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The Reserve Bank of India (RBI) is expected to cut its repo rate or key lending rate at its monetary policy review. This will be the first monetary policy review after demonetisation of old 500 and 1,000 rupee notes. The two-day meeting of monetary policy committee, which is headed by RBI chief Urjit Patel, began yesterday and RBI will announce rate decision at 2:30 pm today. At its previous meet, the monetary policy committee had cut repo rate by 0.25 per cent to 6.25 per cent.

Prime Minister Narendra Modi’s notes ban threatens to hit nearly every aspect of the economy, from consumers to supply chains. Analysts only differ on the likely quantum of rate cut – most say 25 basis points and the rest 50. This will be the RBI’s first monetary policy review after Prime Minister Narendra Modi stunned the country with a ban last month on 500 and 1000 rupee notes, removing 86 per cent of the currency in circulation, in a bid to crack down on black or untaxed money. A cut in the central bank’s repo rate or key lending rate could lower loan EMIs for consumers.

 

After demonetisation, it is widely expected that the monetary policy committee will lower the repo rate to allow commercial banks to cut interest rates for industry and retail customers to cushion the impact of anticipated slowdown in the economy. Economists polled by Reuters expect a 0.25 per cent rate cut from RBI. Some economists expect the RBI to go for a deeper 0.50 per cent cut as growth is expected to take a hit following demonetisation.

Monetary policy committee is likely to face these challenges before taking a call on the rate cut:

1)    According to economists, demonetisation will have a negative impact on the economy for at least the two quarters. In this scenario, the monetary policy committee will have to consider what amount of rate cut will support growth in the economy.

2)    However, the US Federal Reserve is expected to hike interest rates later this month which may lead to dollar outflow from India, weakening the Indian rupee. A rate reduction by RBI may also hurt the rupee more.

3)    While excess liquidity in the system gives RBI space to go for a rate cut, according to analysts, the panel will also have to consider the possible impact of higher global oil prices on domestic inflation.

4)    RBI chief Urjit Patel will address the press after the monetary policy announcement. This will be his first press conference after demonetisation and he may face questions on RBI’s role and planning in rolling out the demonetisation drive.

5)    In the previous meeting of the MPC all the six members of the committee took a unanimous decision to cut the repo rate by 25 basis points. It would be important to see whether all members share an unanimous view on the interest rate this time.

 

 

Here are 10 things to know: 

1) The central bank will announce the decision of the six-member Monetary Policy Committee at 2:30 p.m. A 25-basis-point cut could bring down the RBI’s repo rate to 6 per cent – the lowest since September 2010.

 

2) Data so far shows the notes ban has hit India’s cash-reliant economy more than expected: auto sales plunged and services sector activity dived into contraction last month for the first time in a year and a half.

3) Analysts warn the impact from demonetisation may well last through 2018. Many global brokerages have already slashed their full-year growth forecasts for the Indian economy. Analysts will closely watch the RBI’s commentary on growth forecast for the rest of this year.

4) A rate cut would signal that the RBI’s priority is in supporting the economy, which grew an annual 7.3 per cent between July and September, the fastest rate for a large economy in the world but still below the levels needed to sustain full employment.

5) On the global front, emerging markets like India are under pressure after the election of Donald Trump as US president last month sparked a surge of capital flows back into the United States, a trend that could accelerate as the Federal Reserve gears up to raise interest rates next week.

6) As part of the broad move out of emerging markets after Donald Trump’s election victory, foreign investors sold a net $4.7 billion in Indian debt and equities in November. That pushed the rupee to a record low against the dollar – which could also add pressure on inflation – even though it eased to 4.2 per cent in October, below the RBI’s target of 5 per cent by March 2017.

7) Also, global oil prices have risen sharply since the November 30 decision of the Organization of Petroleum Exporting Countries (OPEC) to cut output. Higher global oil prices have already sparked concerns over impact on domestic growth and inflation.

8)But a rate cut is not without risks. It would mark a second consecutive easing by the monetary policy committee and some foreign investors warn it could raise concerns about whether the central bank is losing its focus on inflation.

9) A cut in lending rate from the RBI could lead to faster transmission of rate cuts by banks and so lower EMIs for consumers. The demonetisation of 500 and 1,000 rupee notes has led to a sharp increase in bank deposits. Economists say that even if the withdrawal limits are relaxed, the net deposit base of banks is likely to rise by around Rs 1.5 lakh crore.

10) Last month, the RBI had to resort to extraordinary measures to manage surging liquidity as people scrambled to deposit old notes. Analysts would be looking at more clarity on how the liquidity will be managed.

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