Monetary Policy Framework Agreement

The Government of India and Reserve Bank of India signed a Monetary Policy Framework Agreement on 20th February, 2015. The objective of monetary policy framework is to primarily maintain price stability, while keeping in mind the objective of growth.
As per the agreement, RBI would set the policy interest rates and would aim to bring inflation below 6 per cent by January 2016 and within 4 per cent with a band of (+/-) 2 per cent for 2016-17 and all subsequent years.
The proposed reduction in fiscal deficit to 3.9 per cent of GDP in Budget Estimates 2015-16 is designed with a mix of reduction in total expenditure as percentage of GDP and improvement in gross tax revenue as percentage of GDP.

• According to the agreement, the RBI will set policy interest rates with the goal of bringing inflation below 6% by January 2016, and within 4% +/- 2% band for 2016-17 and all subsequent years.

• The Governor of RBI (in his absence the Deputy Governor) is in charge of the monetary policy and will determine policy rates for inflation targeting.
• Every 6 months RBI publishes a report stating
  • Sources of inflation
  • Forecast of inflation for the next 6 to 18 months
• If consumer inflation is more than 6% or less than 2% for three consecutive quarters beginning in the 2015-16 fiscal year, the central bank will be considered to have missed its objective.
• If the central bank fails to meet its inflation target then:
  • it will send a report to the government explaining why and what steps it will take to correct the problem.
  • It will also have to provide an estimate of how long it will take to return to the target level.
• Any dispute regarding implementation and interpretation will be resolved by a meeting between Governor and central government.
• Section 45ZB of the revised RBI Act of 1934 authorises the Central Government to establish a six-member monetary policy committee (MPC). As a result, the Central Government established the MPC in September 2016.

Note:

• The initial Monetary Policy Framework was set for 5 years which ended in 2021.
• The government set the same target of 4% for inflation between 2021-2026 by extending it by another 5 years.

• While the agreement offers the RBI Governor broad discretion in deciding on monetary policy measures to meet the inflation objective, it also compels the RBI to submit a report to the Central Government if the target is missed for an extended period of time.
• As a result, it is a fragile balance between autonomy and accountability.
• Central banks all across the world are moving toward inflation targeting as a monetary policy management criterion. The MPFA represents a step in the right direction.
• The MPFA will admit India to the League of Nations, which has a monetary policy based on rules.