The Reserve Bank of India (RBI) today left the repo rate unchanged, in what was a shock to economists and markets, which were largely expecting an interest rate cut. Repo rates are interest rates at which the RBI lends money to banks and any drop in these rates leads to a drop in lending rates for loans. The interest rate cut happens based on the recommendations of the Monetary Policy Committee. Today's status quo on interest rates was against expectations.
Interest rates unlikely to fall
Interest rates are unlikely to fall soon, following the RBI decision. Banks have already to contend with high level of NPAs and a huge round of liquidity, following demonetization. The status quo on interest rates is likely to lead to a further blow for banks, who were expecting some respite on the interest rate front. As far as individuals are concerned interest rates on loans are unlikely to fall anytime soon.
Worries over inflation
The RBI was clearly worried over inflation which is why policy rates were on hold.
"The Committee took note of the upturn in the prices of several items that is masked by the easing of inflation on base effects during October. Despite some supply disruptions, the abrupt compression of demand in November due to the withdrawal of SBNs could push down the prices of perishables in the reading that
becomes available in December. On the other hand, prices of wheat, gram and sugar have been firming up," the RBI said in its policy statement.
On November 26, 2016 the Reserve Bank had announced an incremental cash reserve ratio (CRR) of 100 per cent of the increase in net demand and time liabilities (NDTL) of scheduled banks between September 16, 2016 and November 11, 2016 effective the fortnight beginning November 26, 2016. It was intended to absorb a part of the large increase in liquidity in the system following the withdrawal
of the legal tender status of ₹500 and ₹1,000 denomination bank notes. The incremental CRR has now been withdrawn.
Base effects may reverse
The RBI is worried that base effect would soon reverse. "Going forward, base effects are expected to reverse and turn unfavourable in December and February. If the usual winter moderation in food prices does not materialise due to the disruptions, food inflation
pressures could re-emerge. Furthermore, CPI inflation excluding food and fuel has been resistant to downward impulses and could set a floor to headline inflation. With
the OPEC's agreement to cut production, crude prices may firm up in the coming months," the RBI said in its policy statement.
How markets reacted?
The markets which were trading higher for most of the day, fell sharply following the status quo, as the expectations were of a cut in interest rates. The Sensex was trading with losses of 147 points, following the decision.