Modi’s demonetisation decision is like pressing the nuclear button

The Reserve Bank of India surprised the market with its first monetary policy review, after demonetisation, by keeping its repo rate unchanged at 6.25%. Noted Ajit Ranade, economist and political analyst spoke on impact of demonetisation on growth and the possible upside risks to inflation. Ranade in his interview stated that the goal is not to move to cashless, but use less cash.

There was big expectation of a rate cut from RBI. But the central bank has surprised everyone. Are you disappointed that RBI did not cut the policy rate this time?

Not at all, there are at least five reasons for caution that I can think of:

(a) The US rates are going up, and a Fed hike is almost certain. Most developed country bond yields are also going up. So gap between Indian and US rates is narrowing.

(b) Oil prices are up after OPEC decision to cut output that may lead to some inflationary pressure.

(c) GST will also be inflationary in the beginning period and might warrant tightening of rates.

(d) The rupee has been on a weakening path so may need to be supported.

(e) The CRR action had been taken to take out excess liquidity that has been reversed, giving relief to banks, so case for rate cut that much weaker. All in all it was good to pause now, since the last MPC produced an unexpected rate cut, so best to keep the ammunition for a future decision.

The SBI Chairperson has also expressed her disappointment. She has argued that the SBI has always passed on rate cuts. How should the banks react now?

As liquidity situation improves, there is ample space to pass on reduced rates even with current policy rate. The MCLR (marginal cost of lending regime) is on, which connects lending rates to cost of deposits. So there too it is possible that in successive quarters lending rates may fall further.

What are the implications of the RBI Governor saying there will be no impact on the RBI balance sheet as a result of demonetisation?

So long as currency notes are out there, they are liabilities of the RBI (they are called “promissory notes”). Even if the notes are no longer legal tender, they still are liabilities of the RBI, extinguishing those liabilities requires an explicit decision by the appropriate authority (backed by adequate legal powers). Not a simple or trivial thing to simply repudiate a “promise” of the central bank.  Hence, if the liabilities remain the same, it cannot be the case that there is any fiscal benefit from the demonetisation through RBI balance sheet. There may have been fiscal benefit due to higher tax payments, stamp duty payment, clearance of dues to government companies (MTNL, utilities etc).

RBI still seems concerned about inflation though there are fears of a dip in growth numbers. Why?

Inflation may partly be influenced by global commodity prices, which are on a gradual upward trend. With the recent decision of OPEC to curtail output, oil prices may also move upwards. In addition we may see some supply bottleneck issues domestically, especially, in the agriculture sector. Industrial capacity expansion is also been lagging so may fall behind demand growth.

How fast can India move to a cashless economy?

India has already broken a few world records, opening 240 million networked bank accounts in such a short time was unthinkable (Jan Dhan Yojana). The demonetisation decision was like pressing the “nuclear button”, sort of like Mr. Modi’s Pokhran moment. India’s telecom revolution continues, being the fastest growth in the world. Telecom forms the bedrock forming the digital economy. The goal is not to move to cashless, but to use less cash. So, India may surprise the world at its pace of going toward less cash.

Given the state of our infrastructure, is it even desirable to do so and push for it aggressively?

 There are far too many benefits to using less cash.  It will bring more transactions into the legitimate tax net, increase fiscal resources, provide for more funds to build infrastructure. It also introduces fairness, if all taxpayers are potentially in the net.