Reserve Bank Prefers To Wait And Watch Impact Of Demonetisation

The key takeaway from the December policy of the Reserve Bank of India (RBI) is the central bank downplaying the impact of demonetisation.

Uncertainties surrounding the US Federal Reserve’s outlook on interest rates over the next year (though it’s a given that the Fed will hike the rate at the 13-14 December meeting) and the impact of the Organisation of the Petroleum Exporting Countries’ (Opec) agreement to cut crude oil production, as well as the award of the Seventh Pay Commission and one-rank, one-pension on retail inflation, is being regularly discussed, but most thought that RBI would cut the policy rate by a quarter percentage point to take care of the impact of demonetisation on inflation as well as growth.

RBI has chosen to wait and watch the impact on growth although it feels that the inflation could be temporarily reduced by 10-15 basis points in the December quarter. So, the consensus among the six members of the monetary policy committee was to maintain status quo.

Many are saying that the action-less policy demonstrates the central bank’s independence. I am not sure whether the government would have liked a rate cut at this juncture as that would have focussed on the impact of demonetisation too soon.

Nonetheless, it’s good to see the central bank deciding against pandering to market expectations for a rate cut. Naturally, the yield on the benchmark 10-year bond, which was hovering around 6.17-6.20% before the policy announcement, jumped to 6.35-6.40% after it.

The banks shouldn’t have much to complain as RBI has been continuing with its accommodative monetary policy stance and, on top of that, it is withdrawing the 100% incremental cash reserve ratio (CRR) on Rs3.24 trillion of deposits that the banks had raised between 16 September and 11 November. It is being withdrawn from 10 December.

RBI will now soak up excess liquidity from the system through securities under the market stabilisation scheme (MSS), the ceiling for which has been raised to Rs6 trillion. This means banks will earn on their excess cash which they would not have been able to do had RBI decided to continue with the incremental CRR arrangement.

Currency in circulation plunged by Rs7.4 trillion as on 2 December, the policy document says, and net of replacements, deposits surged in the banking system. Till now, Rs11.55 trillion worth of currency has come back to the system out of around Rs14 trillion worth of Rs1,000 and Rs500 currency notes that are being replaced. The window for accepting old currency notes closes on 30 December.

Indeed, retail inflation measured by the headline consumer price index (CPI) eased more than expected for the third consecutive month in October to 4.2%, driven down by deflation in the prices of vegetables. Most analysts say that it will drop below 4% in December and end the fiscal year in March a little less than 5%. However, RBI does not seem to be convinced about that. It is continuing with the inflation projection at 5% in March 2017 with risks tilted to the upside but lower than in the October policy review. It has cut the gross value added (GVA) growth forecast to 7.1% from 7.6% for the year, but uncertainties on the inflation front has prompted the central bank to keep the repo rate on hold.

In the past two years, since January 2015, the policy rate has come down by 175 basis points—from 8% to 6.25%. The next rate cut could happen on 8 February 2017 at RBI’s next policy meeting after the presentation of the Union Budget. By that time, it will have a clear picture on the trajectory of inflation, growth as well as the impact of demonetisation. There will be clarity on the fiscal front too.

Postscript 1: At both meetings of the monetary policy committee held so far, the decision to cut the key rate (in October) and maintain status quo (in December) has been unanimous. This is quite interesting, particularly the latest meeting being held against the backdrop of widespread expectations of a 25 basis points rate cut.

Postscript 2: Two things I like about this policy are: a) Governor Patel looks more in control at the press conference and interacted with the media as a team and b) the RBI has restored the surprise element in a policy which has been missing for long.

Tamal Bandyopadhyay, consulting editor at Mint, is adviser to Bandhan Bank. He is also the author of A Bank for the Buck, Sahara: The Untold Story and Bandhan: The Making of a Bank.

His Twitter handle is @tamalbandyo.Comments are welcome at [email protected]

This column first appeared in www.livemint.com