Reserve Bank of India's monetary policy announcement disappoints market

For a  change , the  market was surprised  with the 'pause' decision of the monetary policy committee.  The  6-member  MPC have taken a decision to keep the repo rate unchanged in its monetary policy statement here today.  The repo rate - the rate at which banks borrows  funds from the RBI --   stays  at 6.25 per cent.

In fact , this decision of the committee  has come as a huge disappointment for the market , which was expecting at least 25 basis to 50 basis points cut in the repo rate. Clearly , demonetization of currency has brought in huge unpredictability and hence the committee wants to wait and  watch.  In addition ,   the central banks of US  and Europe would also be reviewing their rates in the coming month.

In the last two years , the RBI  has slashed the repo rate by 175 basis points. The RBI kicked off the  interest rate easing cycle as inflation softened from a high of 10 per cent plus to 4 per cent now.  In October , the CPI or the retail inflation closed at 4.20 per cent.  The current inflation is well within the  target of 4 per cent plus  and minus 2 per cent  ( a range of 2 to 6 per cent ).

According to experts , there are several near term risks to inflation.  The decision to demonetize  the high value currency , which is over 85 per cent in value to total currency in circulation --  has brought  in lot of unpredictability. First , the demonetization has created a huge liquidity in the banking system.  The banks have got  estimated 10 -11 lakh crore in deposits.  There is likelihood of these deposits  moving out from the  banks en masse once withdrawal limits are removed by the banks. Currently , there is a weekly limit of Rs 24 ,000 for savings account holder and Rs 50 , 000 for current account holders.  To that extent , it has  impacted the demand  as lesser cash in hand has reduced the purchasing power of people.

After touching the  lows, the commodity prices are  also on the upswing.  In the last one year , the oil prices have moved up from USD 35-36  a barrel to 52-54 a barrel.  This has the potential to fuel inflationary pressure  as the domestic economy relies on huge oil imports.  

The rupee depreciation is yet another element , which is dangerously  placed  as  the world's largest economy is showing signs of improvement.  The US dollar is already strengthening against the major currencies.  If rupee weakens against  the US dollar  going forward ,  there is likely to be outflow of dollars from the Indian economy. This will have a negative impact on rupee value  and consequently on the inflation as India  suffers from two deficits  - trade as well as current account deficit.