RBI monetary policy: Key rates unchanged as Urjit Patel defends demonetisation

Mumbai: Taking markets by surprise, RBI Governor Urjit Patel on Wednesday kept short term lending rate unchanged even as the central bank lowered GDP growth rate to 7.1 per cent and short term disruption in economic activities due to demonetisation. Patel-led 6-member Monetary Policy Committee, which had in its first policy review cut interest rate by 0.25 per cent in October, belied expectations to keep benchmark repo rate unchanged at 6.25 per cent unanimously.

In view of disruption in economic activities due to demonetisation, RBI lowered growth forecast from 7.6 per cent to 7.1 per cent for the current fiscal. The headline inflation is projected at 5 per cent by the fourth quarter of 2016-17 with risks tilted to the upside but lower than in the October policy review.

The fuller effects of the house rent allowances under the Seventh Pay Commission award are yet to be assessed, pending implementation, and have not been reckoned in this baseline inflation path, the fifth bi-monthly monthly monetary policy said.

On demonetisation, it said, the withdrawal of old high value currency notes 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.

"In the services sector, the outlook is mixed with construction, trade, transport, hotels and communication impacted by temporary old currency notes effects, 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)," it added.

The central bank also said that almost Rs 12 lakh crore out of total Rs 14.5 lakh crore in scrapped notes have already been deposited in banks.

 RBI monetary policy: Key rates unchanged as Urjit Patel defends demonetisation

Reserve Bank of India (RBI). Reuters

RBI has also withdraw 100 per cent incremental Cash Reserve Ratio (CRR) from 10 December, a move that would allow banks to retain the deposits coming to them as part of demonetisation.

All the six members of Monetary Policy Committee headed by the RBI Governor voted in favour of the today's decision. In the view of the Committee, this bi-monthly review is set against the backdrop of heightened uncertainty.

"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 emerging markets," it said.

While supply disruptions in the backdrop of currency replacement may drag down growth this year in India, it is important to analyse more information and experience before judging their full effects and their persistence, RBI said, adding that short-term developments that influence the outlook disproportionately warrant caution with respect to setting the monetary policy stance.

"On balance, therefore, it is prudent to wait and watch how these factors play out and impinge upon the outlook. Accordingly, the policy repo rate has been kept on hold in this review, while retaining an accommodative policy stance," it said.

The withdrawal of old Rs 500 and 1,000 notes "could result in a possible temporary reduction in inflation of the order of 10-15 basis points in Q3 (October-December period", the central bank said in the Fifth Bi-monthly Monetary Policy Statement Resolution of the Monetary Policy Committee (MPC).

RBI, however, kept retail inflation target of 5 percent for the fourth quarter of the fiscal and the medium-term target of 4 per cent within a band of +/- 2 per cent while supporting growth.
MPC, RBI said, felt that the assessment is clouded by the still unfolding effects of the withdrawal of specified bank notes (SBNs).

"The outlook for GVA (gross value added) growth for 2016-17 has turned uncertain after the unexpected loss of momentum by 50 basis points in Q2 and the effects of the withdrawal of SBNs (Rs 500/1,000 notes) which are still playing out," the policy document said.

Downside risks in the near term could travel through two major channels.

One is "short-run disruptions in economic activity in cash-intensive sectors such as retail trade, hotels and restaurants and transportation, and in the unorganised sector". The second channel is aggregate demand compression associated with adverse wealth effects.

"The impact of the first channel should, however, ebb with the progressive increase in the circulation of new currency notes and greater usage of non-cash based payment instruments in the economy while the impact of the second channel is likely to be limited," RBI said.

The Reserve Bank Wednesday cut the economy's expansion forecast for current fiscal to 7.1 per cent from 7.6 per cent earlier, saying that short-term disruption in economic activity and demand compression arising out of demonetisation have led to downside risks to growth.

It said that in the near term the risks could travel through "short-run disruptions in economic activity" in cash-intensive sectors such as retail trade, hotels and restaurants and transportation, and in the unorganised sector and aggregate demand compression associated with adverse wealth effects.

"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 is revised down from 7.6 percent to 7.1 percent, with evenly balanced risks," the RBI said in the fifth bi-monthly Monetary Policy Statement for the current fiscal.

"The outlook for Gross Value Added (GVA) growth for 2016-17 has turned uncertain after the unexpected loss of momentum by 50 basis points in Q2 and the effects of the withdrawal of specified bank notes (SBNs) which are still playing out," it said.

RBI said the impact of demonetisation should ebb with the progressive increase in the circulation of new currency notes and greater usage of non-cash based payment instruments in the economy.

"It is appropriate to look through the transitory but unclear effects of the withdrawal of SBNs while setting the monetary policy stance. On balance, therefore, it is prudent to wait and watch how these factors play out and impinge upon the outlook. Accordingly, the policy repo rate has been kept on hold in this review, while retaining an accommodative policy stance," RBI said.
RBI said the second quarter GDP quarter was lower than projected because of deeper than expected slowdown in industrial activity.

"Manufacturing slowed down both sequentially and on an annual basis, with weak demand conditions and the firming up of input costs dragging down the profitability of corporations," it said.

(With inputs from PTI)

Updated Date: Dec 07, 2016 17:40:30 IST