India hits pause on easing cycle
The Indian central bank’s decision to hold rates at 6.25% confounded market expectations of a cut, but was in line with our view following what seems like only a limited impact of demonetisation on growth.
Following a trip to India at the end of last year, we noted that domestic market participants were extremely bearish on the impact of demonetisation despite a lack of effective modelling methods for what was essentially an entirely unique event1.
The central bank too was more sanguine on the impact, at least in public. Featuring more prominently in past statements has been the bank’s view that inflation could rebound somewhat in early 2017 on a range of effects. It seems that a combination of better-than-expected growth data post-demonetisation and those worries over inflation have led to a pause in the easing cycle.
The accompanying statement said in effect that policy would be on hold until the bank’s economists can work out exactly what demonetisation has done to growth and inflation, so we would not rule out further rate cuts this year. At a minimum, cuts will likely have to wait until the second half of the year, when the bank’s most immediate inflation concerns will have hopefully been assuaged.
However, we think it is more probable that growth will recover after what will prove to be a short- lived disruption. Much more cash returned to the banking system than was expected, so long-term negative wealth effects will be limited, and banks may utilise the higher liquidity to boost lending. As this growth should also add inflationary pressure, the compulsion for the central bank to cut further should be correspondingly diminished.
1. India’s demonetisation entailed scrapping all 500 and 1000 rupee notes, approximately 86% of all banknotes in circulation. The measure was aimed at curbing the black market.↩
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