Monetary Policy Committee - List of Various Instruments, Its Purpose, Meaning & More!

The Governor of the Reserve Bank of India (RBI) chairs the Monetary Policy Committee (MPC). The purpose of the Monetary Policy Committee was to set the benchmark policy interest rate (repo rate) in order to keep inflation under control. The RBI governor makes monetary policy decisions with the support and direction of an internal team and a technical advisory committee. The Monetary Policy Committee is one of the most important topics for UPSC IAS Examination.

In this article on the Monetary Policy Committee, we shall discuss its overview, composition, and aims/functions in detail. This will be very useful for aspirants in the UPSC Prelims Exam.

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The Monetary Policy Committee (MPC) is a committee responsible for formulating and determining the monetary policy of a country. Typically established by a central bank, the MPC is tasked with making decisions on key policy rates, such as the interest rate, to achieve specific economic objectives. The committee's primary goals often include maintaining price stability, controlling inflation, and supporting economic growth. Members of the MPC typically include central bank officials and external experts in economics or finance. The MPC conducts regular meetings to assess economic conditions, analyze data, and decide on appropriate adjustments to interest rates or other policy tools. The transparency and independence of the MPC are essential for effective monetary policy implementation.

Background on the Monetary Policy Committee

• Prior to the creation of the committee, the Reserve Bank of India’s Governor made all significant interest rate decisions on his own.
• The MPC was founded under the Reserve Bank of India Act 1934 to increase transparency and accountability in India’s monetary policymaking.
• The MPC meets at least four times a year, and following each meeting, the monetary policy is published, with each member declaring his or her position.

What does it mean to have a Monetary Policy?

• Monetary policy refers to the central bank’s approach to using monetary tools within its competence to achieve the Act’s objectives.
• In terms of monetary policy, the RBI’s major purpose is to preserve price stability while still seeking growth.
• Price stability is a necessary condition for long-term expansion.
• The updated RBI Act of 1934 further states that the Indian government, in collaboration with the Reserve Bank, sets the inflation objective (4 percent + 2%) every five years.

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What exactly is the purpose of Monetary Policy?

• According to the Chakravarty Committee’s recommendations, price stability, economic growth, equity, social justice, and supporting the establishment of new financial enterprises are all vital aspects of India’s monetary policy.
• The Reserve Bank of India (RBI) aims to keep inflation at a tolerable level while the Indian government strives to boost the country’s GDP growth rate.
• In order to meet the country’s inflation target and achieve its major objectives, the Monetary Policy Committee estimates the necessary policy interest rate.
• The Reserve Bank lends overnight liquidity to banks against the collateral of government and other approved assets at a repo rate under the liquidity adjustment facility (LAF).

Reverse Repo Rate:

• Under the LAF, the Reserve Bank absorbs liquidity from banks in exchange for eligible government assets at an overnight interest rate.

Liquidity Adjustment Facility:

• The Liquidity Adjustment Facility (LAF) assists banks in adjusting their liquidity.
• Both overnight and term repo auctions are part of the LAF.

Repo Rate:

• The repo rate is the rate at which the RBI is willing to buy or rediscount bills of exchange or other commercial papers.
• The Bank Rate is published under Section 49 of the RBI Act of 1934.
• Because this rate is connected to the MSF rate, it adjusts automatically whenever the MSF rate and the policy repo rate change.

Cash Reserve Ratio:

• The CRR (Cash Reserve Ratio) is a measure of how much money a bank has on hand.
• The Reserve Bank may notify in the Indian Gazette from time to time the average daily balance that a bank must maintain with the Reserve Bank as a proportion of its Net Demand and Time Liabilities (NDTL).

Statutory Liquidity Ratio:

• The SLR (Statutory Liquidity Ratio) is a measure of how liquid a bank is.
• The amount of NDTL a bank is required to retain in safe and liquid assets such as unencumbered government securities, cash, and gold.
• Changes in the SLR significantly impact the ability of the banking system to lend to the private sector.

Open Market Operations:

• OMOs (Open Market Operations) are a type of trading that takes place on the open market.
• For the objectives of infusing and absorbing long-term liquidity they include both outright acquisitions and sales of government assets.

Market Stabilization Scheme:

• MSS stands for Market Stabilization Scheme.
• The initial version of this financial management programme was released in 2004.
• Short-dated government securities and Treasury bills are sold to absorb excess long-term liquidity caused by large capital inflows.
• The funds are kept separate from the rest of the government’s funds at the Reserve Bank of India.

How did the Monetary Policy Committee come into being?

• The Urjit Patel Committee was the first to suggest that a five-member Monetary Policy Committee be formed.
• Following that, the government recommended the formation of a seven-member commission.
• The Monetary Policy Department (MPD) of the Reserve Bank aids the MPC in policy development.
• On June 27, 2016, the Monetary Policy Committee was established.
• The Financial Markets Operations Department (FMOD) is responsible for implementing monetary policy, principally through daily liquidity management operations.

Functions of MPC:

• The MPC is in charge of determining the MSF, Repo Rate, Reverse Repo Rate, and Liquidity Adjustment Facility, among other policy rates.

MPC consists of the following elements:

• The committee will be made up of six persons.
• Three of the six members will be chosen by the government.
• No government officials will be present in the Monetary Policy Committee.
• The other three members would represent the RBI, with the governor serving as the ex-officio chairperson.
• The RBI’s deputy governor in charge of monetary policy, as well as an executive director of the central bank, will each be a member.

Selection of members and tenure of office:

• A Search-cum-Selection Committee chaired by the Cabinet Secretary, with the RBI Governor and Economic Affairs Secretary as members, as well as three experts in economics, banking, finance, or monetary policy, will choose the government’s nominees to the MPC.
• MPC members will be appointed for a four-year term and will not be eligible for reappointment.

What criteria are used to make decisions?

• Decisions will be made by a majority vote, with each member having one vote.
• The governor of the Reserve Bank of India will chair the committee.
• The governor, on the other hand, will not have veto power over the other members of the panel but will have the ability to cast a tie-breaking vote in the event of a tie.

Committee:

• Following its meeting on April 6-8, 2022, the Monetary Policy Committee (MPC) held its 35th meeting between May 2 and 4, 2022, as an off-cycle meeting to evaluate evolving inflation-growth dynamics and their consequences.
• The MPC discussed in considerable depth the staff’s macroeconomic assessment as well as potential scenarios for substantial risks to the outlook.
• Based on the preceding and subsequent detailed debates on monetary policy stance, the MPC approved the following resolutions:

Resolutions undertaken:

• Raise the policy repo rate under the liquidity adjustment facility (LAF) by 40 basis points to 4.40 percent with immediate effect.
• As a result, the SDF rate has been reduced to 4.15 percent, while the MSF rate and the Bank Rate have both been increased to 4.65 percent.
• In order to keep inflation within the target range while stimulating GDP, the MPC also decided to keep policy accommodative while focusing on removing it.
• These actions are in line with the goal of maintaining growth while meeting a medium-term target for consumer price index (CPI) inflation of 4% within a 2-percentage-point range.

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