Modernizing the monetary policy framework

Deciding on monetary policy framework by a committee is the practice of US and UK. However the objective of the monetary policy committee differs among the nations. In UK the objective is to stabilize the price mandated by the government. It has to deliver on to balance the government‘s economic growth objective at the same time keeping the inflation low. While in US, the monetary policy objective serves to promote the sustainable output, employment and to stabilize the prices.

Monetary policy framework in India

The reserve bank of India is responsible for deciding upon monetary policies. It is the RBI which regulates the currency and credit system to secure the monetary stability in India. The main objectives of the monetary policy in India are to maintain the price stability, securing the financial stability and to ensure the adequate flow of credit.

In India the final decision on monetary policy is done by the RBI governor. The governor however holds general consultations with the 4 deputy governors, but the final decision comes from the governor’s desk. In India we already have informal monetary policy committee in the form of technical advisory committee (TAC) comprising of governor as its chairman, the deputy governor as its vice-chairman and other 3 deputy governors. Along with 5 external members, two form the central board of bank and the 3 nominated by a wider pool of experts by the RBI governor. However the committee is advisory in nature and is not put to vote, hence less democratic.

 Steps towards a new monetary policy framework

Urjit patel panel report becomes the locus classicus on monetary policy in India. One of its recommendations suggests monetary policy decisions to be vested to the MPC (Monetary Policy Committee). B N Srikrishna headed Financial sector legislative reforms Commission (FSLRC) also suggested framing a MPC to meet the challenge of the growing complex economy.

It is in the last budget speech the government signaled the formations of MPC, which become more concrete with this budget. It is time to move towards an MPC system in a phased manner. However it should be kept in mind that such framework should not tussle with the autonomy or demean the position of RBI, hence it should be given legally-backed autonomy. Also, since inflation is more of a dynamic situation which sometimes is dictated by the supply-side elements, in such conditions the central bank’s ability to control the inflation is restricted. So a coordinated balance between the finance ministry and the central bank is important to make the MPC realistic.

Significance of MPC

Transparency, clear communication and forward guidance are the pillars of modern monetary policy framework. This new framework would enable more transparency and make RBI more accountable, as now it will have to explain if it fails to meet the inflation targets. It will restrict the RBI form taking any aggressive policy instance. It would enable flexible inflation targeting, bringing the nation at par with the developed economy. Coordination between the RBI and the government would be strengthened.

MPC when formed would set CPI inflation target below 6% for January 2016, with a bandwith of +/- 2%. RBI will be considered if it fails to contain the inflation below 6% for the three consecutive quarters of 2015-16. And MPC would be asked for explanation and proposed remedial measures for failing to do so.

Composition of MPC

The MPC would comprise of RBI as its chairman, Deputy Governor as its vice-chairman. One executive director of RBI and two other Members from outside decided by the governor and the deputy governor on the basis of expertise and experience in economic policies, macroeconomics, financial markets, public finance and related areas. The membership conditions for the outsiders would be: they should not be holding any office of profit, should not be involved in work that is in conflict with RBI, a term of 3 years and not eligible for second term. Both will be full time member.

MPC must meet once in every two month and the decision should be made by majority voting with every member having single vote and governor and Deputy Governor casting their vote in case of tie. It should publish a bi-annual report and the explanation signed by all the members for failing to contain the inflation within the permissible limit. RBI shall be publishing the changes in the monetary policy targets in case any, because of changing macro-economic scenario. This will make RBI more accountable.

Such model of inflation targeting published in the public domain infuses the confidence and credibility of the government among the masses. This is good for the transparency, accountability and credibility of monetary policy in India.