The Reserve Bank of India on Wednesday decided to hold the repo rate at 6.25%, going against all predictions and triggering a fall in the stock markets.
The repo rate influences interests on loans since this is the rate at which the RBI lends money to banks. Everyone expected the central bank to cut the rate in the wake of the government’s decision to ban `500 and `1,000 banknotes, which culled 86% of the currency in circulation and left the economy reeling.
RBI’s monetary policy committee, which voted 6-0 in favour of the status quo, attributed the move to its assessment that any moderation in prices following demonetisation would be temporary.
“The prices of wheat, gram, and sugar have been firming up... while discretionary spending on goods and services in the CPI could have been affected by restricted access to cash, the prices of these items may weather these transitory effects,” RBI governor Urjit Patel said.
Underscoring the uncertainty brought in by the currency recall, the central bank sent out the message it was not willing to cut rates to shore up growth. It put the onus on banks to cut lending rates, as they will be flush with money on which the usual interest is 4%, compared to the lending rates that run well into double digits.
The RBI’s statement, at its bimonthly policy review, did acknowledge the adverse impact of the demonetisation on the economy and cut its forecast for the GDP growth this financial year from 7.6% to 7.1%.
It also poured cold water on the expectations that the government would get a windfall – brokerages estimated it at `3 lakh crore – equal to the culled notes that do not come back into the banking system by December 30.
“There is no such plan. That question does not arise as there is no implication on RBI’s balance sheet as of now... Not just by the withdrawal of legal tender character...no. They still carry the RBI’s liability,” Patel said.
The refusal of a special dividend means demonetisation will yield less money to spare for development and infrastructure projects, while the spectre of rising inflation goes against the belief that the hoards of cash coming into bank will curb prices.
The government’s chief economic adviser, Arvind Subramanian, called the RBI’s decision to hold rates “bold and brilliant”. He said the decision was taken despite high expectations of a rate cut and signalled policy stability at a time of high global volatility leading to rising interest rates and falling capital flows.
The RBI governor was non-committal when asked, at a press conference after the policy announcement, if the entire culled currency would come into the system and if that would make India free of black money.
“The costs are what we are witnessing now in terms of the inconvenience we are all aware of. The benefits are in the medium and long term…We will have more transparency, in terms of fiscal and tax compliance, we will be in a better place, our public finances could improve and the collateral benefit is the digitisation taking place,” Patel said.
He reassured the public about the safety of its deposits. “The money in your bank account is yours. We have some controls in the transition process but in terms of your wealth, the money is where it is and the liability of the RBI will be fulfilled.”
The central bank rolled back its recent decision to mop up the incremental deposits from demonetisation – so far Rs 11.55 lakh crore has flowed into the system in old currency – through a higher cash reserve ratio (CRR). The CRR hike for banks to park the entire deposits with RBI will end on December 10.
State Bank of India chairman Arundhati Bhattacharya told a television channel the RBI policy announcement was a non-event that disappointed her.