RBI credit policy 2016: Central bank does well to take a stance contrary to market expectations

Published: December 9, 2016 6:16:54 AM

Reserve Bank of India surprised the market with its first monetary policy review, after de-monetisation, by keeping its repo rate unchanged at 6.25%.

The lowering of the GDP forecast may prompt RBI to encourage consumer expenditure, which has been affected the most post de-monetisation.The lowering of the GDP forecast may prompt RBI to encourage consumer expenditure, which has been affected the most post de-monetisation.

Reserve Bank of India surprised the market with its first monetary policy review, after de-monetisation, by keeping its repo rate unchanged at 6.25%. The market had factored in a rate cut, but the debate was on about the quantum of cut—whether it ought to be 25 bps or 50 bps? Belying market expectations, RBI has kept status quo on rates, however, announced the withdrawal of incremental Cash Reserve Ratio (CRR) from December 10. The markets should have adequate liquidity and if there is excess liquidity then the same can be absorbed through RBI market stabilisation scheme (MSS), whose limit has been enhanced to R6 lakh crore from Rs 30 thousand crore.

We think RBI has taken a very pragmatic stance based on the wider market conditions; Global factors: it is widely perceived based on the US Federal Reserve’s own commentary and employment data that it may hike its benchmark rates in next week’s Fed Committee meeting. If this happens, it will further narrow the gap between the US and our interest rates, which may see further outflow of funds and destabilising the rupee (which is under pressure after the US election).

Inflationary expectations: the increase in global crude oil prices due to cut in oil production by the OPEC members may spike the inflation. If the usual winter moderation in food prices does not materialise due to the disruptions, food inflation pressures could re-emerge.

RBI is also probably closely monitoring the impact of de-monetisation on the real economy. The policy statement for the very first time officially recognises the lowering the GDP by 50 bps from 7.6% to 7.1% for 2016-17, measured through gross value added (GVA). The lowering of the GDP forecast may prompt RBI to encourage consumer expenditure, which has been affected the most post de-monetisation.

If we look at the market, the rate transmission already has started with lowering of yields. The one year yield had declined from 6.52% before demonetisation to 6.08% on December 6. As discussed earlier, the CRR withdrawal from December 10 may force banks to pass on some benefits in the form of rate cuts to consumer lending and mortgage loans.

Given this backdrop, RBI has taken a wait and watch policy. In due course, the central bank will have much more clarity on global factors like the US Fed rate hike, oil price volatility, winter crop productions and domestic deficit numbers. If these internal and external factors turn favourable, RBI may take a decision on rates before its next bi-monthly policy. Till then, we must welcome the RBI’s independent view, which is contrary to market expectations.
The author, Kuntal Sur is partner, financial services (risk and regulation leader), PwC India. Views are personal

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