Quashing speculation of rate cut from all quarters, be it markets, industry or bankers, the Reserve Bank of India (RBI) on Wednesday kept the key interest rates unchanged, while it lowered the economic growth forecast to 7.1 per cent from 7.6 per cent earlier.
The central bank’s decision also caught the market by surprise as the Sensex switched gear by reversing its two days of gains and lost 156 points on Wednesday to close at 26,237.
Most analysts expected that the RBI would go for a 25-basis points rate cut, hoping that lower inflation would provide a cushion against liquidity and spurt in demand after the demonetisation move by the Government.
Though the RBI kept headline inflation at 5 per cent by the fourth quarter of 2016-17, on the growth front, the RBI surprised all by cutting the economy’s expansion forecast for the current fiscal to 7.1 per cent, from 7.6 per cent earlier, saying that short-term disruption in economic activity, and demand compression arising out of demonetisation have led to downside risks to growth.
“Incorporating the expected loss of growth momentum in Q3 and waning effects in Q4 alongside the boost to consumption demand from higher agricultural output and the implementation of the 7th Central Pay Commission award, Gross Value Added growth for 2016-17 is revised down from 7.6 per cent to 7.1 per cent, with evenly balanced risks,” the RBI said in its statement.
RBI Deputy Governor SS Mundra said the impact of demonetisation on the gross domestic product (GDP) growth rate would “only be 15 basis points and it would be transitory”.
The central bank also kept its key repo rate - the interest rate at which the RBI lends to banks - unchanged at 6.25 per cent, aiming to check inflation.
Announcing the fifth bi-monthly monetary policy review of the current fiscal, decided unanimously by the RBI Governor Urjit Patel-led six-member Monetary Policy Committee, Patel spoke at length about the growth forecast as well the impact of demonetisation.
Asked whether the RBI’s status quo on rates was based on the expectations of the US Fed rate hike, Patel said, “Our decision has nothing to do with that. Demonetisation
was not done in haste and efforts were being made to increase the supply of currency notes and the public should not hoard them.”
Acknowledging that supply disruptions against the backdrop of currency replacement may drag down growth this year in India, he further said, “Short-term developments that influence the outlook disproportionately warrant caution with respect to setting the monetary policy stance.”
Satisfied with the RBI’s decision to keep the repo rate or short-term lending rate unchanged at 6.25 per cent, the Finance Ministry described it as a ‘bold and brilliant’ move which will prevent the flight of overseas capital in uncertain global environment, while bankers and industry had mixed response on the status quo decision of the central bank.
In its last review, which was first under Patel, the MPC had lowered the rate by 0.25 per cent. However, bankers felt that there could be easing of interest rate in the days to come with RBI deciding to remove the incremental Cash Reserve Ratio (CRR) of 100 per cent from December 10. “The combination of removal of incremental CRR limit and market stabilisation scheme will help banks to manage their liquidity conditions better and bring financial stability to the system,” SBI Chairperson Arundhati Bhattacharya said.
ICICI Bank Chief Executive Chanda Kochhar also said the RBI has maintained stability in monetary policy with a focus on the medium-term inflation targets being sustainably achieved while continuing to be supportive of growth. “The policy has maintained an accommodative stance while taking into account global developments and domestic economic conditions,” Kochhar said.
India Inc, which was also hoping for a 0.5 per cent cut in interest rate on account of surge in bank deposit following demonetisation, expressed disappointment saying the RBI should cut the rate to support growth of trade and industry hit by demonetisation.
On inflation front, the central bank projected the headline inflation at 5 per cent by the fourth quarter of 2016-17 with risks tilted to the upside, but lower than in the October policy review. “The fuller effects of the house rent allowance under the Seventh
Pay Commission award are yet to be assessed, pending implementation, and have not been reckoned in this baseline inflation path,” RBI said.
On demonetisation, it said the withdrawal of old high value currency notes could transiently interrupt some part of industrial activity in November-December due to delays in payments of wages and purchases of inputs, although a fuller assessment is awaited.
The RBI also said that almost Rs 12 lakh crore out of total Rs 14.5 lakh crore in scrapped notes have already been deposited in banks. The Government had scrapped the old Rs 500/1000 notes from November 9, giving the public time to exchange them till December 30. It led to cash shortages in the system, besides unending queues at banks and ATMs for exchange/deposit of invalid currency and withdrawal of new notes.
All this has impacted the economic activity majorly.
“In the services sector, the outlook is mixed with construction, trade, transport, hotels and communication impacted by temporary old currency notes effects, while public administration, defence and other services would continue to be buoyed by the 7th Central Pay Commission (CPC) award and one rank one pension (OROP),” the RBI said.
The Finance Ministry said rate cut in times of global uncertainty would have prompted overseas investors to withdraw their investments. “Perhaps there is uncertainty about US Fed rate decision which is due shortly and keeping the uncertainty in the international sector in mind. With some kind of resistance to downward pressure on inflation,
RBI has taken a decision to take a pause and adopt wait and watch policy,” Economic Affairs Secretary Shaktikanta Das said.