Dealing with demonetisation

The liquidity-draining measures that were eventually introduced by the Reserve Bank of India (RBI) to deal with the rush of cash entering the banking system after the demonetisation announcement have led to suggestions that the central bank may now refrain from cutting interest rates in next week’s policy meeting. But the measures were a response to extraordinary circumstances rather than a signal that the RBI is concerned about monetary conditions becoming too loose. And with the MPC having already shown that it is willing to prioritise growth even at the risk of missing targets for inflation, we think that it will attempt to cushion the blow from demonetisation next week with another 25bp cut in the repo rate, to 6.00%.