic fragmentation, and prolonged geopolitical tensions, however, pose risks to the outlook, he added.
• Taking all these factors into account, real GDP growth for 2023-24 has been forecasted at 6.5%, with risks evenly balanced, he further stated.

Monetary Policy Committee (MPC)

• The Monetary Policy Committee (MPC) is a body of six members that decides the key policy interest rate and the monetary policy stance of the Reserve Bank of India (RBI).
• The policy interest rate, also known as the repo rate, is the rate at which the RBI lends money to commercial banks for short-term purposes.
• The monetary policy stance is the direction in which the MPC intends to move the policy rate in the near future.

Background

• The MPC was set up in 2016 as a result of an agreement between the RBI and the Government of India to ensure transparency and accountability in the conduct of monetary policy. The agreement, also known as the Monetary Policy Framework Agreement, was signed in 2015 and came into effect in 2016.
• The agreement specified the objectives, targets, and instruments of monetary policy, as well as the composition, functions, and procedures of the MPC.

Composition

• The MPC has three members from the RBI, including the Governor, who acts as the chairperson, and two other officials nominated by the RBI. The other three members are external experts appointed by the Government based on their knowledge and experience in economics, banking, finance, or monetary policy.
  • The external members have a term of four years and are not eligible for reappointment.
• The MPC members have one vote each and in case of a tie, the Governor has a casting vote.

Working Structure

• The MPC meets at least four times a year and more often if necessary. The meetings are usually held two weeks before the end of each quarter and last for two days.
• The MPC reviews the macroeconomic and financial developments and projections and decides on the policy rate and stance by majority vote.
• The MPC publishes its decisions and rationale after each meeting in a resolution statement, along with a summary of its deliberations and individual votes.

The MPC has several features that make it an effective and credible institution for monetary policymaking.

Maintain Price Stability

• It has a clear mandate to maintain price stability while keeping in mind the objective of growth.
  • Price stability is defined as low and stable inflation that does not distort economic decisions and preserves the value of money.
  • Growth is defined as sustainable and inclusive economic expansion that creates employment opportunities and improves living standards.
• For achieving price stability, the MPC has a target range of 2-6% for consumer price inflation (CPI), which is measured by changes in the prices of a basket of goods and services consumed by an average urban household.
• The target range is reviewed every five years by the RBI and the Government based on their assessment of macroeconomic conditions and global best practices.

Operational independence

• It has operational independence to decide the policy rate and stance without any interference from the Government or other authorities.
• Operational independence means that the MPC has full autonomy in choosing its instruments and methods to achieve its objectives, without being influenced by political or other pressures.
• Operational independence is ensured by a statutory basis under the RBI Act 1934, which gives it legal authority and protection to conduct monetary policy.
• Operational independence is also supported by institutional arrangements such as a fixed term for external members, a secretariat for providing technical support, and a code of conduct for ensuring ethical standards.

Flexible Inflation Targeting

• It has a flexible inflation targeting framework that allows it to adjust the policy rate in response to changing economic conditions and inflation expectations.
• Flexible inflation targeting means that while maintaining price stability as its primary objective, the MPC also takes into account other factors such as the output gap (the difference between actual and potential output), exchange rate movements, financial stability risks, and fiscal policy stances that affect inflation and growth outcomes.
• Flexible inflation targeting also means that while aiming for a medium-term inflation target of 4%, with a tolerance band of +/- 2%, the MPC allows for some deviations from the target in case of temporary shocks or structural changes that are beyond its control.
• Flexible inflation targeting enables the MPC to respond effectively to various scenarios such as demand-pull inflation (when aggregate demand exceeds aggregate supply), cost-push inflation (when input costs such as wages or raw materials increase), or deflation (when prices fall below zero).

Transparent Communication

• It has a transparent communication strategy that enhances its accountability and predictability.
• Transparent communication means that the MPC provides clear and timely information on its objectives, decisions, rationale, outlook, and risks to various stakeholders such as the public, the media, and the financial markets.
• Transparent communication helps in building trust and confidence in the MPC and its policies, and in aligning inflation expectations with the inflation target.
• Transparent communication helps in improving monetary transmission, which is the process by which changes in the policy rate affect other interest rates, exchange rates, asset prices, and ultimately inflation and growth.
• Transparent communication is achieved by various means such as releasing a monetary policy report every six months that explains its assessment of the macroeconomic situation and its policy outlook, holding a press conference after each MPC meeting, publishing the minutes of the MPC meetings within 14 days, and disclosing the individual votes of the MPC members.

The MPC has significant implications for the Indian economy and financial markets

Foster Economic Growth and Stability

• By anchoring inflation expectations and ensuring price stability, the MPC can foster economic growth and stability in the medium to long term.
• Price stability has several benefits for the economy such as enhancing consumer confidence and spending, reducing borrowing costs and debt burdens, improving investment and productivity, increasing competitiveness and exports, and reducing poverty and inequality.
• Price stability also helps in maintaining macroeconomic stability by avoiding boom-bust cycles, currency crises, and hyperinflation that can have adverse effects on growth and welfare.

