Vault Matters: Government-RBI tussle over interest rate begins. Will it prolong?

It also signals the start of an interesting debate between the government and the RBI on what should be the effective interest rate

At a recent CNBC TV18 event, Piyush Goyal, Minister of Commerce and Industry, said the Reserve Bank of India needs to cut interest rates. At the very same forum, when Shaktikanta Das, Governor, RBI, addressed the audience and a question was put forth on whether there is a case for RBI to cut interest rates, he replied that the monetary policy is a few weeks away, and the answer will be known then.

As diplomatic as the response could be, it also signals the start of an interesting debate between the government and the RBI on what should be the effective interest rate. Probably the first time in a near six-year long tenure as the central bank chief, Das is encountering a different viewpoint from the government on interest rates. However, such differences are par for course. While it’s a decade old, the clash between the then finance minister P. Chidambaram and RBI governor, Duvvuri Subbarao,  on interest rate reduction is something which is tough to forget for people who’ve have tracked economy and the banking system for long.

Such debates also tend to be common when India is charting its own path on interest rates when compared to how other countries are functioning. The moot question though is whether a repo rate cut is likely around the corner.

Key members of the financial services industry such as banks and non-banks have accepted the fact that given how steep inflation on the food side continues to be, a reduction in rates is unlikely in the upcoming December monetary policy committee meeting.

Nonetheless, in the past members on the committee have been in favour of a rate cut (though in minority) for almost four meetings in a row. The fifth one which concluded in October also saw one member voting in favour of a rate cut. This goes to show that there is divergence within.

Before one can answer the importance or significance of a rate cut in the near future, it is critical to understand whether a rate cut is going to change the dynamics of growth. For one, capacity utilisation is just on the mend. It has not yet reached a stage where setting up new capacities is critical to meet the existing demand or the existing demand cannot be met by making certain tweaks to the current production capabilities. If anything, demand only seems to be tapering in some of the major consumer pockets, be it staples, durables or even discretionary items such as vehicles. The narrative from most FMCG companies in the September quarter was dull and uninspiring.

While one is made to believe that there are signs of strong rural demand, that is yet to percolate into sustainable numbers. In other words, demand is not compelling enough to trigger a wave of greenfield capex.

Secondly, inflation that we are seeing currently is largely coming from the food side. Core inflation is still very much under control, which means that increasing interest rates per se have not yet led to a situation of a price rise across the board. In other words, it is business as usual for industries, irrespective of whether repo rate is at 6.5 percent or otherwise. Under such a circumstance to go in for a rate cut without food inflation under control could further push inflation upwards.

Once reduced, it is difficult to tinker with numbers or push them up again. To be fair, RBI’s MPC has been status quo on repo rates since June 2023, whereas the rest of the world has been increasing base rates even till early this year. Possibly only section which is under pressure is the MSME who rely more on non-banks versus banks to meet their funding. NBFCs have been faced with elevated cost of borrowings ever since the repo hikes started in May 2022. As a component of the ecosystem, NBFCs account for much lesser, at about 20 percent, of total loans compared to retail borrowers or industries.

RBI bending its back to accommodate small industrial borrowers is unlikely. With the base case for a rate cut not yet crystallising, the tug of war between RBI and the government on this front would be interesting to note. Goyal, has just as kick-started the war of words. Will it continue for too long?