India Insight:Draft on new monetary policy committee

Event.

The Ministry of finance has issued a fresh draft of the Indian Financial Code(IFC) that proposes a monetary policy committee (MPC) to decide on interestrates by a majority vote. The revised IFC draft has been released for publiccomments until August 8th. It is expected to be tabled in the winter session ofparliament. Once finalised, it will go to the Cabinet for approval. We think theentire process will take another 6-9 months to complete and would not havemuch impact on the interest rate cycle in FY16.

We believe the proposed MPC might create a conflict of interest between thegovernment and RBI with respect to meeting the objectives of balancinggrowth and price stability. Also in view of the composition of the proposedMPC being skewed in favour of the central government, we believe itundermines the importance and independence of the RBI in monetary policydecisions. Considering that the majority of the committee members will beappointed by the government, it is imperative, in our view, that thesemembers are selected for a longer duration than the election cycle to ensurethat the credibility of monetary policy is maintained over political objectives.

We maintain our base case expectation that RBI will keep rates on hold in theupcoming monetary policy review on August 4, to wait for more clarity on thelikely impact of the monsoons on crop production and, hence, inflation.

However, we do see scope for a further 25bp cut in policy rates in FY16,preferably during the period of Dec-15 to Mar-16 once the Fed’s normalisationof interest rates is behind us.

What are the details? Current monetary policy framework: Currently, the RBI governor decidesthe monetary policy. There is a technical advisory committee comprising ofinternal members and external experts, but their role is purely advisory.

Inflation target: Under the new draft, it is recommended that the inflationtarget for each financial year be determined in terms of Consumer Price Indexby the Central Government in consultation with the RBI every three years.

Monetary policy committee (MPC) planned: The draft mentioned that underthe new framework, RBI must constitute a Monetary Policy Committee todetermine by majority vote the policy rate required to achieve the inflationtarget. The Monetary Policy Committee will comprise: (a) the RBIchairperson; (b) one executive member of the RBI Board; (c) one employee ofthe RBI nominated by the RBI chairperson; and (d) four persons appointed bythe Central Government. In the event of a tie amongst the members of theMPC, the RBI chairperson will have a second and casting vote. Also thedecisions of the MPC will be binding on the RBI. It advised that the MPC mustmeet at least once every two months.

Accountability: The MPC will be accountable if the inflation target is not metand the RBI must set out a report to the Central government stating the: (a)reasons for the failure, (b) remedial actions proposed, and (c) the likely periodof time over which the inflation target is proposed to be achieved pursuant totimely implementation of proposed remedial actions.