The Reserve Bank of India has cut growth estimates for the economy to 7.1 per cent from 7.6 per cent way before the demonetisation effect plays into effect. It cited a slowdown in the second quarter but underplayed the impact of the radical currency change. Disappointed at the central bank's decision to hold its key policy rates, stock and bond prices fell mid week. The BSE Sensex fell 156 points, reversing a two-day trend and yield on the benchmark 10 year bond shot up by 20 basis points to 6.40 per cent. However, banks are confident that loans will get cheaper after the RBI decided to release funds locked by way of an incremental cash reserve requirement.
Before the policy, most bankers and economists were of the view that the RBI would cut rates in its bi-monthly policy review. "The decision to keep the repo rate unchanged was a little surprising given that there has been sizeable demand destruction," said Arundhati Bhattacharya, Chairman, State Bank of India. The main bank, in its defense, downplayed the impact of demand contraction following demonetisation, saying the impact on GDP growth would at worst be 15 basis points, adding that it was only a temporary phenomenon.
"The growth estimates are down because of the Q2 revision which is in the past. The withdrawal of specified bank notes is also factored in but that is only about 15 basis points and we regard that as a very transitory phenomenon and monetary policy should not be reacting to transitory phenomenon," it said. RBI governor Urjit Patel came on too strong in his defense of the government move. "The motivation for the decision was to deal with the problem of high-quality counterfeit notes and unearth black money that may be held in cash. The decision was not taken in haste but after detailed deliberations."
Speaking on inflation, Patel said, "CPI inflation, excluding food and fuel, has been resistant to downward impulses and could set a floor to headline inflation. With the OPEC's agreement to cut production, crude prices may firm up in the coming months."
Even as bond yields rose sharply following Reserve Bank of India's decision to hold rates, bankers expect interest rates to ease as banks will be flush with liquidity for some time. Helping to bring down the cost of funds for banks will be the withdrawal of the 100% incremental cash reserve ratio (CRR) requirement imposed on November 26.
