In a surprise decision, the Reserve Bank of India (RBI) in its fifth bi-monthly policy announcement maintained status quo, keeping the policy repo rate unchanged at 6.25 per cent. It was first monetary policy review after the government’s announcement of demonetization and was largely expected that the RBI will go for atleast a quarter percent of cut in the policy rates. But, the six-member Monetary Policy Committee (MPC), voted unanimously in favour of keeping the policy repo rate unchanged at 6.25 per cent, they felt that “the assessment is clouded by the still unfolding effects of the withdrawal of specified bank notes (SBNs)” of Rs 500 and Rs 1,000 denominations, prompting it to adopt a wait-and-watch approach.
On the basis of an assessment of the current and evolving macroeconomic situation, the Monetary Policy Committee (MPC) decided to keep the policy repo rate under the liquidity adjustment facility (LAF) unchanged at 6.25 per cent. Consequently, the reverse repo rate under the LAF remains unchanged at 5.75 per cent, and the marginal standing facility (MSF) rate and the Bank Rate at 6.75 per cent.
The RBI, however, withdrew the 100 per cent incremental Cash Reserve Ratio (CRR) - the ratio of deposits to be kept with the central bank – requirement on deposits raised between September 16 and November 11, effective the fortnight beginning December 10, 2016, releasing more liquidity into the system.
In its assessement MPC noted that global growth picked up modestly in the second half of 2016 but the expectations of reflationary fiscal policies in the US, Japan and China, and the waning of downward pressures on EMEs in recession are tempered by still-prevalent political risks in the euro area and the UK, emerging geo-political risks and the spectre of financial market volatility. On the domestic front, the growth of real gross value added (GVA) in Q2 of 2016-17 turned out to be lower than projected on account of a deeper than expected slowdown in industrial activity. Regarding inflation it said that retail inflation measured by the headline consumer price index (CPI) eased more than expected for the third consecutive month in October, driven down by a sharper than anticipated deflation in the prices of vegetables. Underlying this softer reading, however, was an upturn in momentum as prices rose month-on-month across the board. In the external sector, India’s merchandise exports rebounded in September and October. After a prolonged fall for 22 months, imports rose in October on the back of a sharp rise in the volume of gold imports and higher payments for POL imports.
In its outlook the MPC noted that upturn in the prices of several items that is masked by the easing of inflation on base effects during October. Despite some supply disruptions, the abrupt compression of demand in November due to the withdrawal of SBNs could push down the prices of perishables in the reading that becomes available in December. The withdrawal of SBNs could result in a possible temporary reduction in inflation of the order of 10-15 basis points in Q3 and the headline inflation is projected at 5 per cent in Q4 of 2016-17 with risks tilted to the upside but lower than in the October policy review. However, 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 CPC award, GVA growth for 2016-17 was revised down from 7.6 per cent to 7.1 per cent, with evenly balanced risks. MPC also noted that globally, the imminent tightening of monetary policy in the US is triggering bouts of high volatility in financial markets, with the possibility of large spillovers that could have macroeconomic implications for EMEs.
