ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

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Setting Repo Rate by Committee

The significance of the Monetary Policy Committee and its first decision are overstated.

The Fourth Bi-monthly Monetary Policy Statement for 2016–17, announced on 4 October, was different for one reason: the newly-constituted Monetary Policy Committee (MPC) passed its first resolution. It unanimously decided to reduce the policy repo rate (annualised repurchase option rate) under the liquidity adjustment facility by 25 basis points or 0.25% to 6.25%. The repo rate is the rate at which the central bank lends money to banks for a short term, and is used as a tool of monetary policy to influence the rate at which banks lend. The financial media reacted to the policy statement with euphoria around the rate cut, viewing the rate cut as the beginning of a new phase of the Reserve Bank of India (RBI) accommodating the Government of India’s interests. The government too is pleased that the MPC, chaired by Urjit Patel, the new governor it appointed, has taken a decision that it has long wanted and which may herald a cycle of rate cuts. But what does the new framework of decision-making, the process by which decisions are taken and the current decision to cut rates really mean?

The six-member MPC has three academicians nominated by the Government of India and three (including the governor) from the RBI. With the formation of the MPC, the governor no longer takes the final decision on the benchmark rate, but has a casting vote in case of a tie in the MPC. This time it was a unanimous decision by the MPC, but certainly not in keeping with the stubborn line on inflation targeting that the RBI took under Raghuram Rajan’s governorship, during which period the central bank had repeatedly resisted accommodating calls to push interest rates downwards citing continued inflationary pressures. A quick perusal of the Consumer Price Index (CPI) data available before each bimonthly policy statement shows that CPI inflation in July was 6.1% and consumer food price inflation was 8.4%, both of which are the highest year-on-year increases since August 2014. Thereafter, in August and September, the CPI came down to 5.05% and 4.31% while food inflation decelerated to 5.91% and 3.88% respectively. Incidentally, current governor Patel, when he was deputy governor under Rajan, headed the committee that ­recommended the shift to inflation targeting.

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