Taking the financial markets by surprise, the Reserve Bank of India’s six-member Monetary Policy Committee (MPC), headed by Governor Urjit Patel, decided to keep the policy repo rate unchanged at 6.25 per cent.

The decision came in the backdrop of an upturn in the prices of several items, possible re-emergence of food inflation pressures, likelihood of crude prices firming up in the coming months, and imminent tightening of US monetary policy.

Simultaneously, the central bank alleviated the banks’ burden of maintaining temporary incremental cash reserve ratio (CRR) of 100 per cent. It announced withdrawal of this requirement with effect from the fortnight beginning December 10. This move could give banks some leeway to cut lending and deposit rates going forward.

CRR is the slice of deposits that banks have to park with the RBI. It is currently at 4 per cent of deposits. The MPC said its decision is consistent with an accommodative stance of monetary policy in consonance with the objective of achieving consumer price index (CPI) inflation at 5 per cent by the fourth quarter of 2016-17 and the medium-term target of 4 per cent within a band of +/-2 per cent, while supporting growth.

The markets were widely expecting the RBI to follow up its October 4 repo rate cut of 25 basis points with a similar cut in the fifth bi-monthly monetary policy review on Wednesday. The repo rate is the interest rate at which banks borrow funds from the central bank to overcome short-term liquidity mismatches. Since January 2015, the RBI has cut the repo rate cumulatively by 175 basis points.

Markets disappointed The equity market gave the thumbs-down to the RBI announcement. The benchmark S&P BSE Sensex ended down -155.89 points (or 0.59 per cent) to close at 26,236.87.

Patel said the Committee felt it important to ensure that the consumer price inflation target of 5 per cent by the fourth quarter of 2016-17 and the medium target of 4 per cent within a band of +/-2 per cent are achieved.

“This assumes critical importance in view of the stickiness in inflation, excluding food and fuel,” it said, and cited the “recent rising profile of international crude prices and the continuing firmness in some salient food items.”

“Given these indicators of underlying inflation, it is appropriate to look through the transitory but unclear effects of the withdrawal of specified bank notes (of ₹500 and ₹1,000 denominations) while setting the monetary policy stance. On balance, therefore, it is prudent to wait and watch how these factors play out and impinge upon the outlook. Accordingly, the policy repo rate has been kept on hold in this review, while retaining an accommodative policy stance,” explained the Governor.

This was the second meeting of the MPC since its formation two months ago. It was also the second monetary policy review of Urjit Patel since he took over as RBI Governor in September.

On the decision to do away with the incremental CRR requirement, which the RBI had enforced on November 26 to suck out excess liquidity from banks owing to the flood of deposits following the demonetisation, the Governor emphasised that it was intended as a temporary measure to manage the transition from an exclusive reliance on liquidity adjustment facility operations to a mix of instruments including the market stabilisation scheme (MSS) issuances.

“The government has proactively responded to the situation by enhancing the limit of MSS securities to ₹6 lakh crore. This has enabled the withdrawal of the incremental CRR with effect from the fortnight of December 10,” he said.

“Banks will no longer have to bear the burden of the incremental CRR as they will be adequately compensated through the coupons on MSS securities,” said Patel.

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