RBI today unexpectedly kept interest rate unchanged despite calls for lowering it while it slashed the economic growth projection by half a per cent to 7.1 in the first policy review post demonetisation.
Announcing the fifth bi-monthly monetary policy review of the current fiscal, RBI Governor Urjit Patel also said demonetisation was not done in haste and efforts were being made to increase the supply of currency notes and appealed to the public not to hoard them.
Acknowledging that supply disruptions against the backdrop of currency replacement may drag down growth this year in India, he said short-term developments that influence the outlook disproportionately warrant caution with respect to setting the monetary policy stance.
"On balance, therefore, it is prudent to wait and watch how these factors play out and impinge upon the outlook. Accordingly, the policy repo rate has been kept on hold in this review, while retaining an accommodative policy stance," RBI said.
Satisfied with the RBI decision to keep the repo (short term lending) rate unchanged at 6.25 per cent, decided unanimously by Patel-led 6-member Monetary Policy Committee, the Finance Ministry described it as a "bold and brilliant" move which will prevent flight of overseas capital in uncertain global environment.
In its last review, which was first under Patel, the MPC had lowered the rate by 0.25 per cent.
India Inc, which was hoping for a 0.5 per cent cut in interest rate on account of surge in bank deposit following demonetisation, expressed disappointment saying RBI should cut the rate to support growth of trade and industry hit by demonetisation.
Bankers felt that there could be easing of interest rate in the days to come with RBI deciding to remove the incremental Cash Reserve Ratio (CRR) of 100 per cent from December 10.
"The combination of removal of incremental CRR limit and MSS (market stabilisation scheme) will help banks to manage their liquidity conditions better and bring financial stability to the system," SBI Chairperson Arundhati Bhattacharya said.
The Reserve Bank projected the headline inflation at 5 per cent by the fourth quarter of 2016-17 with risks tilted to the upside, but lower than in the October policy review.
The fuller effects of the house rent allowance under the Seventh Pay Commission award are yet to be assessed, pending implementation, and have not been reckoned in this baseline inflation path, RBI said.
On demonetisation, it said the withdrawal of old high value currency notes could transiently interrupt some part of industrial activity in November-December due to delays in payments of wages and purchases of inputs, although a fuller assessment is awaited.
The central bank also said that almost Rs 12 lakh crore out of total Rs 14.5 lakh crore in scrapped notes have already been deposited in banks.
Government had scrapped the old Rs 500/1000 notes from
November 9, giving the public time to exchange them till December 30. It led to cash shortages in the system, besides unending queues at banks and ATMs for exchange/deposit of invalid currency and withdrawal of new notes.
All this has impacted the economic activity majorly.
RBI said: "In the services sector, the outlook is mixed with construction, trade, transport, hotels and communication impacted by temporary old currency notes effects, while public administration, defence and other services would continue to be buoyed by the 7th Central Pay Commission (CPC) award and one rank one pension (OROP)."
Asked about whether the RBI's status quo on rates was based on the expectations of the US Fed rate hike, Patel said "our decision has nothing to do with that".
The Fed move has been factored in all the financial market, he said, adding that "we will wait for more data to come in and then take a call...With the incoming data if we find on durable basis some space is found then we will take a look at that".
The Finance Ministry said rate cut in times of global uncertainty would have prompted overseas investors to withdraw their investments.
"Perhaps there is uncertainty about US Fed rate decision which is due shortly. So keeping the uncertainty in the international sector in mind...With some kind of resistance to downward pressure on inflation, RBI has taken a decision to take a pause and adopt wait and watch policy," Economic Affairs Secretary Shaktikanta Das said.
According to Chief Economic Adviser Arvind Subramanian: "It is a bold and brilliant call by the Reserve Bank of India. Bold, because it is contrary to what people expected."
Patel said this bi-monthly review is set against the backdrop of heightened uncertainty.
"Globally, the imminent tightening of monetary policy in the US is triggering bouts of high volatility in financial markets, with the possibility of large spillovers that could have macroeconomic implications for emerging markets," he said.
RBI's decision to leave interest rates untouched caught market by surprise as the Sensex switched gear by reversing its two days of gains and cracked 156 points today to close at 26,237.
