Why Urjit Patel did not cut interest rates on Dec 7

RBI's intention to keep its target inflation rate at 5% was the main reason behind keeping rates unchanged, says Adhil Shetty, CEO of BankBazaar.com.

In the build-up to the monetary policy review on December 7, many pundits had predicted a repo rate cut of 25 to 50 basis points. This did not happen. Going against those expectations, the Reserve Bank of India has decided not to cut the repo rate.

The RBI intends to keep its target inflation rate at 5 per cent. Crude oil prices have increased 40 per cent since January 2016, and this would bolster inflationary trends in the months to come.

Food prices are displaying similar inflationary tendencies. Reducing the repo rate would have boosted lending and liquidity, which would have further boosted inflationary forces in the near future.

Secondly, the Federal Reserve System has been gradually raising its rate, bringing the United States out of the near-zero rate of borrowing maintained since the crash of 2008. Any upward rate revision in the US would make it a more attractive investment destination, and this would have implications on emerging markets, including India.

While some global shifting in investments towards the US will happen, it remains to be seen how the emerging markets will react to this scenario. We have already seen FIIs pulling huge sums of money from India. With the Fed rate cut, the dollar will strengthen vis-à-vis other currencies including the rupee; imports will become costlier and contribute to inflation. These developments notwithstanding, India remains macro-economically strong and any Fed rate implications should be only for the short term.

Finally, there’s the demonetisation issue. It’s currently an ongoing process. The prime minister had made this a 50-day process, and we’re still over three weeks short of that deadline. Once the 50-day window ends, most of the exchanging and depositing of currency notes would have been accomplished, and we can then start taking stock of the impact the demonetisation process has had on the Indian economy.

Naturally, banks are flush with cash, and we can expect lending to get cheaper and gain pace. By this time, we will be in the first quarter of 2017, and based on the macroeconomic scenario at the time, the RBI will make its move. Borrowers will hope for lower rates since this would mean cheaper home loans, cheaper car loans, and so on.

By the next policy review, we would also be closer to the Union Budget, making February an altogether interesting month for observers of the Indian economy.

Photograph: Vivek Prakash/Reuters