MC Interview | Keeping interest rates high for too long likely to hit growth, says RBI MPC’s external Member Ashima Goyal

RBI MPC member Ashima Goyal

Keeping interest rates high for too long is expected to hit consumption, and ultimately, growth, Ashima Goyal, an external member of the Reserve Bank of India’s (RBI) Monetary Policy Committee (MPC), told Moneycontrol in an exclusive interview.

“Yes, our interest elasticity of aggregate demand is high because of a young population consuming on credit. Therefore, monetary policy has a stronger effect on demand, while fiscal action can more effectively reduce supply-side inflation,” Goyal said.

The central bank has been keeping repo rate unchanged for over a year now. In the June policy, too, the RBI kept the repo rate unchanged by a majority decision of the panel members, citing continuing risks on the inflation front.

Goyal is also the Emeritus Professor at the Indira Gandhi Institute of Development Research.

Goyal further said that high interest rates do raise the probability of delinquency for sectors.

In the RBI Minutes, Goyal had said that spreads are high in India. The average loan rates are in double digits. While risk-based pricing is required, a cut in repo rates will prevent retail interest rates rising to unbearable levels.

Also read: MC Interview | As inflation falls, repo should be cut to prevent real rate from rising too high, says Jayanth Varma

Edited excerpts:

What is the impact of the 'too-high-rates-for-too-long' in the banking system?

Borrower stress would reduce aggregate demand. High interest rates do raise the probability of delinquency for sectors with high leverage or rapid growth, such as retail loans, but lending is now risk-based. Retail loans are small in size, capital cover is adequate and prudential or preventive regulation has tightened for such loans, so that lending institutions will remain robust.

You voted for a 25 bps rate cut and change in stance, but considering the higher food inflation, do you think it is a right time for this action? What if food price shocks hit inflation upward?

The good monsoon is likely to reduce food prices. Over the last year, we have seen that price spikes and threatened supply shocks have not been able to upset the approach to the inflation target.

Do you think the last leg of disinflation to be tough, and, if yes, why so?

Recurrent supply shocks due to the fragile geopolitics and our relative neglect of measures that improve agricultural productivity, crop choices, marketing and logistics that can sustainably reduce food inflation. The repo rate does not affect supply shocks but reduces demand.  A low positive real repo rate, implying that the nominal repo rate rises with inflation, is adequate to credibly anchor inflation. A higher real repo rate can actually aggravate inflation by reducing investment and worsening the supply side.

When can we expect inflation to reach the 4% target in a sustainable manner?

This will happen as expectations converge to the target and it is also internalised by price regulators. As the economy diversifies and deepens, supply shocks become less volatile and will have reduced impact. We have seen some of this over the past year.

Also read: RBI MPC Minutes: Food inflation remains main factor behind slow pace of disinflation

Do you think keeping rates higher for too long will hit consumption?
Yes, our interest elasticity of aggregate demand is high because of a young population consuming on credit. Therefore, monetary policy has a stronger effect on demand, while fiscal action can more effectively reduce supply-side inflation. Post pandemic, the macroeconomic policy did well because of good coordination where fiscal supply-side action allowed monetary policy to keep the real repo rate low. This coordination should continue. Growth projected in FY25 is already below that in FY24.

The spread between the repo rate and 10-year benchmark bond yield is narrowing. Do you think if it narrows further after Indian bond inclusion, the central bank will intervene in bond market?

The central bank bond market actions will be aimed at their liquidity targets, not at the spreads in the market.