India unexpectedly keeps rates unchanged
Economic growth forecast reduced to 7.1% from 7.6%
The Reserve Bank of India unexpectedly left its benchmark repo rate unchanged at a six-year low of 6.25% on Wednesday despite wide expectations of a cut.
Analysts had been predicting a 25 basis points cut as the intense cash shortage brought about by Prime Minister Narendra Modi’s currency gamble threatens to hit nearly every aspect of the economy, from consumers to supply chains.
Policymakers said the decision was consistent with the goals of achieving consumer price index inflation at 5% for the fourth quarter, but reduced their economic growth forecast to 7.1% from 7.6%.
Pressure had been building on the RBI and Governor Urjit Patel to act since Modi stunned the country on November 8 with a drastic plan to abolish 500 and 1,000 rupee notes (US$7.35-US$14.70), removing 86% of the currency in circulation in a bid to crack down on India’s “shadow economy.”
Data so far shows the measure has hit the cash-reliant economy more than expected: auto sales plunged and services sector activity dived into contraction last month for the first time in 1-1/2 years.
Facing the prospect that India’s robust growth could be derailed has seen the rupee sink to a record low as part of a sell-off in emerging market assets.
However, there were also warnings that a rate cut could raise concerns about whether the central bank was losing its focus on inflation.
In addition, emerging markets have been under pressure since the election of Donald Trump as US president last month which has sparked a surge of capital flows back into the United States, a trend that could accelerate as the Federal Reserve gears up to raise interest rates next week.
In India, foreign investors sold a net US$4.7 billion in debt and equities in November, even though the country is seen as in better shape than other emerging markets, and a rate cut could have hastened a bigger sell-off.
India’s economy grew an annual 7.3% between July and September, the fastest rate for a large economy in the world but still below the levels needed to sustain full employment.
Without the cut, investors will want more details from Patel about how the RBI is managing the process of demonetization after coming under criticism from market participants for frequently announcing adjustments to its policies.
Most analysts say the RBI will likely partly roll back a directive for banks to place their entire deposits under the central bank’s cash reserve ratio in a bid to absorb the extra liquidity generated by the government’s banknotes move.
The need to keep it in place has eased after the government announced last week it would raise the issuance of special bonds to soak up the liquidity.