The Reserve Bank of India (RBI) on December 7 kept its key lending rate —the repo rate—unchanged at 6.25 percent dashing hopes of lower borrowing costs arresting the demonetisation-induced slide in spending and investment.

The six-member monetary policy committee (MPC) headed by RBI Governor Urjit Patel, also retained the MSF and bank rate at 6.75 percent and reverse repo rate at 5.75 percent.

Cash reserve ratio (CRR) – the proportion of deposits banks are required to park with the RBI – is also retained at 4 percent. However, the incremental CRR requirement on deposits made between September 16 to November 11 has been withdrawn.

This will be effective starting December 10. Following the government’s demonetisation move, banks were awash with funds prompting the central bank to raise the CRR to suck out the excess liquidity. A higher CRR is not favoured by banks as it earns no return.

However, government had assured that it will be lowered once fresh market stabilisation scheme (MSS) bonds are issued. Accordingly, the limit for MSS bonds had been raised to Rs 6 lakh crore for the fiscal from Rs 30,000 crore aiding in withdrawal of incremental CRR. So far banks have aggregated “demonetised” deposits worth close to Rs 11.5 lakh crore.

Outlook on growth for FY17 as measured by gross value added (GVA) has been revised down from 7.6 percent to 7.1 percent as RBI says, the outlook 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, which are still playing out.

Consumer Price Index (CPI) projections are maintained at 5 percent for Q4FY17 with risks tilted to the upside, lower than the October policy, RBI said in a release. A drop in retail inflation to 4.20 percent in October had triggered hopes of a rate cut. The RBI and the government had set a retail inflation target of 4 percent for the next five years with an upper tolerance level of 6 percent and lower limit of 2 percent.

A lower repo rate would have meant major benefits for households like cheaper bank loans to buy houses and goods such as cars, most of which are bought through loans. Although the CRR hike would have dissuaded banks from passing on the full benefits to consumers.

Since January 2015, the RBI has cut the repo rate seven times. Household spending accounts for more than half of India’s GDP, underlining the need to goad families to buy more and keep the broader economy’s growth engine chugging. Initial estimates suggest that “demonetisation” of Rs 500 and Rs 1,000 notes have dampened consumer durable sales, particularly in rural areas where most transactions take place in cash, partially offsetting the gains from abundant summer rains this year after two years of successive drought.

The slowdown in household spending could push back investment growth with firms already sitting on vast unused capacities in consumption-linked sectors.

Source: Money Control