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Business News/ News / India/  MPC faces uphill task of recovery amid high prices

MPC faces uphill task of recovery amid high prices

The RBI’s new MPC comes in against the backdrop of the coronavirus pandemic, which has disrupted economic activity at an unprecedented scale. Mint looks at the challenges the new panel faces

Photo: MintPremium
Photo: Mint

The Reserve Bank of India’s new Monetary Policy Committee (MPC) comes in against the backdrop of the coronavirus pandemic, which has disrupted economic activity at an unprecedented scale. Mint looks at the challenges the new panel faces.

What are the critical roles of RBI’s MPC?

The Reserve Bank of India (RBI) and the government of India moved to a new monetary policy framework, which resulted in the creation of the MPC in 2016, when Urjit Patel was the RBI governor. The committee has three external members and three members from within RBI. The panel handles the key responsibility of fixing the policy interest rate with the intention of keeping inflation closer to its target rate of 4% (+/-2%). Prior to the formation of the first MPC, the RBI governor was entrusted with the power to determine the key policy rates such as the repo and reverse repo rates.

What does the shift to a new MPC imply?

There has been a lot of discussion regarding the conduct of the previous MPC. Many people have repeatedly illustrated the hawkish stance of the previous MPC, which kept the real rates at one of the highest levels in the world.

The new MPC is likely to step in at a time when inflation is well beyond the mandate and gross domestic product (GDP) is contracting. The key will be the decision regarding the extent of deviation from the explicit objective of taming inflation to revive economic growth. The stance of the new MPC could thus be dovish over the next few quarters.

Challenges galore
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Challenges galore

Can there be rate cuts with inflation above 6%?

As the Reserve Bank of India’s deputy governor Michael Patra had indicated, the problems with the present monetary policy framework would restrict the ability to cut key rates. The decision on rate cuts would depend on multiple factors, but RBI and MPC will continue to ensure an accommodative stance of the monetary policy.

What about concerns of external balances?

One other challenge that the new MPC faces relates to the increase in capital flows along with current account balance being in a surplus. This could have implications for the appreciation of the rupee and a build-up of foreign reserves. RBI had already mentioned in one of its releases that the appreciation of rupee could help keep “imported-inflation" in check. External sector stability is not the purview of the MPC. However, it is critical to the aim of ensuring price stability while keeping in mind RBI’s objective of macroeconomic stability.

What does this imply for the new MPC?

The new MPC would need to work in tandem with RBI as it attempts to revive growth. With RBI using different policy instruments to ensure systemic liquidity, drive transmission, and reduce the cost of capital, the underlying objective is to revive activity. MPC would’ve to decide on how long interest rates should be kept low even as inflation is beyond its comfort zone. This would depend on their understanding of whether the inflation is transitionary or likely to become persistent.

Karan Bhasin is  a  policy  researcher.

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Published: 07 Oct 2020, 09:07 PM IST
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