Increasing uncertainty surrounding the withdrawal of currency notes with denominations of R500 and R1,000 and expectations of reflationary monetary policy in the US were among the primary reasons for the Reserve Bank of India deciding to hold rates at the Monetary Policy Committee meeting earlier this month.
In the minutes of the meeting, which was published by the RBI on Wednesday, it was revealed that almost all the members of the Monetary Policy Committee (MPC) felt that the impact of the withdrawal of specified bank notes, although likely to be significant on consumption in the short-term, would probably be transitory. In fact, all six members of the MPC concurred that the withdrawal of the SBNs is unlikely to have any significant impact on the medium-to-long term growth prospects of the economy.
“While a negative demand shock because of the withdrawal of SBNs will lead to a decline in consumption demand, the risks that such a reduction will have longer term effects by impinging on overall investment sentiment and investment activity are low,” said MPC member Dr Chentan Ghate in his statement. “What counters the adverse effects of the withdrawal of SBNs is the aggressive pace of digitisation, and the fast restoration of the transaction demand for money from the re-tendering process. I therefore expect the demand and supply effects from the withdrawal of SBNs to be transient with the accompanying increase in the output gap likely to be temporary. This makes it inappropriate to respond with a rate cut.”
Other members of the MPC made similar statements to back their decision of holding rates. “There is uncertainty about the short-term impact of the decision to withdraw the legal tender status of R500 and R1000 denomination bank notes on the macro economy, although the impact is likely to be transitory. I, however, don’t see any significant downside risks to the medium-term growth prospects of the economy,” said Dr R Gandhi, who is also a deputy governor for the RBI.
In addition to this, the MPC also highlighted other factors which led to their decision of not cutting the repo rate like excess liquidity in the system in the period leading up to the government’s announcement of the withdrawal of SBNs, which was further boosted by the decision.
Expectations of a rate hike by the Federal Reserve, in its meeting on December 14, was also one of the main reasons for the MPC deciding to holding rates. The Federal Reserve increased rates by 25 basis points and said that the market could expect three such cuts over the next year. This meant that the spread between the US 10-year treasury and the Indian 10-year benchmark gilt would have narrowed further, had the MPC decided to cut rates at its December meeting.
Most of the members expressed their concern over rising crude oil prices and increasing inflationary risks. They also said that slow transition of central bank rate cuts – 175 basis points since January 2015 – into lending rate cuts by banks was an important factor that resulted in their decision.