Monetary Policy Committee

The Monetary Policy Committee (MPC) is a group set up by the Central Government and led by the Governor of the RBI. It was created to set the benchmark policy interest rate (repo rate) to control inflation within a specified target. The RBI Governor makes monetary policy decisions with the support and advice of an internal team and a technical advisory committee.

Before the MPC was established, the RBI Governor made all interest rate decisions alone. The MPC was formed under the Reserve Bank of India Act, 1934, to bring more transparency and accountability to India’s monetary policy. The MPC meets at least four times a year, and after each meeting, the monetary policy is published, with each member explaining their opinions.

Use of Monetary Policy

Monetary policy involves regulating the money supply in an economy by the country’s monetary authority. It generally adjusts inflation rates or interest rates to maintain price stability and predictable exchange rates with foreign currencies. The Reserve Bank of India, the central banking authority, controls monetary policy in line with the central government’s development goals. The RBI is authorized to create monetary policy under the Reserve Bank of India Act, 1934.

Monetary policy can be either contractionary or expansionary and is distinct from fiscal policy, which deals with government taxation, spending, and borrowing. A rapid increase in the money supply is called an expansionary policy, while a slower increase or decrease is known as a contractionary policy. Various direct and indirect instruments are used to implement monetary policy, including:

• Repo rate
• Reverse Repo rate
• Liquidity Adjustment Facility (LAF)
• Marginal Standing Facility (MSF)
• Corridor
• Bank Rate
• Cash Reserve Ratio (CRR)
• Statutory Liquidity Ratio (SLR)
• Open Market Operations (OMOs)
• Market Stabilisation Scheme (MSS)

Objectives of Monetary Policy

Monetary policy aims to ensure reasonable price stability, high employment, and faster economic growth. The four main objectives are:

1. To stabilize the business cycle.
2. To provide reasonable price stability.
3. To foster faster economic growth.
4. To maintain exchange rate stability.

Formation of the Monetary Policy Committee

The idea for a five-member MPC was first proposed by the Urijit Patel Committee. As per the provisions of the RBI Act, out of the six Members of the Monetary Policy Committee, three Members will be from the RBI and the other three Members of the MPC will be appointed by the Central Government. The MPC, which came into effect on 27th June 2016, is assisted by the Monetary Policy Department (MPD) of the Reserve Bank in formulating policy. The Financial Markets Operations Department (FMOD) implements the monetary policy through daily liquidity management operations. The Members of the Monetary Policy Committee appointed by the Central Government shall hold office for a period of four years nd will not be eligible for reappointment.

Structure of the Monetary Policy Committee

The MPC was established under Section 45ZB of the RBI Act of 1934 by the Central Government. Its first meeting was held on 3rd October 2016 in Mumbai. The committee sets the policy interest rate needed to meet the inflation target and must meet at least four times a year. The quorum for an MPC meeting is four members. Each member has one vote, and in the case of a tie, the Governor has a second or casting vote. Every six months, the Reserve Bank must publish a Monetary Policy Report, explaining the sources of inflation and forecasting inflation for the next 6-18 months.

Members of the Monetary Policy Committee

The Monetary Policy Committee (MPC) comprises six members, including:

1. Governor of the Reserve Bank of India (RBI): The Governor of the RBI is the ex-officio chairperson of the MPC.
2. Deputy Governor of the RBI: One of the Deputy Governors of the RBI is a member of the MPC.
3. Two External Members: The government appoints two external members to the MPC. These members are experts in the field of economics, finance, or monetary policy.
4. Executive Director of the RBI: The Executive Director of the RBI is also a member of the MPC.
5. Secretary of the Department of Economic Affairs: The Secretary of the Department of Economic Affairs, Ministry of Finance, is a non-voting member of the MPC.

Various Instruments of Monetary Policy

1. Repo Rate: The interest rate at which the Reserve Bank provides overnight liquidity to banks against the collateral of government and other approved securities under the liquidity adjustment facility (LAF).
2. Reverse Repo Rate: The interest rate at which the Reserve Bank absorbs liquidity, on an overnight basis, from banks against the collateral of eligible government securities under the LAF.
3. Liquidity Adjustment Facility (LAF): The LAF consists of overnight as well as term repo auctions. The aim of term repo is to help develop the interbank term money market, which in turn can set market based benchmarks for pricing of loans and deposits, and hence improve transmission of monetary policy. The RBI also conducts variable interest rate reverse repo auctions, as necessitated under the market conditions.
4. Marginal Standing Facility (MSF): A facility under which scheduled commercial banks can borrow additional amount of overnight money from the Reserve Bank by dipping into their Statutory Liquidity Ratio (SLR) portfolio up to a limit at a penal rate of interest. This provides a safety valve against unanticipated liquidity shocks to the banking system.
5. Corridor: The MSF rate and reverse repo rate determine the corridor for the daily movement in the weighted average call money rate.
6. Bank Rate: It is the rate at which the RBI is ready to buy or rediscount bills of exchange or other commercial papers. The Bank Rate is published under Section 49 of the RBI Act, 1934. This rate has been aligned to the MSF rate and, therefore, changes automatically as and when the MSF rate changes alongside policy repo rate changes.
7. Cash Reserve Ratio (CRR): The average daily balance that a bank is required to maintain with the Reserve Bank as a share of such per cent of its Net demand and time liabilities (NDTL) that the Reserve Bank may notify from time to time in the Gazette of India.
8. Statutory Liquidity Ratio (SLR): The share of NDTL that a bank is required to maintain in safe and liquid assets, such as, unencumbered government securities, cash and gold. Changes in SLR often influence the availability of resources in the banking system for lending to the private sector.
9. Open Market Operations (OMOs): These include both, outright purchase and sale of government securities, for injection and absorption of durable liquidity, respectively.
10. Market Stabilisation Scheme (MSS): This instrument for monetary management was introduced in 2004. Surplus liquidity of a more enduring nature arising from large capital inflows is absorbed through sale of short-dated government securities and treasury bills.The cash so mobilised is held in a separate government account with the RBI.

Various Policy Stances of RBI

1. Accommodative: An accommodative stance means the central bank is prepared to expand the money supply to boost economic growth. The central bank, during an accommodative policy period, is willing to cut the interest rates. A rate hike is ruled out. The central bank typically adopts an accommodative policy when growth needs policy support and inflation is not the immediate concern.
2. Neutral: A ‘neutral stance’ suggests that the central bank can either cut rate or increase rate. This stance is typically adopted when the policy priority is equal on both inflation and growth. The guidance indicates that the market can expect a rate action on either way at any point.
3. Hawkish Stance: A hawkish stance indicates that the central bank’s top priority is to keep the inflation low. During such a phase, the central bank is willing to hike interest rates to curb money supply and thus reduce the demand. A hawkish policy also indicates tight monetary policy.When the central bank increases rates or 'tightens' the monetary policy, banks too increase their rate of interest on loans to end borrowers which, in turn, curbs demand in the financial system.
4. Calibrated Tightening: Calibrated tightening means during the current rate cycle, a cut in the repo rate is off the table. However, the rate hike will happen in a calibrated manner. This means the central bank may not go for a rate increase in every policy meeting but the overall policy stance is tilted towards a rate hike. This can happen outside the policy meetings as well if the situation warrants.