Context: The Monetary Policy Committee (MPC) has kept inflation front and centre of its approach to policy. The MPC’s recent unwavering focus on price stability is informed largely by its mandate to achieve the Consumer Price Index (CPI) inflation target of 4%, a goal that it has struggled to actualise right since January 2021 — a period during which inflation remained stuck above or close to the upper tolerance band of 6% in 20 of the 27 months.
About Monetary Policy
- Monetary policy is a set of tools used by a nation’s central bank to control the overall money supply and promote economic growth and employ strategies such as revising interest rates and changing bank reserve requirements.
- Under the Reserve Bank of India, Act,1934 (RBI Act,1934) (as amended in 2016), RBI is entrusted with the responsibility of conducting monetary policy in India with the primary objective of maintaining price stability while keeping in mind the objective of growth.
The Monetary Policy Framework
- In May 2016, the RBI Act, 1934 was amended to provide a statutory basis for the implementation of the flexible inflation targeting framework.
- Inflation Target: Under Section 45ZA, the Central Government, in consultation with the RBI, determines the inflation target in terms of the Consumer Price Index (CPI), once in five years and notifies it in the Official Gazette.
- Accordingly, the Central Government notified 4 per cent Consumer Price Index (CPI) inflation as the target for the period from August 5, 2016 to March 31, 2021 with the upper tolerance limit of 6 per cent and the lower tolerance limit of 2 per cent. On March 31, 2021, the Central Government retained the inflation target and the tolerance band for the next 5-year period – April 1, 2021 to March 31, 2026.
- Section 45ZB of the RBI Act provides for the constitution of a six-member Monetary Policy Committee (MPC) to determine the policy rate required to achieve the inflation target.
Monetary Policy Committee
- Section 45ZB of the amended RBI Act, 1934 provides for an empowered six-member monetary policy committee (MPC) to be constituted by the Central Government by notification in the Official Gazette. The first such MPC was constituted in September, 2016. The present MPC members, as notified by the Central Government in the Official Gazette of October, 2020, are as under:
- Governor of the Reserve Bank of India – Chairperson, ex officio
- Deputy Governor of the Reserve Bank of India, in charge of Monetary Policy – Member, ex officio
- One officer of the Reserve Bank of India to be nominated by the Central Board – Member, ex officio
- Prof. Ashima Goyal, Professor, Indira Gandhi Institute of Development Research – Member
- Prof. Jayanth R. Varma, Professor, Indian Institute of Management, Ahmedabad – Member
- Dr. Shashanka Bhide, Senior Advisor, National Council of Applied Economic Research, Delhi – Member
- Last three persons are to be appointed by the central government. This category of appointments must be from “persons of ability, integrity and standing, having knowledge and experience in the field of economics or banking or finance or monetary policy”. (Section 45ZC)
- The MPC determines the policy repo rate required to achieve the inflation target.
- The MPC is required to meet at least four times in a year. The quorum for the meeting of the MPC is four members.
- Each member of the MPC has one vote, and in the event of an equality of votes, the Governor has a second or casting vote.
- Each Member of the Monetary Policy Committee writes a statement specifying the reasons for voting in favour of, or against the proposed resolution.
Positives of Recent RBI Rate Hikes
- Headline inflation had eased appreciably in March and April, slowing to 4.7% in the first month of the current fiscal year from the bruising 6.7% average pace in 2022-23.
- Macroeconomic fundamentals have strengthened after the unrelenting focus on preserving price and financial stability.
Negative Impact of Recent Rate Hikes
- Increase in credit costs since the RBI started raising its benchmark interest rates in May 2022 appears to have retarded investment and consumption activity last year.
- Bank credit data show the pace of growth in loans to industry, particularly the MSME and medium sectors, slowed appreciably last year.
- The sequential contraction in estimated private consumption spending in the fourth quarter of the last fiscal year is also likely a fallout of the higher borrowing costs.
Risks to Inflation Projections
- The spatial and temporal distribution of rainfall during this monsoon in the wake of El Niño conditions.
- Unabated geopolitical tensions.
- Uncertainty over international commodity prices including those of sugar, rice and crude oil.
- Volatility in global financial markets.
Conclusion
Policymakers cannot afford to take their eyes off inflation. Price stability is after all a public good and achieving durable disinflation must remain a non-negotiable goal, especially amid widening income inequality and high levels of joblessness.
