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EDITORIAL

The Reserve Bank of Indias big surprise

DECEMBER 08, 2016 00:02 IST
UPDATED: DECEMBER 07, 2016 23:52 IST

he Reserve Bank of India has surprised markets by opting to keep benchmark interest
rates unchanged and cutting the outlook for full-year growth in the wake of last
months decision to withdraw legal tender status to high denomination currency notes. In the
fifth bimonthly monetary policy statement, the RBI cited a backdrop of heightened
uncertainty. It listed global factors including the imminent tightening of U.S. monetary
policy and the rise in oil prices, and disconcerting domestic inflation trends that could
potentially endanger its price stability goals. Expectations that the U.S. Federal Reserve will
resume its normalisation of policy by raising interest rates on December 14 have combined
with a homeward-bound flight of capital from emerging markets in the wake of Donald
Trumps win in the presidential election to buoy the dollar at the expense of other currencies.
The rupee has not been spared, forcing the RBI to intermittently intervene to reduce volatility.
Given that the exchange rate has the potential to exert upward inflationary pressure as a bulk
of the countrys commodity imports, including crude oil, are largely paid for in dollars, the RBI
had little choice but to ensure that at least interest rates dont end up being another alibi for
capital outflows. On the domestic front, food prices other than those of vegetables are
showing sustained firmness. More worryingly, inflation excluding food and fuel has
stubbornly displayed a downward inflexibility that could, coupled with volatile energy costs
and further financial market turbulence, jeopardise the RBIs end-March retail inflation target
of 5 per cent.
That the central bank has adopted a wait and watch approach in the wake of the liquidity
shock to the banking system sparked by the withdrawal from circulation of about 86 per cent
of the bank notes, is instructive. Trimming its Gross Value Added (GVA) growth projection for
2016-17 by 50 basis points to 7.1 per cent, the RBI cited an unexpected loss of momentum in
the second quarter, particularly in industrial activity, and the impact from the withdrawal of
currency. The RBI observed that the currency replacement exercise was likely to have the
biggest impact on cash-intensive sectors. The resultant disruptions could drag down growth
in this fiscal and more data are needed before conclusions can be drawn on the full impact and
persistence of such an impact. It is understandable therefore that the RBI has opted for
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caution. Observing that economic growth could rebound strongly if the impact is transient
as widely expected, the central bank has for now chosen to hedge its bets by reiterating an
accommodative policy stance.
Printable version | Dec 8, 2016 7:11:47 AM | http://www.thehindu.com/opinion/editorial/TheReserve-Bank-of-India%E2%80%99s-big-surprise/article16773630.ece
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