RBI Cuts Growth Forecast to 7.1% Because of 'Short-Term Disruption' from Demonetisation

RBI kept the short-term lending rate unchanged, saying it is adopting a 'wait and watch' policy to see the effect of demonetisation.

Mumbai: The Reserve Bank of India (RBI), on Wednesday, cut the economy’s expansion forecast for the current fiscal year to 7.1%, from 7.6% earlier, saying that short-term disruption in economic activity and demand compression arising out of demonetisation have led to downside risks to growth.

In the short-term, the risks that demonetisation represents are disruptions in sectors such as retail, trade/hotel/unorganised sectors. These disruptions are happening, in part, because of reduced demand because people have less cash to spend (adverse wealth effect), the RBI said.

“Incorporating the expected loss of growth momentum in Q3 and waning effects in Q4 alongside the boost to consumption demand from higher agricultural output and the implementation of the 7th CPC award, GVA growth for 2016-17 is revised down from 7.6 per cent to 7.1 per cent, with evenly balanced risks,” the RBI said in the fifth bi-monthly monetary policy statement for the current fiscal year.

The Indian economy expanded by 7.1% and 7.3% in the first and second quarter of the ongoing fiscal year.

“The outlook for gross value added (GVA) growth for 2016-17 has turned uncertain after the unexpected loss of momentum by 50 basis points in Q2 and the effects of the withdrawal of specified bank notes (SBNs) which are still playing out,” the central bank said.

Upsetting expectations

RBI has chosen not to cut rates contrary to the market’s, and perhaps even the government’s, expectations. This is mainly because it sees a near-term risk of food inflation going up due to a possible supply shock caused by demonetisation and oil prices firming up.

Crucially, the central bank also clarified that there is no provision under which the stock of black money held in cash would be extinguished by demonetisation. Consequently, the current process theoretically should not result in increased fiscal space for the Centre.

RBI officials also pointed out that the impact of demonetisation should ebb with the progressive increase in the circulation of new currency notes and greater usage of non-cash based payment instruments in the economy. It did not, however, give a date on when withdrawal limits would be removed.

When asked how many new notes had been put back into circulation, the central bank said approximately 19 billion notes had been released to the public; the great majority of this being Rs 100, Rs 50 and Rs 10 notes.

After announcing that the short-term lending rate would remain unchanged, the RBI said it is adopting a ‘wait and watch’ policy to see the effect of withdrawal of Rs 500 and Rs 1000 notes from circulation.

“It is appropriate to look through the transitory but unclear effects of the withdrawal of SBNs while setting the monetary policy stance. On balance, therefore, it is prudent to wait and watch how these factors play out and impinge upon the outlook. Accordingly, the policy repo rate has been kept on hold in this review, while retaining an accommodative policy stance,” RBI said.

RBI said the second quarter GDP was lower than projected because of deeper than expected slowdown in industrial activity.

“Manufacturing slowed down both sequentially and on an annual basis, with weak demand conditions and the firming up of input costs dragging down the profitability of corporations,” it said.

These are the highlights from the RBI’s fifth bi-monthly monetary policy statement, 2016-17:

  • Repo rate unchanged at 6.25%, reverse repo at 5.75%
  • Cash reserve ratio or CRR unchanged at 4%
  • Cuts growth forecast to 7.1%, from 7.6% for this fiscal year
  • Inflation target remains 5% for March 2017
  • Demonetisation to lower prices of perishables, could reduce inflation by 10-15 basis points by December
  • All MPC members voted in favour of status quo in policy
  • Demonetisation to result in short-run disruptions in cash-intensive sectors
  • Crude price volatility, surge in financial market turbulence could put March end inflation target at risk
  • Foreign exchange reserve rose to all-time high of $364 billion on December 2

(With inputs from PTI)