RBI stunned all economists, keeps Repo Rate Unchanged

Today, 07 December 2016, Reserve Bank of India in its fifth bimonthly policy review surprised all the economists and analysts by keeping the repo rate unchanged at 6.25%. However the RBI has cut FY17 GVA(Gross Value Added) estimate from 7.6% earlier to 7.1%.

What is RBI’s speculation?
RBI Governor, Dr. Urjit Patel told the media that prices of perishable products such as butter and fruits may come down by curbing cash. He estimates a 5% CPI(Consumer Price Index) in the fourth quarter of the year 2016-17. The only relief RBI has given is that it will withdraw incremental CRR from 10 December 2016. It may help banks to lower lending rates.

Immediate Effect Post RBI Announcement

  • Indian Stock Markets tumbled. Sensex and Nifty fallen 155 and 41 points respectively while BankNifty made a swing from 18588 to 17952 but closed at 18234.
  • Indian Rupee gained 26 paisa (0.38%) just after the RBI policy released and closed at 67.64.
  • Govt. bond yields dramatically rose 21 basis points and closed at 6.41%.

Why RBI kept Repo Rate Unchanged?
Almost 80% economists had predicted and expected at least 25 basis points cut but maintaining a status quo by RBI stunned everyone. Let’s see what RBI thought before going for this unchanged move:

Procrastination Strategy: Before jumping to any conclusion, RBI wants to monitor the short term effects of demonetization. The central bank knows that there will be an economic disruption in the sectors – like retail, logistics, hotels, etc – that deals in cash. Moreover, RBI also wants to monitor how cashless transactions shape up.

The central bank speculated, “It is appropriate to look through the transitory but unclear effects of the withdrawal of SBNs while 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.”

This seems reasonable since there is immense liquidity in the system.

Inflation check: The prices of perishable items such as wheat, gram, sugar are going up and commodity and crude oil prices may also go up after the OPEC decides to cut the output of crude oil from January 2017. RBI expects inflation rates will be unfavourable for the economy for the period of December 2016 and February 2017.

In central Bank’s words, “If the usual winter moderation in food prices does not materialise due to the disruptions, food inflation pressures could re-emerge. Furthermore, CPI inflation excluding food and fuel has been resistant to downward impulses and could set a floor to headline inflation. With the Opec agreement to cut production, crude prices may firm up in the coming months,”

Global Factors: Government’s inflation targets may not meet for the Q4 of 2017 financial year. This is because of the high volatility in global crude market.

In addition to this, developed economies of the world are facing inflation below their targets while in developing countries inflation is easing up. So reflationary fiscal policies in developed countries may change and impact emerging economies.

Fed rate behaviour and Trump policies are also main factors which RBI would like to look out for.

Europe is also a matter of concern which can lead to global recession in coming year, provided things didn’t fall in place post Brexit implementation.

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