Monetary Policy Committee I IASTarget IAS Target

Monetary Policy Committee

22 Feb 2020

Category : Economical Issue

Topic: Monetary Policy Committee

The Monetary Policy Committee (MPC) is the body of the RBI, headed by the Governor, responsible for taking the important monetary policy decision about setting the repo rate. Repo rate is ‘the policy instrument’ in monetary policy that helps to realize the set inflation target by the RBI (at present 4%). The MPC replaces the previous arrangement of Technical Advisory Committee. The MPC was setup after a Memorandum of Understanding between the government and the RBI about the conduct of the new inflation targeting monetary policy framework in February 2015. First meeting of the MPC was held on October 4, 2016 after the Government made amendment of the RBI Act in June 27, 2016. Committee’s meeting also marked the beginning of full-fledged implementation of the new inflation targeting monetary policy framework.

Framework of MPC

Monetary Policy Framework Agreement is an agreement reached between Government and the central bank in India – The Reserve Bank of India (RBI) - on the maximum tolerable inflation rate that RBI should target to achieve price stability.

Constitution of MPC

The 6 members Monetary Policy Committee (MPC) constituted by the Central Government as per the Section 45ZB of the amended RBI Act, 1934. The first meeting of the Monetary Policy Committee (MPC) was held on in Mumbai on October 3, 2016.

The composition of the MPC as on April 2019 is as follows;

  • Governor of the Reserve Bank of India – Chairperson, ex officio;
  • Deputy Governor of the Reserve Bank of India, in charge of Monetary Policy – (Member, ex officio)
  • One officer of the Reserve Bank of India to be nominated by the Central Board – Member, ex officio; and three member appointed by Government of India

Voting power of MPC on key issues

The proceedings of MPC are confidential and the quorum for a meeting shall be four Members, at least one of whom shall be the Governor and in his absence, the Deputy Governor who is the Member of the MPC. The MPC takes decisions based on majority vote. In case of a tie, the RBI governor will have the second or casting vote. The decision of the Committee would be binding on the RBI.

No act or proceeding of the Monetary Policy Committee shall be invalid merely by reason of:

  • any vacancy in, or any defect in the constitution of the MPC; or
  • any defect in the appointment of a person acting as a Member of the MPC; or
  • any irregularity in the procedure of the MPC not affecting the merits of the case.

As per the Act, RBI has to organise at least four meetings of the MPC in a year. The government may, if it considers necessary, convey its views, in writing, to the MPC from time to time. RBI is mandated to furnish necessary information to the MPC to facilitate their decision making and if any Member of the MPC, at any time, requests the RBI for additional information, including any data, models or analysis, the same have to be provided, not just to that member but to all member

Functions of the MPC

  • Under the Monetary Policy Framework Agreement, the RBI will be responsible for containing inflation targets at 4% (with a standard deviation of +-2%) in the medium term.
  • Under the RBI Act, 1934, the Central Government determines the inflation target in terms of the Consumer Price Index, once in every five years in consultation with the RBI. This target would be notified in the Official Gazette.
  • Though the central bank already had a monetary framework and was implementing the monetary policy, the newly designed statutory framework would mean that the RBI would have to give an explanation in the form of a report to the Central Government, if it failed to reach the specified inflation targets. It shall, in the report, give reasons for failure, remedial actions as well as estimated time within which the inflation target shall be achieved.
  • Further, RBI is mandated to publish a Monetary Policy Report every six months, explaining the sources of inflation and the forecasts of inflation for the coming period of six to eighteen months.
  • Given this backdrop, MPC decides the changes to be made to the policy rate (repo rate) so as to contain the inflation within the target level specified to it by the Central Government.
  • Each Member of the Monetary Policy Committee has to write a statement specifying the reasons for voting in favour of, or against the proposed resolution, and the same alongwith the resolution adopted by the MPC is published as minutes of the meeting by RBI after 14 days of the said meeting. In addition, subsequent to the MPC meeting, RBI has to publish a document explaining the steps to be taken by it to implement the decisions of the Monetary Policy Committee, including any changes thereto.

Instruments of MPC

Repo Rate. Bank rate in India is determined by Reserve Bank of India (RBI). It is the rate at which RBI gives loan to commercial banks without keeping any collateral. The RBI also provides short term loans to its clients (keeping collateral) which is called the repo rate.
Liquidity Adjustment Facility A liquidity adjustment facility (LAF) is a tool used in monetary policy, primarily by the Reserve Bank of India (RBI), that allows banks to borrow money through repurchase agreements (repos) or for banks to make loans to the RBI through reverse repo agreements. This arrangement manages liquidity pressures and assures basic stability in the financial markets. The RBI introduced the LAF as a result of the Narasimham Committee on Banking Sector Reforms (1998).
Cash Reserve Ratio Cash reserve ratio is the amount of funds that the banks have to keep with the RBI. If the central bank decides to increase the CRR, the available amount with the banks comes down. The RBI uses the CRR to drain out the excessive money from the system. Scheduled banks are required to maintain with the RBI an average cash balance, the amount of which shall not be less than 4% of the total of the net demand and time liabilities.
Reverse Repo Rate Reverse repo rate is the rate at which the RBI borrows money from commercial banks. The rate at which the RBI lends money to commercial banks is known as repo rate. It is an instrument of monetary policy. Whenever banks have any shortage of funds they can borrow money from the RBI.
Statutory liquidity ratio (SLR) Statutory liquidity ratio (SLR) is the term used for reserve requirement that the commercial banks in India require to maintain in the form of gold, government approved securities before providing credit to the customers.
REPO denotes Re Purchase Option REPO denotes Re Purchase Option – the rate by which RBI gives loans to other banks. In other words, it is the rate at which banks buy back the securities they keep with the RBI at a later period. Bank gives loan to the public at a higher rate, often 1% higher than REPO rate, at a rate known as Bank Rate (now bank rate will be 8.75%). RBI at times borrows from banks at a rate lower than REPO rate, and that rate is known as Reverse REPO rate (now 6.75%).
Marginal standing facility (MSF) Marginal standing facility (MSF) is a window for banks to borrow from the Reserve Bank of India in an emergency situation when inter-bank liquidity dries up completely.
Market Stabilization Scheme (MSS) Market Stabilization Scheme (MSS) is a monetary policy tool used by the RBI to manage money supply in the economy. Under Market Stabilization Scheme or MSS, if there is an excess money supply in the economy, RBI intervenes by selling Government securities (like Treasury Bills, Cash Management Bills & Dated securities.). This helps to withdraw the excess liquidity from the system.
Corridor The MSF rate and reverse repo rate determine the corridor for the daily movement in the weighted average call money rate.
Open Market Operations Open market operations is the sale and purchase of government securities and treasury bills by RBI or the central bank of the country.

The objective of OMO is to regulate the money supply in the economy.

RBI carries out the OMO through commercial banks and does not directly deal with the public. When the RBI wants to increase the money supply in the economy, it purchases the government securities from the market and it sells government securities to suck out liquidity from the system