Economists warn against RBI cutting interest rates amid high inflation

RBI Governor Shaktikanta Das

The debate over whether the Reserve Bank of India (RBI) should reduce interest rates during a period of high inflation has intensified, with leading economists cautioning against potential destabilising effects, after Union finance minister Nirmala Sitharaman said that banks interest rates will have to be far more affordable.

While the government’s push for lower rates reflects its focus on accelerating industrial activity and job creation, economists argue that easing rates too soon could risk reversing the gains made in inflation control.

The discussion comes ahead of the RBI’s December monetary policy meeting, where all eyes are on Governor Shaktikanta Das's next move.

“When you have such a large fiscal deficit, the interest rates are bound to be high. Taming inflation does require the RBI to keep up the guard by keeping interest rates high. RBI has no choice,” M. Govinda Rao, economist and former member of the Economic Advisory Council to the Prime Minister, told Moneycontrol.

India’s retail inflation rose to a 14-month high of 6.2 percent in October compared with 5.5 percent in the previous month, as food inflation galloped on the back of rising vegetable prices. India's retail inflation remains above the RBI's medium-term target of 4 percent. This has led to calls for prudence in monetary policy to ensure price stability.

Despite these concerns, the RBI’s neutral stance suggests it will weigh domestic inflation trends and global central bank actions, particularly those of the US Federal Reserve, before making any major policy shifts.

“Given the geopolitical uncertainties and inflation risks, lowering of interest rate right now can be destabilising. However, RBI has switched the regime to a ‘neutral stance,’ indicating that both price stability and economic growth are given equal significance. My hunch is RBI will reduce rates after observing the US Federal Reserve moves to avoid capital flight,” Professor Lekha Chakraborty of the National Institute of Public Finance and Policy (NIPFP) told Moneycontrol.

The RBI has maintained the repo rate at 6.50 percent for 10 consecutive monetary policy reviews, reflecting its cautious approach to addressing inflation while supporting economic growth.

Transmission of RBI’s interest rates

Reserve Bank of India’s (RBI) monetary policy interest rates are fundamental to the transmission of monetary policy. Banks typically adjust their interest rates in response to changes in the RBI’s monetary policy rates. When RBI changes the repo rate, it directly affects the cost at which banks borrow short-term funds. Changes in the cost of funds influence the interest rates that banks charge.

Higher lending rates make borrowing expensive, discouraging investment and consumption. This can help control inflation but may slow down economic growth. By influencing bank interest rates, the RBI’s monetary policy rates play a central role in shaping borrowing, saving, and investment behavior, thereby impacting the overall economy.

Political Pressure for Rate Cuts
The RBI is also facing mounting pressure from policymakers to make borrowing cheaper. Finance Minister Nirmala Sitharaman, speaking at the 11th SBI Banking and Economics Conclave on November 18, urged banks to lower lending rates.

“The cost of borrowing is really very stressful. And at a time when we want industries to ramp up and build capacities, bank interest rates will have to be far more affordable,” Sitharaman had said.

Commerce Minister Piyush Goyal added to the calls for monetary easing, suggesting last week that the RBI “should definitely cut interest rates.” However, Governor Das, in a measured response, noted that he would “reserve” his comments for the December meeting.