The formal constitution of a Monetary Policy Committee (MPC), which will decide on the Reserve Bank of India’s benchmark interest rates, ends an over seven-decade-long tradition that vested this power with the governor. The three academic economists appointed by the Centre will join three representatives from the RBI to the MPC, with the governor being only one out of the six responsible for setting the central bank’s policy rates. The current governor, Urjit Patel, is known to keep a low profile, unlike his illustrious predecessor, Raghuram Rajan, and, to that extent, may seem to fit more easily into the new institutional arrangement where the governor, while having a casting vote in the event of a tie, cannot veto a majority decision.
This is welcome, given the inherent inadvisability of vesting absolute power in any institution with a single person, howsoever eminent he or she may be. The existing system for monetary policy formulation did provide for a Technical Advisory Committee. But its advice was not binding on the central bank.
The MPC — which may well decide whether interest rates are to be cut or not in the next policy review on October 4 — has its work cut out. On the face of it, its mandate is simple — to implement the new framework agreement mandating the central bank to achieve a retail inflation target of four per cent, plus or minus two percentage points. But that is easier said in a country where a significant chunk of inflation has to do with food prices, on which there is not much that monetary policy can do.
Nor is there clarity on what failure to meet the target would entail — apart from sending a report to the Centre stating reasons and the proposed remedial actions. Can the RBI — or the MPC, in this case — do anything about inflation that is also a result of fiscal profligacy or poor supply management at the level of the Centre and states?
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But having said that, an MPC should still lead to a more transparent method of determining interest rates, based on the opinion of not one, but six wise persons. That, within a modern monetary policy framework, should also ensure more accountability when it comes to delivering on inflation. Such accountability in other countries such as the US — which has a 12-member Federal Open Market Committee, of which seven are selected by the US President and also ratified by the senate — extends to bringing in legislative oversight on policy-making. It would be interesting to see how the new MPC evolves in India.
If the contribution of external experts adds more credibility to the process of interest rate setting — and this is complemented by regular consultation between Mint Street and North Block on coordination of monetary and fiscal policy actions — there could be no better collateral outcome from the new institutional arrangement.
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