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The monetary policy states the use of financial instruments under the control of the Reserve Bank of India to standardise magnitudes such as availability of credit, interest rates, and money supply to achieve the ultimate objective of economic policy mentioned in the Reserve Bank of India Act, 1934.
The main aim of the financial policy is to retain price stability while considering the goal of growth. Stability in price is a necessary prerequisite to sustainable growth.
The Reserve Bank of India Act of 1934, in May 2016, was amended to provide a legal basis for the execution of the flexible inflation targeting agenda.
The edited RBI Act also provides for the inflation target to be set by the Indian Government, after discussing with the Reserve Bank, once in every five years.
The Central Government has mentioned in the Official Gazette 4% Consumer Price Index (CPI) inflation as the target for the period from 5 August 2016 to 31 March 2021, with the higher tolerance limit of 6% and the lower tolerance limit of 2%.
The Central Government also notified the following factors that causes a failure to achieve the inflation target:
Before the RBI Act was amended in May 2016, the flexible inflation targeting agenda was administered by an Agreement on Monetary Policy Framework between the RBI and the government of February 20, 2015.
The modified RBI Act provides the legislative mandate explicitly to the Reserve Bank of India in order to operate the policy framework of the country.
The monetary policy framework aims to set the policy repo rate as per the assessment of the present and developing macroeconomic situation. The agenda also aims at modulating liquidity conditions to adjust the money market rates at/around the repo rates.
The repo rate changes spread through the money market to the entire financial system, influencing the aggregate demand – a key factor of inflation and growth.
Once the repo rate is declared, the operating structure designed by RBI predicts liquidity management on a daily basis through suitable actions, aiming to anchor the weighted average call rate (WACR) around the repo rate.
The operating framework is modified and reviewed depending on the growing financial market and economic conditions, while ensuring uniformity with the financial policy stance. The liquidity management framework was revised significantly in April 2016.
Section 45ZB of the revised RBI Act, 1934 provides for an authorised six-member monetary policy committee (MPC) to be founded by the Central Government by notification in the Official Gazette. Therefore, the Central Government in September 2016 constituted the MPC as under:
Please note: Members mentioned from 4 to 6 above, will hold office for four years or until further notice, whichever is earlier.
The MPC fixes the policy interest rate required to reach the high target. The MPC’s first meeting was held on 3 and 4 October 2016 prior to the Fourth Bi-monthly Monetary Policy Statement, 2016-17.
The RBI’s Monetary Policy Department (MPD) supports the MPC in framing the monetary policy. Views of important stakeholders in the economy, and logical work of the RBI add to the process for arriving at a decision on the policy repo rate.
The Financial Markets Operations Department (FMOD) operationalises the financial policy through the daily liquidity management operations. The Financial Markets Committee (FMC) meets on a day-to-day basis to evaluate the liquidity conditions to ensure that the working target of the weighted average call money rate (WACR).
Before the MPC was constituted, a Technical Advisory Committee (TAC) on the monetary policy with specialists from fiscal economics, financial markets, central banking, and public finance advised the Reserve Bank on the stance of monetary framework.
Though, its role was only advisory in nature. With the formation of MPC, the TAC on Monetary Policy ceased to exist.
There are numerous direct and indirect instruments used for executing monetary policy, which are as follows:
Under the modified RBI Act, the monetary framework making is as under:
On the 14th day, the minutes of the meeting of the MPC are printed, which are as follows:
Once in every six months, the RBI is should publish a document called the Monetary Policy Report to explain:
The Reserve Bank of India Act, 1934 is amended from time to time. To know the changes, check out the official RBI website.