Contrary to the broad consensus in the market, the Reserve Bank of India (RBI) has not lowered the policy rate to boost growth. Not that the central bank disagrees with the common perception about a downward revision of India’s economic growth; in fact, it has reduced its estimate of gross value-added growth for 2016-17 from 7.6 per cent in October to 7.1 per cent now. The decision to not reduce rates was even more surprising to many given the fact that demonetisation is expected to depress prices further. RBI, too, expects that inflation, the other crucial variable while deciding a rate cut, will meet the five per cent target for March-end in 2017. The only possible way to rationalise the central bank’s decision is that it is more concerned about the upside risks to inflation than the downside risks to growth.
It is clear now that RBI will wait for data on the uncertain impact of the ongoing currency exchange on the economy rather than be swayed by pressure from the financial markets. These data points include the supply disruptions and demand compression due to demonetisation, the unfavourable base effect on inflation between December and February, the possible increase in oil prices, a likely interest rate hike by the US Federal Reserve, the depreciation of the rupee, and the stickiness of retail inflation, especially on account of education and health services. These “risks” are essentially related to the uncertainty that plagues even the RBI’s assessment of the economy. It says, “it is appropriate to look through the transitory but unclear effects” of demonetisation and, therefore, “it is prudent to wait and watch how these factors play out and impinge upon the outlook”. This is in sharp contrast to the expectations of clarity that observers had from the policy review, the first one since demonetisation. Unsurprisingly, both the decision to not cut the interest rate as well as the unclear outlook have disappointed industry and even leading bankers.
However, there are some welcome features as well in Wednesday’s monetary policy announcements. Though the RBI Governor did not offer any further clarity on several critical issues regarding demonetisation, he did say that Rs 11.55 lakh crore deposits had already come back into the banking system either by exchanging or depositing old notes. This officially rules out speculations of a windfall from RBI to the government and raises questions on what will be the tangible gains to the economy at the end of this painful exercise. In particular, RBI said the incremental cash reserve ratio (CRR) of 100 per cent of net demand and time liabilities would not be in play from December 10. This has been made possible by the sharp increase in the limit of Market Stabilisation Scheme bonds, from Rs 30,000 crore to Rs 6 lakh crore for the current financial year, and the CRR move will reduce the burden on banks. RBI also assured the people that there was enough currency, especially with the supply of 19.1 billion pieces of small currency notes (Rs 100 and less), which is more than the cumulative figure for the last three years. On balance, a more specific outlook from RBI would have helped provide some clarity, just as a repo rate cut would have helped — even if it shored up nothing but sentiment.