The Monetary Policy Committee (MPC) has decided to conduct an off-cycle meeting today to discuss the failure to meet the inflation target under Section 45ZN of the Reserve Bank of India Act, 1934. As per the Reserve Bank of India Act (RBI), 1934, MPC is required to meet at least four times each year, to discuss the macroeconomic issues in the country, and take policy decisions to address those. This is the second time MPC has conducted an off-cycle meeting in 2022-23. The meeting is scheduled in light of inflation being consistently high for nine consecutive months.
In this blog, we discuss what the inflation targeting framework is, examine retail and wholesale prices, and the divergence between them.
What is the inflation targeting framework, and what happens if inflation is persistently high?
In 2016, Parliament amended the RBI Act, 1934 to change the monetary policy, and introduce an inflation targeting framework. This framework prioritises price stability to achieve sustainable GDP growth. Price stability allows investors to confidently invest their money for productive activities, without worrying about it losing value. Price stability also maintains the purchasing power of consumers, i.e., the ability to purchase a good (or service) with a given amount of money.
As per the new framework, the central government, in consultation with RBI sets: (i) an inflation target, and (ii) an upper and lower tolerance level for retail inflation. The target has been set at 4%, with an upper tolerance limit of 6% and a lower tolerance limit of 2%. The upper and lower limits indicate that although it is desirable for inflation to be close to 4%, deviation between these limits is acceptable. The target and bands are revised every five years. In March 2021, the existing targets were carried forward.
Retail inflation has been above 6% for the past nine months, and it has been above 4% from October 2019 onwards (See Figure 1).
Figure 1: Consumer price index (year-on-year; in percentage)
Sources: Database on Indian Economy, Reserve Bank of India; PRS.
If inflation is above or below the prescribed limits for three quarters, RBI must submit a report to the central government explaining why prices have been rising (or falling) persistently, what will be done to correct that, and an estimate as to when the target will be achieved.
The MPC uses tools such as interest rates to control the level of inflation in the economy. One such rate is the policy repo rate, which is the rate at which RBI lends money to banks. An increase in the policy repo rate makes borrowing money more costly, and hence is expected to control inflation by reducing the money supply. MPC increased this rate from 4% in April 2022 to 4.4% in May 2022, to 4.9% in June 2022, to 5.4% in August 2022, and to 5.9% in September 2022.
Breaking down the Consumer Price Index and the Wholesale Price Index
Consumer Price Index (CPI) measures the general prices of goods and services such as food, clothing, and fuel over time. Retail inflation is calculated as the change in the CPI over a period of time. Goods and services such as petrol, food products, health, and education are considered for its calculation, which are assigned different weights (See Table 1). Between February 2022 and August 2022, the average annual inflation was 6.9%. The rise in prices of subcomponents of the CPI during this period is indicated in Table 2.
|
Table 1: Assigned weights for the calculation of CPI
Sources: MOSPI; PRS. |
Table 2: Average inflation of some CPI components
Sources: Database on Indian Economy, RBI; PRS. |
CPI is not the only index that measures inflation in an economy. The Wholesale Price Index (WPI) measures the wholesale prices of goods. A change in wholesale prices reflects wholesale inflation. Table 3 indicates the weights assigned to goods for calculating the WPI. Manufactured goods include metals, chemicals, food products, and textiles.
|
Primary articles (23%) include food articles, and crude petroleum and natural gas. Fuel and power (12%) include mineral oils, electricity, and coal. WPI has remained above 10% from April 2021 onwards. It reached an all-time high of 17% in May 2022. This was driven by the inflation in metals, kerosene and petroleum coke, fruits and vegetables, and palm oil. |
Table 3:Assigned weights for the
Sources: Ministry of Commerce and Industry; PRS. |
Why has WPI inflation been consistently above CPI inflation?
Movements in the WPI have an impact on the CPI. For almost a year and half, CPI inflation has remained below WPI inflation. However, as per the design of the indices, it is expected that CPI would remain above WPI, and that any increase in WPI would reflect in the CPI after a time lag. This is because retail prices include taxes (as a percentage of price), while wholesale prices do not. Additionally, some of the goods in WPI act as inputs in the goods considered in CPI. An increase in input prices would lead to higher retail prices after a time lag.
We discuss possible reasons for why CPI has remained below WPI for a year and a half.
Figure 2: Consumer Price Index and Wholesale Price Index
Sources: Database on Indian Economy, Reserve Bank of India; PRS.
