India’s Monetary Policy

India’s Monetary Policy

Introduction

Monetary Policy is an integral arm of public policy whose main objective is to ensure that an economy grows steadily along a path in which all available resources such as labour and capital are gainfully employed, or in other words, along its potential. The central tent of the monetary policy is to balance the demand and supply imbalances by using a variety of measures.

Changes in Indian Monetary Policy: Flexible Inflation Targeting(FIT)

  • The primary objective of monetary policy is to achieve an inflation rate of 4 percent, while keeping in mind the objective of growth.
  • A lower tolerance limit of inflation is set at 2 percent and an upper tolerance limit is at 6 percent. These aspects – a band rather than a point target; the achievement of the target over a period of time rather than at all times; and the specification of ‘keeping in mind the objective of growth’- are the flexible elements of FIT.
  • The second important element of FIT is transparency.
  • By keeping CPI inflation at the target, which is judged
    to be the tolerable level of price rise, monetary policy contributes to the welfare of the lay person. By specifying that inflation will be measured in terms of the CPI, it has been ensured that the lay person can easily judge whether or not monetary policy is working for the betterment of the people of India.
  • Third, under the new framework, clear rules of accountability have been laid out. In this case, if the inflation targets deviate from the predefined bands for more than three consecutive quarters, Reserve Bank of India (RBI) has to write a letter to the Government of India explaining the reasons for the deviation, the actions that will be taken to correct the deviations and the time it will take to return inflation to its target.
  • The fourth aspect of the new monetary policy framework is its decision making process. Earlier it was the Governor of the RBI who was the sole decision-maker in respect of monetary policy actions and stance. Under the new framework, the decision has to be taken by a six-member committee called the monetary policy committee (MPC).
  • The Governor is the Chairperson, and the Deputy Governor and an office of the RBI are appointed as ex-officio internal members of the MPC. Three other members are external, selected by the Gol in terms of criteria relevant to the conduct of monetary policy and specified in the RBI Act. Each member has a single vote, with the Governor exercising a casting vote in the case of a tie.
  • The MPC is required to meet at least once every quarter The minutes of the MPC’s meeting
    containing the statements of each individual member setting out his/her assessment, vote and reasons thereof are published within 14 days of the MPC’s meeting.

Performance of Indian Monetary Policy

  • In terms of the most important metric of performance, CPI inflation has fallen from double digits and has remained aligned to the target of 4 percent throughout the period of the working of the new framework – between September 2016 and March 2020, it has averaged 4.2 percent.
  • During the lockdown period, it was not possible to obtain price quotations and the NSO provided imputed estimates for business continuity purposes. Abstracting from this period, however, inflation ruled closely aligned with the mandated target.
  • The currently applicable inflation target of 4 (+/- 2) percent, which was set on August 5, 2016, will continue to guide the conduct of monetary policy in the RBI up to March 31, 2021.
  • The MPC committee has set repo rate to 4 percent and has taken accommodative stance for as long as necessary to meet the inflation targets.

Conclusion

Monetary policy is all about balancing the desirable and the feasible. Ensuring macroeconomic stability as reflected in low and stable prices is its biggest contribution to strong, sustainable and inclusive growth in India. The changes in the RBI act which have proved to be useful in the post Covid world will help in the revival of the economy in the longer run.

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