RBI holds interest rates, cuts growth forecast to 7.1%

DEMONETISATION EFFECT Says fall in prices may only be temporary, puts onus on cash-flush banks to cut lending rates

MUMBAI: 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.

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