Demonetisation prevented rate cut in last RBI monetary policy review; remonetisation in this one

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Updated: April 6, 2017 5:41:56 PM

While demonetisation was blamed for the RBI’s decision to keep key policy rates unchanged in the last monetary policy review in February, this time around, the remonetisation is the culprit to some extent

Remonetisation has left the system flush with liquidity, forcing the central bank’s hand from easing the rates.

While demonetisation was blamed for the RBI’s decision to keep key policy rates unchanged in the last monetary policy review in February, this time around, the remonetisation is the culprit to some extent, which has left the system flush with liquidity, forcing the central bank’s hand from easing the rates.

“With progressive remonetisation, the surplus liquidity in the banking system declined from a peak of Rs 7,956 billion on January 4, 2017 to an average of Rs 6,014 billion in February and further down to Rs 4,806 billion in March,” the Reserve Bank of India said today in its first bi-monthly credit and monetary policy review for the current financial year 2017-18.

In its last policy review in February, the RBI kept the key policy rate unchanged at 6.25% against expectations, and toughened the policy stance to ‘neutral’ from ‘accommodative’, opting to wait for more clarity on the trend of inflation and on the economic impact of demonetisation.

RBI expects the quantum of surplus liquidity to come down in next few quarters, RBI said.

Tackling the excess liquidity remains a challenge for the banking sector.

The RBI first asked banks to maintain an incremental CRR of 100% in November (for new deposits) with regard to excess liquidity post-demonetization. This way around Rs 3.2 trillion was absorbed from the baking sector. However, with the enhancement in the ceiling for securities under the Market Stabilisation Scheme (MSS) to Rs 6 trillion, the central bank decided to withdraw the incremental CRR in December. Later on, even the MSS bills were redeemed and the money withdrawn earlier came back into the system.

Now, with the quick pace of remonetisation, there is around Rs 4 trillion surplus liquidity in the system, which may also lead to a rise in inflation. It is likely to rise further when the government starts spending in the new fiscal year.

Moreover, if the rupee continues to appreciate, there could be added pressure as the RBI starts buying dollars to cap gains in the currency. Leaving the surplus problem unattended could also lead to investments into riskier assets at unwarranted low yields.

 

 

 

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