Should The RBI Cut Interest Rates Now?

In a delayed response to demonetization, the Reserve Bank of India has decided to raise CRR requirements by the banks.

The move to raise CRR to 100% did not just seem like a knee-jerk reaction. But the rationale behind it seemed like an afterthought. The higher CRR is applicable on incremental deposits raised between September 16 and November 11, 2016. That would mean deposits of Rs 3 trillion that accrued to banks during this period will be impounded by the RBI.

All this while banks were earning about 6.2% on the extra deposits with the RBI by way of reverse repo. Having to pay 4% on the savings accounts still earned them a decent spread. However, that will no longer be the case.

However, RBI calls this a 'temporary measure' to check excess liquidity.

The big question that comes up is - What would the RBI's stance be on the repo rate cut?

If someone would have asked this question a month ago, the answer would have been a big 'Yes'. However, now, with so much happening, there is much confusion on the RBI's stance. Some believe that it is no more an independent body.

With FCNR-B dollar outflows and the possible US fed rate hike, there are some concerns over the rate cut. With the high probability of the US Fed rate hike the rupee is struggling against USD and any further rate cut may result in an even weaker rupee.

However, the post-demonetisation wholesale price index (WPI) and consumer price index (CPI) inflation is likely to fall over the next couple of months.

Before demonetisation, the Indian economy was on the verge of a takeoff. A normal monsoon, seventh pay commission, and the RBIs stance towards the rate cut were a big positive.

There was an expectation of the consumer demand revival based on all these factors. But, with some drag due to demonetization, the India growth story is under question.

The demonetization will lead to a slowdown in the medium term. And with no rate cut, the situation would get worse.

We believe that in order to support growth and recovery in the economy and to negate some impact of demonetization, the RBI should cut the policy interest rate.

With the weak rupee on one side and the probable slowdown on the other, it would be very interesting to watch how the RBI would balance its dual responsibility of exchange rate management and interest rate management.