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Signs That The RBI Doesn't Foresee Long-Term Economic Damage Due To Demonetisation

08/12/2016 12:03 PM IST | Updated 08/12/2016 2:36 PM IST
Danish Siddiqui / Reuters

The Reserve Bank of India's policy action of no rate reduction is a reflection of its confidence and conviction that the impact of demonetisation on the economy will only be transitory in nature. Further, the rollback of the hike in the incremental cash reserve ratio (CRR) is a positive move and augurs well for the banking sector, with the excess of liquidity to now be mopped up via upwardly revised limits under MSS and reverse repo.

In my opinion, the ongoing near term adjustments in the economy will be limited, with growth to rebound in Q4 FY17, following a V-shaped growth trajectory.

On the macro outlook, RBI did acknowledge downside risks to its earlier assessments of both domestic growth and inflation. As such, it revised lower—

  • FY17 growth forecast by 50 bps to 7.1%, with further downside risks due to disruption in cash-intensive sectors and negative wealth effects due to demonetisation.
  • Q3 CPI inflation by ~10-15 bps.

However, in my opinion, the ongoing near term adjustments in the economy will be limited, with growth to rebound in Q4 FY17, following a V-shaped growth trajectory.

Post the outcome of the US Fed meeting and stabilisation of the demonetisation initiative, the continued disinflation should give RBI greater comfort in easing rates by a larger dose of 50-75 bps by April 2017. This in conjunction with the durable increase in low-cost bank deposits will improve the appetite for productive lending. In the medium term, formalisation of the economy owing to the transition to a "less cash" economy and the implementation of GST in an environment of lower interest rates would help push growth close to 9% on a sustainable basis.

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