Awash with funds, banks may start cutting loan rates to productively deploy unexpected deposit surge; RBI lowers 2016-17 growth forecast by 50 basis points to 7.1 percent on demonetisation effect.
In an unexpected hawkish move, the Reserve Bank of India (RBI) on Wednesday kept its key lending—the repo rate--unchanged at 6.25 percent, dashing hopes of lower borrowing costs to arrest the demonetisation-induced slide in spending and investment.
The RBI governor Urjit Patel-headed six-member monetary policy committee (MPC) brainstormed for two days before announcing the decision to maintain the status quo on rates.
The panel’s meeting took place amid looming questions over the currency recall exercise that has forced households, hit by a cash-crunch, to cutback spending on both essential and aspirational products.
"The Committee felt that the assessment is clouded by the still unfolding effects of the withdrawal of specified bank notes (SBNs)," the RBI said in its monetary policy review.
It, however, lowered its growth forecast for 2016-17 to 7.1 percent from 7.6 percent earlier, signs that the cash-crunch will likely decelerate the broader economy.
"The MPC felt further felt no need to cut rates," Patel said.
The MPC also decided to restore the cash reserve ratio (CRR)—the proportion of deposits banks are required to park with the RBI—at 4 percent.
That surge in post-demonetisation liquidity had prompted the RBI to temporarily ask banks to park the entire mountain of additional cash as 100 percent cash reserve ratio (CRR) with the central bank.
The central bank on Wednesday said that this interim measure stands withdrawn from December 10, a move that will likely soothe frayed nerves of banks.
“Incremental CRR was intended as a purely temporarily measure. Banks will not have to bear the burden of incremental CRR,” Patel said during the post-policy press conference.
Last week, the RBI revised the ceiling on issuance of securities under the market stabilization scheme (MSS) to Rs 6 lakh crore, from the previous limit of Rs30,000 crore for financial year 2016-17
“The government has proactively responded by raising the MSS,” Patel said.
Banks are awash with funds as millions of people are queueing up every day to deposit banned Rs 500 and Rs1000 notes ahead of the December 30 deadline.
So far, people have deposited Rs 11.55 lakh crore worth of “demonetised” notes.
The central bank said that the RBI has so far replaced Rs 4 lakh crore of new notes since November 8 when the unexpected currency culling exercise was announced.
Banks were not in favour of a higher CRR, as parking funds with the RBI in this window does not fetch any returns, and works against lowering lending rates for final individual and corporate borrowers.
Patel also dismissed speculation that the withdrawal of old notes will result in a windfall for the central bank which could have been transferred to the government by way of special dividend.
"The withdrawal of the legal tender status does not remove the liability," Patel said.
A lower repo rate—the rate at which banks borrow from RBI--would have hastened cheaper bank loans to buy houses and goods such as cars, most of which are bought through loans.
The BSE Sensex fell more than 130 points mirroring the stock markets’ heightened disappointment over unchanged rates.
Since January 2015, the RBI has cut the repo rate six times.
India’s retail inflation has touched 4.20 percent in October, triggering hopes of a rate cut.
The RBI and the government have set a retail inflation target of 4 per cent for the next five years with an upper tolerance level of 6 percent and lower limit of 2 per cent.
Household spending accounts for more than half of India’s GDP, underlining the need to goad families to buy more and keep the broader economy’s growth engine chugging.
Initial estimates suggest that "demonetisation" of Rs 500 and Rs 1000 notes have dampened consumer durable sales, particularly in rural areas where most transactions take place in cash, partially offsetting the gains from abundant summer rains this year after two years of successive drought.
The slowdown in household spending could push back investment growth with firms already sitting on vast unused capacities in consumption-linked sectors.
"Industrial activity remains weak…The withdrawal of SBNs 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 said.
In the services sector, the outlook is mixed with construction, trade, transport, hotels and communication impacted by demonetisation, 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) payouts, the RBI said.