Monetary Policy Review

The Reserve Bank took the market by surprise by holding the benchmark repo rate steady at 6.25%. The monetary policy committee of the RBI voted unanimously on the decision. The market had expected the RBI to cut rates with expectations of a 25-50 bps rate cut being priced in. Following the decision yields rose by over 20 bps with the benchmark 10-year government bond trading at a yield of 6.4%.

 The RBI was facing two opposite forces in its decision today. On the one hand evidence on inflation till October indicated that the year-end target of 5% would be met, while incoming data on global factors suggested some upside risk. Most commodities including oil have been trending up, which could lead to some inflationary pressures here. On the other hand the recent demonetization move could prove to have some downward pressure on growth and inflation. The RBI judged that the impact of demonetization would prove transitory and that the medium term inflation target of 4%±2% required maintenance of current rates. In any case hard evidence of the impact of demonetization on the economy was not available and the RBI chose to wait and see before acting on any potential impact.

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