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  • 6 reasons why RBI chose to not cut rates

    The Reserve Bank of India has an unenviable job; it has to balance between inflation and growth—two sides of the same coin. Focussing on either too much could endanger people’s money and the country’s long-term growth.

    In the recent past, inflation slowed down to comfortable levels. Moreover, the recent move of demonetising the 500 and 1,000-rupee notes is expected to slow the economy. So, many expected the RBI to cut rates by 0.25%.

    The RBI’s monetary policy committee, however, decided otherwise—it held interest rates steady.

Here’s why the RBI chose to not cut rates:

  • Crude oil:

    Recently, the network of major oil producers – OPEC – decided to cut production. If supply falls, prices tend to rise. Naturally, the prices of oil shot up in the international markets. This could shoot up India’s oil import bill. Moreover, it could also increase the prices of petrol and other fuel in India. This can be inflationary.

  • Core inflation:

    It’s not just about food and fuel. The prices of other goods and services too are growing at a faster-than-comfortable pace. “Although housing and personal care inflation softened marginally, the steady rise in inflation in respect of education, medical and health services, and transport and communication has imparted stickiness to inflation in this category,” the RBI statement said.

  • Global uncertainty:

    On one hand, there’s the worry about an increase in rates by the US central bank – Federal Reserve. On the other hand, there’s uncertainty regarding the new US President Donald Trump’s policies; Britain’s exit from the European Union, and other geopolitical risks. This is causing financial markets to be turbulent. In fact, foreign investors sold investments worth $7.3 billion in October and November. Even bond and commodity markets were affected. The rupee too has been nudging hovering around Rs 70/ 68/$ levels.

  • Liquidity:

    The amount of money in the system—liquidity—is another concern for the RBI. The demonetization of the currency notes caused a liquidity crunch in the markets and excess liquidity in the banking system. This is potentially disinflationary. Experts and analysts suggested that this gives room to cut rates. However, this is the only positive factor compared to all the above negative factors. Moreover, the effects of the demonetization move are still unclear, as per the RBI. It thus decided to wait and watch for any measurable impact.

  • Removal of CRR hike:

    Instead of cutting interest rates, the RBI changed the Cash Reserve Ratio (CRR) norms. This is the percentage of deposits that a bank must keep with the RBI compulsorily. Recently, the RBI asked banks to keep all the excess deposits from the demonetization as CRR. It’s called the 100% Incremental CRR norm. This was negative for banks as deposits in CRR do not earn any interest even though banks have to keep paying depositors interest on their deposits. So it came as a relief to banks when the RBI also revoked this rule in its latest monetary policy announcement.

  • Banks may pass on rate cut:

    Excess deposits give banks the leeway to cut loan interest rates. After all, the RBI cut rates by around 1.5% since January 2015. But, banks did not pass on this rate cut in full. They barely cut rates by 0.5-0.75% during the same period. With a surge in deposits, banks have responded by cutting deposit rates which gives them legroom to pass on the benefit to borrowers by cutting interest rates further.

    • Why the clamour for rate cut is baseless Read more

    • RBI monetary policy: Three questions Urjit Patel never answered on demonetisation pain Read more

  • 6.4%

    The RBI expects economic growth – measured by Gross Value Addition (GVA) – to slow to 7.1% for the fiscal year ending March 2017. This is down from the earlier forecast of 7.6%. This is because of the impact of demonetization. However, Kotak analysts expect the impact of demonetization to be higher. “While we do see medium-term economic gains, the short-term disruption could slow FY2017 real GVA growth at 6.4%,” a Kotak Institutional Equities report said. This could lead to a rate cut in the RBI’s February monetary policy review, the report said.