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Six reasons RBI’s rate cut looks imminent in these times of demonetisation

05 December, 2016

The Reserve Bank of India (RBI) will announce on Wednesday its bi-monthly monetary policy, the second under governor Urjit Patel, who had taken over from Raghuram Rajan in September. It will also be the second time that the policy will be decided by the Monetary Policy Committee (MPC), which consists of three nominees each of the government and the RBI. 

In October, the MPC had surprised many analysts and economists as it cut interest rates by 25 basis points (bps), even as its review had said that global growth projections, especially for emerging markets like India, remained a worry. 

Here are the reasons that could determine the RBI’s decision on Wednesday.

Demonetisation: The banning of the Rs 500 and Rs 1,000 notes worth Rs 14.6 lakh crore, or 86% of the currency in circulation by value, will perhaps be the biggest reason that could virtually force the MPC to go in for a 25- or even a 50-bps cut. Citing government sources, several news reports have said that as much as Rs 11 lakh crore has already returned to banks. On the other hand, demonetisation has almost certainly meant a disruption in the economy, prompting ratings firms such as Fitch to lower gross domestic product (GDP) growth expectations to 6.9% from 7.4% for 2016-17.

Liquidity management: Although, on 26 November, the RBI sucked Rs 3.25 lakh crore from out of the system, as it asked banks to maintain an incremental cash reserve ratio of 100% on deposits between 16 September and 11 November, it will continue to have to manage liquidity and get banks to deploy this excess cash. In a report last month, financial services firm HSBC had said that it expects a 25 bps rate cut, as demonetisation is “likely to put additional downward pressure on growth and inflation over the next year”.

Moderating inflation: The other major determinant that will guide the central bank’s hand will be retail inflation, which in October eased to 4.20%, riding on the back of softening food prices. The wholesale price index fell for the second month in a row to 3.39%. Food inflation for November is further likely to ease, especially in the wake of demonetisation, which had brought the rural economy to a virtual standstill.   

Bond yields: Following demonetisation, benchmark bond yields have come down to 6.11% levels from over 6.8%, although the yields did perk up last week after the RBI mandated banks to deposit their extra cash. In a 30 November report, the Nikkei Asian Review said that during 9-24 November, foreign investors net sold government securities worth Rs 15,300 crore, adding, that if this trend continued, monthly net sales would hit their highest levels since June 2013. 

Weakening rupee: Ever since prime minister Narendra Modi announced his government’s decision to demonetise

old Rs 500 and Rs 1,000 notes on 8 November, the Indian rupee has tumbled 2.4% as foreign investors have sought to invest in dollar assets. In fact, on 29 November, the rupee hit a 39-month low of Rs 68.80, registering a 3.81% decline since the beginning of the year.   

US Fed rate hike: The US Federal Reserve is widely expected to go in for a rate increase later this month, after it held off in September. The latest US jobs data shows that unemployment at 4.6% is down at its lowest since August 2007, boosting the case for a rate hike. Another reason that signals an imminent Fed rate hike is the consensus reached last week at the meeting of the Organization of Petroleum Exporting Countries, which agreed to cut crude output by 1.2 million barrels a day, sending Brent crude prices up by more than 14%. Rising crude prices could be inflationary, thereby boosting the case for a rate increase. 

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Six reasons RBI’s rate cut looks imminent in these times of demonetisation

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