Over to the MPC

RBI monetary policy will get increasingly institutionalized…

The idea of Monetary Policy Committee (MPC) propounded by Dr. Raghuram Rajan is set to become a reality. The MPC approach is a more democratic and institutionalized process to take important decisions pertaining to setting the benchmark rates in the economy. Here is how the MPC will work.

MPC a mix of RBI and FinMin…

The MPC will consist of 6 members of which 3 will be drawn from the RBI and 3 from the Ministry of Finance. While the RBI will be represented by the Governor, 1 deputy governor and an additional member, the finance ministry will also be represented by 3 members. In the current dispensation, the setting of rates is largely a prerogative of the RBI governor. He virtually has the veto power and can even veto the joint decision of all other members when it comes to setting benchmark rates. Under the MPC there will be a subtle shift. Each of the 6 members of the MPC will have one vote when it comes to setting rates. Only in the event of a tie, the RBI governor can cast the deciding vote. In all other cases, the decision on benchmark rates will be based on the majority point of view.

Regulation plus development…

Interestingly, Dr. Raghuram Rajan was himself a votary of adopting an MPC approach to setting rates. To a large extent, the rate policy of the RBI has been an extension of the personality of the RBI governor. Dr. Rangarajan was extremely hawkish and believed in rate hikes as a means of controlling inflation. Dr. Bimal Jalan undertook the biggest series of cutting of repo rates, which eventually resulted in the bull market of 2003-2008. Dr. Reddy and Dr. Subba Rao were a lot more focused in establishing RBI as the pivotal regulator of the financial system. The idea of MPC will have two advantages. Firstly, by including voting members from the Ministry of Finance, there will be a mix of financial market regulation and financial market development. Secondly, there is likely to be less perceived differences between the RBI and the MOF on policy issues.

An institutional mechanism…

But above all, the MPC will be instrumental in giving an institutional mechanism to the entire benchmark rate setting process. This is normally the global practice where the entire process of signaling the benchmark rate direction is largely institutionalized. This reduces the impact of an individual’s personality on the monetary policy. This will also ensure that the MPC will be able to take a more strategic and long term view of monetary policy. The stance of the monetary policy need not change with the thinking of the RBI governor, as is the case today. That may, perhaps, be the biggest merit of the shift to the MPC mechanism! ©

You can ask us your stock related questions with #AskReligareOnMarkets via our Twitter channel @religareonline.

One thought on “Over to the MPC

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )


Connecting to %s