Guidance on its Policy actions and Outlook

• By providing clear guidance on its policy actions and outlook, the MPC can reduce uncertainty and volatility in the financial markets and improve monetary transmission.
• Financial markets are sensitive to changes in monetary policy and react to signals from the MPC.
• By communicating its policy intentions and expectations clearly, the MPC can influence market interest rates, exchange rates, asset prices, and market sentiments in the desired direction.
• By reducing uncertainty and volatility in the financial markets, the MPC can enhance liquidity and efficiency in the financial system, and support financial inclusion and innovation.
• By improving monetary transmission, the MPC can ensure that its policy actions have the intended effects on inflation and growth.

Credible and reputable MPC

• By enhancing the credibility and reputation of the RBI, the MPC can strengthen its role as an independent central bank and a lender of last resort.
  • Credibility means that the MPC can achieve its objectives consistently and reliably over time.
  • Reputation means that the MPC is respected and trusted by various stakeholders for its competence and integrity.
• By having a credible and reputable MPC, the RBI can enhance its authority and influence as an independent central bank that conducts monetary policy without any political or other interference.
• The RBI can also perform its other functions such as regulating and supervising banks and other financial institutions, managing foreign exchange reserves, issuing currency notes, promoting financial inclusion and literacy, and maintaining financial stability more effectively.
• The RBI can also act as a lender of last resort that provides emergency liquidity support to banks or other financial entities in times of crisis or distress.

The MPC faces several challenges in fulfilling its mandate, especially in the context of a complex and dynamic economy like India. Some of these challenges are:

Managing the trade-off between growth and inflation

• The MPC has to balance the need for stimulating economic growth and containing inflationary pressures.
• The MPC has to consider the impact of its policy actions on various sectors of the economy, such as agriculture, industry, services, exports and imports. For example, a lower interest rate may boost investment and consumption, but may also increase inflation and current account deficit. A higher interest rate may curb inflation and external imbalance, but may also dampen growth and employment.

Dealing with supply shocks

• The MPC has to cope with frequent supply shocks that affect the inflation dynamics in India. These shocks may arise from factors such as fluctuations in global commodity prices, weather conditions, pandemics, geopolitical events, etc.
• The MPC has to assess the nature and persistence of these shocks and adjust its policy stance accordingly. For example, a rise in crude oil prices may increase inflation and fiscal deficit, but may also improve terms of trade and tax revenue. Drought may reduce agricultural output and income but may also lower food inflation and rural demand.

Communicating effectively with the public

• The MPC has to communicate its policy rationale and expectations clearly and consistently to the public and other stakeholders. The MPC has to enhance its credibility and transparency by providing forward guidance and explaining its policy actions.
• The MPC also has to monitor and respond to feedback from various channels, such as financial markets, surveys, media, etc. For example, clear communication of the inflation target and policy stance may anchor inflation expectations and reduce uncertainty. A timely response to market signals and public opinion may improve policy effectiveness and accountability.

The MPC also has to explore ways to improve its effectiveness and efficiency in conducting monetary policy. Some of these ways are:

Strengthening the data and analytical framework

• The MPC has to rely on timely and reliable data and analysis to make informed policy decisions. The MPC has to enhance its data collection and dissemination systems and use advanced statistical and econometric tools to assess current and future economic conditions. For example, a high-frequency data dashboard may help the MPC track key macroeconomic indicators and identify emerging trends. A robust forecasting model may help the MPC project various scenarios and evaluate alternative policy options.

Coordinating with other policies

• The MPC has to coordinate with other policies that affect the macroeconomic environment, such as fiscal policy, exchange rate policy, financial sector regulation, etc.
• The MPC has to ensure that its policy actions are consistent and complementary with other policies and do not create any conflicts or distortions. For example, a sound fiscal policy may support monetary policy by reducing fiscal dominance and crowding out effects. A flexible exchange rate policy may support monetary policy by absorbing external shocks and maintaining external competitiveness.

Learning from best practices

• The MPC has to learn from the experiences and best practices of other central banks and monetary policy committees around the world.
• The MPC has to benchmark its performance against international standards and adopt suitable innovations and reforms to enhance its policy framework. For example, a peer review mechanism may help the MPC learn from other countries successes and failures in monetary policy. A periodic review of the inflation target and policy framework may help the MPC adapt to changing economic conditions.

Conclusion

• The MPC has played a crucial role in maintaining macroeconomic stability in India since its inception. It has also demonstrated its flexibility and responsiveness in dealing with unprecedented challenges posed by the COVID-19 pandemic. The MPC will continue to strive for achieving its mandate of price stability while supporting growth in a dynamic and evolving economy.

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