The Monetary Policy Committee
(MPC), Indian central bank’s rate-setting body under a new monetary policy framework put in place in 2016, had its 24th meeting last week, completing its four-year term. Six members of the MPC unanimously decided to keep the policy rate on hold. Many of the MPC’s calls have been unanimous, but not all. In the past 24 meetings, there have been split decisions on 14 occasions.
During its four-year tenure, the MPC opted for a status quo 13 times, a rate cut at nine meetings and a hike twice. While the quantum of rate hike was 25 basis points (bps) on both occasions, the cut varied between 25 bps and 75 bps. There were even unconventional 35 and 40 bps rate cuts. (One bps is a hundredth of a percentage point.) The peak policy rate during this time has been 6.5 per cent and base 4 per cent, its historic low.
The architecture was put in place after the Reserve Bank of India
(RBI) got the mandate for flexible inflation targeting based on the report of the Expert Committee to Revise and Strengthen the Monetary Policy Framework, chaired by former RBI Governor Urjit Patel.
The panel outlined the glide path for inflation — from 10 per cent to 8 per cent and 6 per cent, in phases — and, finally, a 4 per cent target with a plus/minus band of 2 percentage points.
For the first five years, the mandate is 4 per cent inflation targeting with the band. This ends in March 2021. (Even though the new law that put in place the structure came into effect in August 2016, the RBI and the government had signed the so-called memorandum of understanding for this in March 2016.)
If it breaches this for three consecutive quarters, the RBI needs to inform the government why that happened and how it wants to bring inflation down within the band.
With regard to sticking to its inflation mandate, the MPC scores well as inflation in Asia’s third-largest economy has mostly remained within the band during the new regime. It dropped below the floor only for two months; and in the past six months, till June, the average inflation has been higher than 6 per cent.
While the MPC has an inflation target, it must also take into consideration the output gap — that is, the actual output growth relative to the trend and potential. This means while maintaining low inflation, it cannot throw growth out of the window. However, there is no particular weight given to inflation and growth; it has been left to the committee. Patel was probably striving to achieve the inflation target, keeping in mind the objective of growth. For the current governor, Shaktikanta Das, growth is priority No. 1 while inflation should be kept within the band. Of course, the economic context has changed and that explains the change in priorities, if any.
Former RBI deputy governor Viral Acharya says, “There is an implicit asymmetric pressure on the monetary policy authority’s interest rate decisions: Rate cuts are preferred and inflation forecasting errors on the downside are okay (even welcome!), while rate hikes are particularly disliked along with inflation forecasting errors on the upside.”
Theoretically, the government can always influence the RBI governor and, in turn, the governor can influence the other two MPC members from the central bank. A move away from the previous framework that made the RBI governor the ultimate authority on this, the MPC now has six members to decide on the direction of India’s monetary policy — three each from the RBI and the academic world. If there is a three-all decision, the governor has the casting vote.
However, during the life of the first MPC, there have been occasions when all three central bankers did not vote unanimously. During its sixth meeting in August 2017, when the MPC voted for a 25 bps rate cut, Patel and his deputy (Acharya) were in favour of the cut along with two external members, but Michael Patra, from the RBI, was for the status quo. Similarly, in April 2019, when the MPC went for a rate cut by an identical margin, Das and Patra along with two other external members favoured it, but Acharya was opposed to it.
The debate on whether the inflation target is still valid has been growing.
Former RBI Governor D Subbarao recently said, “We benchmark inflation in India to global inflation. There is consensus forming around a view that the world has entered a structurally low inflation era because of secular stagnation, demographic dynamics and technology progress. If that is the case, should we still target 4 per cent inflation or mark it down?”
But not everybody is convinced. India is a developing economy and it cannot target a 2 per cent floor for inflation, many say. In fact, they find the RBI inflexible in its inflation targeting, obsessed with the 4 per cent target. If the mandate continues, the lower band should be 1 per cent, making it 3-6 per cent (instead of 2-6 per cent) as 2 per cent is too low in the Indian context, they say.
Should the composition of the MPC be changed by bringing in market experts? The Federal Open Market Committee, the policymaking body of the US Federal Reserve, does not have such experts even though many of the US Federal Reserve bosses are from the market. Three external members of the first MPC are respected researchers with excellent academic background, but there is no harm in considering academicians with diverse backgrounds such as finance and labour along with economists for this body.
Finally, the MPC must have a say in the entire policy architecture: Both the rate at which the RBI gives money to banks and at which the banks park their excess liquidity with the central bank (reverse repo rate) — the so-called liquidity adjustment facility. Currently, it decides only the policy repo rate. So, the RBI could cut the reverse repo rate and make the MPC redundant. When the system is slush with excess liquidity, the reverse repo rate becomes the operational policy rate.
The writer, a consulting editor with Business Standard, is an author and senior adviser to Jana Small Finance Bank Ltd
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