RBI unexpectedly keeps rates unchanged as cash crunch roils economy

By Suvashree Choudhury and Rafael Nam

MUMBAI (Reuters) - The Reserve Bank of India (RBI) unexpectedly kept its key policy rate unchanged at 6.25 percent on Wednesday, despite calls for action in the face of an intense cash shortage that threatens to slam the brakes on the world's fastest growing large economy.

The RBI's monetary policy committee voted 6-0 to leave the repo rate unchanged, saying it needed more time to assess if the recent cash squeeze would cause more lasting damage to the economy.

Pressure on the RBI and Governor Urjit Patel to act has grown since Modi stunned the country on Nov. 8 with a drastic plan to abolish 500 and 1,000 rupee notes ($7.35-14.70), removing 86 percent of the currency in circulation in a bid to crack down on India's "shadow economy."

While shortages of new bank notes are still being reported and some companies' cash-reliant supply chains have been left in tatters, the government insists conditions will steadily improve by the end of the year.

The RBI has also said it expected the impact from the measures to ebb as new notes come into circulation, even as it trimmed its growth forecast for year ending in March 2017.

"While supply disruptions in the backwash of currency replacement may drag down growth this year, it is important to analyse more information and experience before judging their full effects and their persistence," the RBI said in a statement.

"Short-term developments that influence the outlook disproportionately warrant caution with respect to setting the monetary policy stance. If the impact is transient as widely expected, growth should rebound strongly."

A majority of the 56 analysts polled by Reuters had expected a rate cut of at least 25 bps, after a similar move at the RBI's last review in October.

But 18 analysts had forecast policy would remain unchanged.

As expected, the central bank did withdraw the temporary 100 percent hike in the cash reserve ratio announced late last month that was intended to absorb the extra liquidity created after the country banned higher-value notes.

STILL EYEING INFLATION?

In keeping its policy settings steady, the central bank also appeared to remain concerned about the risk of a flare-up in inflation.

Although consumer inflation eased in October to 4.20 percent, the slowest pace in 14 months, prices in India have traditionally been dependant on volatile food and fuel prices. Global crude oil prices have spiked in the last week.

The RBI also cited concerns about the "high volatility" in global financial marketes, and the spillover into emerging market countries, especially as the U.S. Federal Reserve gears up to raise interest rates next week.

The benchmark 10-year bond yield rose sharply, and was up 17 bps from levels before the decision. The NSE stock index was down 0.5 percent, while the rupee weakened slightly to 67.87.

India's economy grew by an annual 7.3 percent between July and September, the fastest rate for a large economy in the world but still below the levels needed to sustain full employment.

Economists warn that expansion is now threatened after data so far shows Modi's action has hit the cash-dependent economy more than expected: auto sales plunged and services sector activity dived into contraction last month for the first time in 1-1/2 years.

That could raise expectations the RBI could cut rates at its next review in February, according to analysts.

"We certainly expect the RBI to cut rates in the next policy meet. It will become a big problem otherwise." said Samrat Dasgupta, chief executive, Esquire Capital Investment in Mumbai.

"Inflation will remain low. This was an opportunity for the governor to cut rates; so I think it is a missed opportunity."

(Editing by Kim Coghill)