Composition of indices
As indicated in Table 2 and 3, the composition of the two indices varies. For instance, prices of manufacture of basic metals, chemicals, and machinery grew at an average rate of 13% between February 2021 and September 2022. They contribute 7% to the WPI. These are input goods for producing final goods and services such as automobiles, which are included in the CPI. The rise in prices of transport vehicles, communication devices, fuel for transport, and housing (CPI components) rose by 6% during this period.
The Ministry of Finance has observed that wholesale prices did not feed into retail prices (from March 2021 onwards) as wholesalers absorbed the rising input costs and did not pass them on to retailers. In August 2022, it noted that as retail prices are rising now, the pass-through may occur.
This week, the centre issued two Ordinances to amend: (i) the Salary, Allowances, and Pension of Members of Parliament Act, 1954 to reduce the salaries of MPs by 30% for a period of one year, and (ii) the Salaries and Allowances of Ministers Act, 1952, to reduce the sumptuary allowance of Ministers by 30% for one year. The government also amended the rules notified under the 1954 Act to reduce certain allowances of MPs for one year, and suspended the MPLAD Scheme for two years. These changes are being made to supplement the financial resources of the centre to tackle the COVID-19 pandemic. These amendments raise larger questions on the effect they have on the capacity of the state to fight the pandemic, and the way in which salaries of MPs should be determined.
Overview of Amendments
The 1954 Act lays out the salary and various allowances that an MP is entitled to during their term in Parliament and also provides pension to former MPs. MPs receive a salary of one lakh rupees per month, along with compensation for official expenses through various allowances. These include a daily allowance for attending Parliament, constituency allowance and office expense allowance. Under the first Ordinance, the salaries of MPs are being reduced by 30%. Further, the constituency allowance and office expense allowance are being reduced by Rs 21,000 and Rs 6,000, respectively.
The 1952 Act regulates the salaries and other allowances of Ministers (including the Prime Minister). The Act provides for the payment of a monthly sumptuary allowance (for expenditure incurred in entertaining visitors) at different rates to the Prime Minister, Cabinet Ministers, Ministers of State, and Deputy Ministers. The second Ordinance is reducing the sumptuary allowances of Ministers by 30%.
Note that the 1952 Act pegs the salaries, and daily and constituency allowances of Ministers to the rates specified for an MP under the 1954 Act. Similar provisions apply to presiding officers of both Houses (other than Chairman of Rajya Sabha) who are regulated by a different Act. Therefore, the amendments to the salaries and constituency allowance of MPs will also apply to Ministers, Speaker and Deputy Speaker of Lok Sabha, and Deputy Chairman of Rajya Sabha. The salary of the Chairman of Rajya Sabha will continue to remain unaffected by the Ordinances (Rs 4 lakh per month).
Further, since 1993, MPs can also identify projects and sanction certain funds every year for public works in their constituencies under the Members of Parliament and Local Area Development (MPLAD) Scheme, 1993. Since 2011-12, each MP can spend up to Rs five crore per year under the scheme. The Union Cabinet has approved the suspension of the MPLAD Scheme for two years. Table 1 below compares the changes in salaries, allowances and MPLAD entitlements of MPs.
Table 1: Comparison of changes in the salaries, allowances and MPLAD entitlements of MPs
|
Feature |
Previous entitlement (in Rs per month) |
New entitlement (in Rs per month) |
Changes for the period of |
|
|
Salary |
1,00,000 |
70,000 |
One year |
|
|
Constituency allowance |
70,000 |
49,000 |
One year |
|
|
Office allowance |
60,000 |
54,000 |
One year |
|
|
Of which |
Office expenses |
20,000 |
14,000 |
- |
|
|
Secretarial assistance |
40,000 |
40,000 |
- |
|
Sumptuary allowance of Prime Minister |
3,000 |
2,100 |
One year |
|
|
Sumptuary allowance of Cabinet Ministers |
2,000 |
1,400 |
One year |
|
|
Sumptuary allowance of Ministers of State |
1,000 |
700 |
One year |
|
|
Sumptuary allowance of Deputy Ministers |
600 |
420 |
One year |
|
|
Funds under MPLAD Scheme |
5 crore |
NIL |
Two years |
|
Sources: 2020 Ordinances; Members of Parliament (Constituency Allowance) Amendment Rules, 2020; Members of Parliament (Office Expense Allowance) Amendment Rules, 2020; “Cabinet approves Non-operation of MPLADs for two years (2020-21 and 2021-22) for managing COVID 19”, Press Information Bureau, Cabinet, April 6, 2020; PRS.
