The RBI stayed prudent in its monetary policy review today rather than move in a haste as it wishes to wait for more information and experience before judging the full effect and persistence of the demonetisation move.
While the central bank has aggressively reduced the real GVA growth projection by 50 bps in view of the ongoing weaknesses in private investment spending and some supply-side disruptions triggered by the demonetisation move, it’s outlook on the future trajectory of CPI inflation has not changed much.
Despite demonetisation, RBI sees the risks to its CPI projection of 5 percent for March 2017 tilted upwards (similar to its assessment in October) on account of continued firmness in food inflation barring vegetable inflation, sticky core inflation and the reversal in global crude prices post the OPEC’s decision to cut output.
It continues to remain pessimistic in its assessment of global outlook. The result of the US presidential elections has made international financial markets more volatile and further added to the dollar’s strength triggering sizable depreciations in currencies around the world. The benefits of expansionary fiscal policies of the US, Japan and China and early signs of economic recovery in some select countries are getting partially offset by continued political risks in the Euro region and Britain, emerging geo-political risks post the OPEC’s decision and the episodes of financial market distress.
Besides dismal global factors, India’s growth has received a short-term setback, especially in its unorganised sectors and services segments on account of the unfolding effects of the withdrawal of specified bank notes (i.e., demonetisation) since November 9th. Yet, the RBI stayed prudent in its monetary policy review today rather than move in a haste as it wishes to wait for more information and experience before judging the full effect and persistence of the demonetisation move.
As we had expected, today’s monetary policy was influenced more by the high impact global events such as the likely increase in the US Fed rate around mid-December and the resultant large spillovers that could impact international capital movement and currency valuations. Moreover, post demonetisation, whatever “transmission” had to happen through the banking channel, has already happened in India during the period Nov 9 till date.
Furthermore, the imposition of incremental CRR of 100% on bank deposits mobilised during September 16 to November 11, has completely wiped off the banks’ ability to cut lending rates anymore, as banks do not earn any interest from the RBI on their CRR balances. Other concerns like the overhang of NPAs and credit costs continue unabated. So even if the RBI had cut rates today, it wouldn’t have benefitted the real sector but would have raised the probability of capital flight.
The RBI’s policy today has again emphasised that to safeguard financial stability is and remains, a core function for any central bank.
Author is a Group Chief Economist at L&T Financial Services.