Nearly a month after Prime Minister Narendra Modi announced his plan to withdraw all older Rs 500 and Rs 1,000 notes, the Reserve Bank of India has concluded that the economy has been seriously hurt by the move. The Monetary Policy Committee, in its last review of the calendar year, voted on Thursday not to cut interest rates because of the troubling signs following demonetisation and the subsequent cash crunch. But it hoped that these would only be temporary.

The outlook for Gross Value Added growth for 2016-’17 “has turned uncertain after the unexpected loss of momentum by 50 basis points in Q2”, the bank said in its fifth bi-monthly monetary policy statement of the fiscal year, explaining that the effects of the withdrawal of “specified bank notes of value...are still playing out”.

Gross Value Added is the measure of all goods and services in the economy, with Q2 covering the July-September part of the year. The specified bank notes of Rs 500 and Rs 1,000 were declared invalid on November 8. The statement said that the move, which has caused economic distress across the economy, would hurt industrial activity.

“The withdrawal of SBNs could transiently interrupt some part of industrial activity in November-December due to delays in payments of wages and purchases of inputs, although a fuller assessment is awaited,” the central bank said.

Lower growth

In fact, the bank even lowered its growth forecast for the year from 7.6% to 7.1%. In particular it pointed out that the demonetisation move would create “short-run disruptions” in cash-intensive sectors like retail trade and transportation, as well as the unorganised sector – a huge portion of the Indian economy – and that aggregate demand would also be compressed as economic activity comes down.

Analysts and economists had widely expected to see a rate cut from the RBI on Wednesday, since inflation has dropped off a bit and businesses were hoping the cheaper credit could help compensate for the drop in Gross Domestic Product expected because of demonetisation. Instead, the central bank said that the short-term effects of the currency withdrawal was clear – it will mean lower growth this quarter – but it might end up being a temporary problem.

“In India, while supply disruptions in the backwash of currency replacement may drag down growth this year, it is important to analyse more information and experience before judging their full effects and their persistence – short-term developments that influence the outlook disproportionately warrant caution with respect to setting the monetary policy stance. If the impact is transient as widely expected, growth should rebound strongly.”

This wait-and-watch approach comes up elsewhere in the statement as well, with the bank concluding that it still needs to see what will happen to the economy before choosing to factor the currency replacement into its monetary policy, which is primarily aimed at controlling inflation.

“Given these indicators of underlying inflation, it is appropriate to look through the transitory but unclear effects of the withdrawal of SBNs 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.