India: A surprise status quo from the RBI

A prudent step.

In a surprise move, the monetary policy committee (MPC) voted 6-0 in favour of keeping the policy repo rate unchanged at 6.25% yesterday. Of the 44 firms polled by Bloomberg, 71% expected a 25bp cut (including us), 11% expected a 50bp cut and 18% expected no cut. The RBI left the cash reserve ratio unchanged at 4%, as expected, and announced that the incremental CRR of 100% will stand withdrawn from 10 December. 

The increase in the market stabilisation securities ceiling to INR6trn has boosted the RBI’s firepower to absorb liquidity. According to the RBI, demonetisation is expected to hurt growth and inflation only for a transitory period. Moreover, with core inflation sticky, global crude oil prices higher and signs of an increase in certain food prices (wheat, gram and sugar), the RBI believes it is prudent to “wait and watch” for now. At the same time, it maintained an accommodative policy stance, keeping the door open to easing if inflation falls on a sustained basis. The RBI retained its baseline CPI inflation projection for March 2017 at 5% with risks tilted to the upside. Meanwhile, it sharply lowered its FY17 GVA growth projection from 7.6% to 7.1%, taking into account the negative impact of demonetisation. 

Despite the surprise yesterday, it is believed that the RBI’s decision to stand pat is a prudent one. It is also expected demonetisation will hurt short-term activity, but medium-term damage is not seen as it will only result in wealth redistribution, and not much wealth destruction. Moreover, while headline inflation is low, underlying inflation has stabilised around 5%. As such, in the light of improved banking system liquidity, the focus needs to be more on the transmission of the rate cuts already delivered, rather than lowering the signalling rates much further.