Challenges Before Monetary Policy Committee

The Monetary Policy Committee (MPC) is the body of the RBI headed by its Governor. The body is responsible for taking the important monetary policy decisions for determining the repo rate.

The Monetary policy committee is a statutory body established under the provisions of RBI act 1934. The functions of the committee are:

  • The main function of the MPC is to keep the inflation within targets set by the government in consultation with RBI.
  • MPC accomplishes the task by making suitable changes to the policy rate i.e. repo rate.
  • RBI has been vested with the responsibility to publish a document explaining the steps to be taken by it to implement the decisions of the Monetary Policy Committee, including any changes thereto.

Challenges before the MPC:

The RBI act mandates MPC to ensure the inflation is within the stipulated targets (current target: between 2% to 6%). MPC is facing diverse challenges in this regard. The challenges faced by MPC are:

  • Crude inflation

The increasing crude oil price is having a spillover on inflation. India is a net importer of crude oil with inelastic demand. The crude inflation is bound to have a significant impact on the functioning of MPC which has been entrusted with maintaining inflation, a key component of macroeconomic stability.

  • Rupee volatility

The rupee has depreciated by 20 percent since May 2014. The depreciation of Rupee is more than 12 percent since the beginning of 2018.  The increasing possibility of a Fed rate hike, rising wages, and positive employment figures will put further thrust upward pressure on the rupee. Estimates suggest that 10 percent depreciation in the rupee could add up to 50 basis points to inflation.

Policy options to deal with the challenges:

Open market operations

RBI can intervene in the foreign exchange market through open market operations to manage volatility. With trade deficit increasing inflation showing upward pressure, RBI can intervene to arrest the depreciation of rupee.

Foreign exchange swap window

RBI can revisit the foreign exchange swap window offered by RBI for oil companies in 2013. Under the swap provisions oil marketing companies can swap rupee for dollars and after a definite time period return the dollars back to RBI.

Non-resident Indians

RBI can raise dollars by borrowing from non-resident Indians. This will increase the inflow of dollars and can reduce the rupee volatility.

Policy rate

RBI along with MPC can increase the policy rate to address the volatility and arrest inflation in the market.

With looming domestic and overseas uncertainties there is a need for a concentrated approach by RBI to ensure the inflation targets are met without having the spillover effect on growth rates.

Question for UPSC Mains:
Discuss the challenges before the monetary policy committee.

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