In the prevailing environment marked by the economic disruption caused by the withdrawal of high value notes and the surge of deposits, it was but natural that the financial markets would bet on the Reserve Bank of India cutting rates. The central bank has poured cold water on such hopes at its fifth bi-monthly policy review, by keeping its key policy rate, the repo rate, unchanged — a decision which appears to be sensible on first reading. Ahead of the policy, the RBI was confronted with the challenge of cutting rates to boost consumer and investor sentiment which had been impacted at least in the short term after the scrapping of Rs 500 and Rs 1,000 notes. The prospect of the US Federal Reserve raising interest rates against a backdrop of unemployment levels hovering at or below 5 per cent for 13 straight months, had also to be taken into account. With the gap between Indian and US 10-year government bond yields narrowing from 500 to 380 basis points during this period — and global crude prices, too, crossing $50-a-barrel after last week’s OPEC-Russia deal to cut production, raising the risk of higher crude prices — the leeway for the RBI to lower its benchmark repo or overnight lending rate was quite limited for it would have encouraged further outflow of foreign funds with its impact on the rupee.
In its policy statement, the RBI has said that after assessing some of these factors and the upside risks to the inflation target and heightened uncertainty, the Monetary Policy Committee felt it was important to analyse more information and experience before judging their full effects and their persistence. On balance, it felt it was more prudent to wait and watch how all these play out. The RBI’s revision of the GDP figures for FY 17 from 7.6 to 7.1 per cent owing to the impact of the withdrawal of currency notes may surprise many economists, analysts, and former Prime Minister Manmohan Singh who estimates that the economy would take a hit of at least two percentage points. But the central bank reckons that the impact of some of the downside risks in the near term could ebb with the progressive increase in the circulation of currency notes and greater usage of non-cash based payments.
And now with the completion of one month of demonetisation marked by a large part of the high value notes in circulation — Rs 11.5 lakh crore at last count, going by the figure put out by RBI officials today — coming back to the banking system, and with the central bank virtually discounting the prospect of a higher transfer of surplus to the government, the focus will shift to quickly regaining economic momentum. That will be the challenge — both from an economic and political perspective. For, the political and economic costs are too high if the growth engines stall after the disruption triggered by the decision to demonetise.