India's central bank stood pat on interest rates on Wednesday, eschewing the market's expectation for a cut as the new demonetization policy continues to play out.
Only 18 of 56 analysts surveyed by Reuters had expected the Reserve Bank of India (RBI) would keep its main policy rate unchanged at 6.25 percent as the country has faced a cash crunch.
A controversial plan from Prime Minister Narendra Modi's government to swap all 500 and 1,000 rupee notes—a combined 86 percent of currency in circulation—with new notes has produced a nation-wide cash crunch amid a limited stock of script, disrupting India's cash-dependent economy.
Several analysts, despite expecting a rate cut, said standing pat may prove "prudent."
"It's a very difficult time for the RBI because there are conflicting signals coming from different parts of the economy," Eswar Prasad, senior professor of trade policy at Cornell University, told CNBC's "The Rundown" on Thursday.
"On the one hand, the demonetization experiment does look like it might have a negative effect on growth in the short run," Prasad said. "But at the same time all the money flooding into the banks right now as people clean out their closets of their cash holdings does pose some risks for inflationary pressures."
Analysts noted that the RBI had other inflation concerns.
The RBI kept its forecast for consumer price inflation of 5 percent at the end of March, which is the end of its fiscal year, compared with 4.20 percent on-month in October, still in line with the RBI's target of within two percentage points of 6 percent.
Shilan Shah and Mark Williams, economists at Capital Economics, noted that the RBI appeared to have turned more hawkish on inflation, citing the central bank's comments that it was concerned headline inflation may hit a floor on sticky core prices.
"We have been arguing for some time that inflation was unlikely to fall much further and that this would become a problem for policymakers given how close inflation currently is to the RBI's targets," Capital Economics' Shah and Williams said in a note Wednesday.
They noted that global oil prices have begun to reverse their long decline.
But still, the two said the RBI may have made a "misstep," as demonetization may not be as transient as the RBI forecasts and may instead have damaged economic activity.
The central bank incorporated demonetization into its forecasts, cutting its gross domestic product (GDP) growth forecast for the fiscal year through March to 7.1 percent from 7.6 percent.
Demonetization has been widely expected to dent economic growth in the short term.
As a result of the program, consumers are holding off from spending as cash is removed from the system, with a daily limit on the amount of old notes that can be exchanged. Private consumption accounts for a whopping 60 percent of GDP so the frugal mood can have weighty economic consequences.
On Monday, Reuters reported activity in India's services sector contracted last month, with the Nikkei/Markit Services Purchasing Managers' Index sinking to 46.7 from 54.5 in October. A reading below 50 indicates contraction.
Launched on Nov. 8, Modi's program is aimed at catching tax evaders holding undeclared cash, or "black money." But so far, the program has mostly hit the lower income population segment, many of whom operate entirely on cash and lack bank accounts to exchange old notes.
Still, several analysts said they expected the RBI's next rate cut, likely at its February meeting, might be its last for a while.
"We expect the RBI to deliver a final 25 basis point repo rate cut in February after the budget, and then stay on hold throughout 2017," Nomura said in a note on Wednesday.
"There are growing signs that underlying inflation is unlikely to fall further given stabilizing rural wages and higher minimum support prices. Commodity prices have also risen," it said. "Given our inflation forecast, we expect real interest rates to compress next year and therefore there is not much room for further accommodation."
Morgan Stanley agreed.
"The rise in oil prices, U.S. rates and stickiness in core inflation means that we appear to be nearing the end of the easing cycle," Morgan Stanley said in a note on Wednesday. —Nyshka Chandran and Saheli Roy Choudhury contributed to this article.
—By CNBC.Com's Leslie Shaffer; Follow her on Twitter @LeslieShaffer1