The institution of the Monetary Policy Committee in many ways signals a monumental change in the process of decision-making at the Reserve Bank of India. For the first time beginning with the new monetary policy announcement scheduled for Oct 4, the committee rather than one person, who until now was the RBI governor, will decide the policy interest rates in the economy.
It is instructive as well as interesting to note that the institution of the MPC has been in the making for a rather long time; in fact the formation is the result of decade-long gradual and calibrated deliberations on the subject. Recommendations of several technical committees, beginning with the Committee on Fuller Capital Account Convertibility, 2006 under S.S. Tarapore; the Committee on Financial Sector Reforms, 2009 under Dr. Raghuram G. Rajan, the Committee on Financial Sector Assessment, 2009 under Dr. Rakesh Mohan; the Financial Sector Legislative Reforms Commission (FSLRC), 2013 under B.N. Srikrishna and the Expert Committee to Revise and Strengthen the Monetary Policy Framework, 2014 under Dr. Urjit R. Patel have gone a long way to give form and shape to what has now emerged as the MPC.
In short, the MPC was long overdue. As the RBI annual report points out, “it also represents a progressive graduation of the initial efforts towards collegial decision-making under the aegis of the technical advisory committee on monetary policy.” The learning experience gained by the Reserve Bank will help refine and entrench decision-making under MPC with the passage of time, says the RBI annual report.
That will be a gradual process. Meanwhile, there are some interesting questions that the MPC raises, given that it has been charged with that one decision (the policy interest rate) that is not only the most watched of all but equally one that evokes strong reactions from various sections, not to speak of the signals and pressures put out by the government.
First, it takes the pressure off the Governor, who can argue rather simply that the decision on rates is now not entirely dictated by the central bank. That would be a fair argument, limited though by the (less noticed) fact that half of the committee is still from the RBI and the Governor has a casting vote in case of a tie. So strictly speaking, the RBI could still have a decision it wants and the other committee members would in that case get to record their views and do no more than that. This is not to speak of the analytical and technical inputs for which the MPC must rely on the RBI, giving the central bank that much more lever on how the MPC will shape its view on the economy and so the interest rates. The RBI’s forward looking surveys will form an important input here, and will for the first time be tested for their robustness at a forum beyond the RBI.
Further, while the MPC will take a view on the policy repo rate, this view is necessarily tied to a view on a host of other indicators and variables which affect how the rates should move. It critically hinges on the forecast of the liquidity situation, outlook on the domestic and global macro-economic development, particularly economic growth, inflation, inflation expectations, current account deficit, capital flows and many lead indicators based on RBI surveys.
Thus, the MPC view on the policy interest rate cannot be divorced from its view on the liquidity management framework of the RBI, particularly the movement of the liquidity position closer to neutrality as set out by the RBI in its April monetary policy statement and the fine driving of this balance over time.
We still do not know if the monetary policy statement due on October 4 will be a Governor’s statement or the MPC statement. If the US model is followed, it should be the statement by the MPC, which will vote and choose a course of action on the policy interest rate. In the interest of transparency, it is desirable that the members and particularly the dissenting members should be named and their views and arguments be known to the people, as is the case in the US under its Federal Open Market Committee (FOMC). Following the prescriptions in the Urjit Patel Committee report, it is expected that the minutes of the meeting would be published with a lag of two weeks from the date of the meeting.
Also critical is the responsibility, accountability and timing of decision making. For an example, who is to be held responsible if the inflation target is not met under the Flexible Inflation Targeting (FIT) framework? According to the Monetary Policy Framework Agreement (MPFA) between the RBI and the Government of India signed and adopted on February 20, 2015, the objective of the monetary policy primarily is price stability while keeping in view the objective of growth. The inflation target for 2016-17 and all subsequent years was set at four per cent, within a variation of two per cent in either direction. This inflation target is applicable from August 5, 2016 to March 31, 2021.
The Reserve Bank shall be seen to have failed to meet the target if inflation remains above six per cent or below two per cent for three consecutive quarters. In such circumstances, the Reserve Bank is required to provide the reasons for the failure, the proposed remedial measures and the expected time to return to target numbers.
The Urjit Patel Committee report had recommended that the MPC be accountable for failure to achieve the inflation target. But in the agreement dated February 20, 2015, MPC was replaced with the RBI. This leads to a moral hazard problem, as the RBI would have to explain the non-achievement of a target that it can legitimately claim is dependent on decisions taken by the MPC.
The MPC has been duly constituted now with barely a fortnight to go for the October 4 policy. It comprises (as expected) the RBI Governor Dr. Urjit Patel, the RBI deputy governor in charge of monetary policy R. Gandhi, RBI Executive Director who has advised on monetary policy Michael Patra, and interestingly, three academics: Chetan Ghate, who was a member of the RBI’s technical advisory committee (which is effectively expected to be disbanded), Ravindra Dholakia and Pami Dua.
It should be obvious that six heads would be better than one when deciding on an important step that rolls down to impact millions in terms of their housing and car loans on the one hand and prices of everyday goods and commodities on the other. Yet, a committee can be no guarantee that the interests of the majority of common citizens will be protected. For that, we will still need to live by the true spirit of the monetary policy objective, which is price stability keeping in mind growth. It is not for nothing that price stability comes before growth.
Dr. R K Pattnaik is Professor of Economics at SPJIMR. Jagdish Rattanani is Editor, SPJIMR (Syndicate: The Billion Press)