Effect of amendments on resources to fight COVID-19
The proposed reduction to the salaries and allowances of MPs and Ministers amounts to savings of around Rs 55 crore, and the suspension of the MPLAD scheme is expected to save Rs 7800 crore. These measures comprise 0.03% and 4.5% respectively, of the estimated amount required to fight the immediate economic distress unleashed due to COVID. Government has estimated Rs 1.7 lakh crore as the requirement for COVID relief measures under the Pradhan Mantri Garib Kalyan Yojana. Therefore, such measures to decrease MP salaries and allowances toward increasing the pool of funds for fighting the pandemic are likely to have an almost negligible impact.
How might MP salaries be set
Each MP is required to represent the interests of his constituents, formulate legislation on important national matters, hold the government accountable, and ensure efficient allocation of public resources. The salary and office allowance of an MP must be assessed in light of the responsibilities expected to be discharged by them. Ensuring MPs are reasonably compensated in terms of salaries allows MPs the means to be able to discharge their duties devotedly, enables them to make decisions in an independent manner and guarantees that citizens from all walks of life can stand a chance of running for Parliament. The question remains – who decides what is reasonable compensation for MPs.
Currently, MPs in India decide their own salaries which is passed in the form of an Act of Parliament. MPs setting their own pay leads to a conflict of interest. A way to resolve this is by setting up an independent commission to determine that salaries of MPs. This is a practice followed in certain democracies, such as New Zealand and United Kingdom. In some other countries, it is pegged to annual wage rate index such as Canada. Table 2 lists various methods used in some other countries to set salaries for legislators.
Table 2: Methods for setting salaries in different democracies
|
Countries |
Process of determining salary of legislators |
|
India |
Parliament decides by passing an Act. |
|
Australia |
Remuneration Tribunal decides the salary. This is revised annually. |
|
New Zealand |
Remuneration Authority decides the salary. This is revised annually. |
|
UK |
Independent Parliamentary Standards Authority sets the pay annually as per the changes in average earnings in the public sector given by the Office for National Statistics. |
|
Canada |
Member’s pay is adjusted each year to federal government’s annual wage rate index. |
|
Germany |
Based on income of a judge of the highest federal court and adjusted annually by the Parliament. |
Sources: Various government websites of respective countries; PRS.
India has experience with appointing independent commissions to examine the emoluments of government officials. The central government periodically sets up pay commissions to review and recommend changes to the wage structure of government employees with a view to attract talent to government services. The latest Central Pay Commission was constituted in 2014 to decides the emoluments of central government employees, armed forces personnel, employees of statutory bodies, and officers and employees of the Supreme Court. Typically, the Commissions have been chaired by a former Judge of the Supreme Court, and have included members representing government service and independent experts.
Suspending MPLADS
In contrast to these amendments, the suspension of the MPLAD Scheme is a positive step.
The MPLAD Scheme (MPLADS) was introduced in December 1993 to enable legislators to address local developmental problems for their constituents. MPLADS allows legislators to earmark up to five crore rupees every year on public works projects in their constituency and recommend these projects to the district authorities for implementation. Typically, funds under the MPLADS are expended on construction or installation of public facilities (such as school buildings, roads, and electrical facilities), supply of equipment (such as, computers in educational institutions) and sanitation projects.
In 2010, a five-judge bench of the Supreme Court decided a challenge to the constitutionality of the MPLADS. It was argued that MPLADS violates the concept of separation of powers between the executive and the legislature since it provides the MP with executive powers on local public works. The Court ruled that there was no violation of the principle of separation of powers because the role of an MP in this case is recommendatory and the actual work is carried out by the local authorities.
However, the Scheme has undermined the role of an MP as a national-level policy maker. The role of an MP is to determine whether government’s budgetary allocations across development priorities are appropriate and once the money is sanctioned by Parliament is it being spent in an efficient and efficacious manner. However, focus on local administration-level issues, such as development of roads or sanitation projects, obscures the role of the MP in conducting oversight. Another fall out of having MPs responsible for MPLADS is that it skews the expectations of citizens have of their MPs – holding them accountable for resolving local development issues rather than broader policy and legislative decision making. The suspension of MPLADs will allow for MPs to focus on their role in Parliament.
The Ordinance route
Through these Ordinances, the executive has amended the salaries and allowances of MPs and Ministers. In principle, Parliament is discharged with law-making powers. In exceptional circumstances, the Constitution permits the executive to make laws through Ordinances if Parliament is not in session and immediate action is required. The two Ordinances will have to be ratified by Parliament within six weeks of its sitting in order to continue to have the force of law. Interestingly, India is one of the few countries, apart from Bangladesh and Pakistan, that vests the executive with authority to make laws, even if temporary in nature.
The Ordinance amending the salaries of MPs also raises a question on whether it is appropriate that the executive has the power to amend the emoluments of MPs – how would this affect the independence of the legislature which is tasked with holding the executive accountable.
