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3 reasons why the RBI maintained status quo on repo rates

09 December 2016
Wondering why RBI didn’t change the repo rate? Here is everything you need to know.
 

Wondering why RBI didn’t change the repo rate? Here is everything you need to know.

In a surprising move, the Reserve Bank of India kept the repo rate unchanged at 6.25% during its fifth bi-monthly policy review. This decision has raised a lot of eyebrows because a rate cut of 25 basis points was largely expected.

Here’s why the RBI did not change the repo rates.

  1. Inflation

A potential rise in food inflation and a sharp increase in the prices of several items have been major factors.

The central bank states that prices of major food products such as wheat, sugar and gram have been steadily increasing. If the moderation in prices does not occur, food inflation pressures could possibly re-emerge.

Related: The 500-1000 rupee note demonetization decoded in India [Infographic]

  1. Market Volatility

The recent decision of OPEC to cut oil production has been a troubling piece of news for the Indian economy. A shortage of supply means that prices will shoot up. This will automatically increase the prices of petrol in the country. In addition, volatility in international markets and an imminent tightening of US Monetary Policy have contributed towards this decision.

  1. Wait and Watch approach

Due to the demonetization drive last month by the Prime Minister Narendra Modi, around 86 percent of the currency in circulation has been withdrawn. This has resulted in a massive liquidity crunch in the country, affecting everyone from farmers to large corporate companies. A rate cut would have provided the much required relief to investors, according to many in the industry.

In the short term, sectors like transportation, hotels and retail trade are facing the pinch of liquidity crunch. But the RBI feels that it is too early to take a decision as the impact of the big-note ban had not played out yet. Furthermore, growth would rebound strongly if the “impact is transient as widely expected,” according to a policy statement by the RBI. An increase in the circulation of new currency is expected as the bank has already issued Rs 4,00,000 crore worth of notes in lower denomination. It is confident that the usage of cashless payment systems would increase too.

The bottom line

The RBI has an unenviable job of balancing growth and inflation. This becomes all the more difficult when major events such as the demonetization drive completely change the equation. The RBI might have its reasons to maintain the status quo on repo rates but a 155 point drop in the Sensex clearly showed the market’s disappointment.

 
 
 

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