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The monetary policy committee (MPC) of the Reserve Bank of India (RBI) has maintained the repo rate at 4%, doing what the herd of economists, who are in the business of predicting such things, expected it to do.

The repo rate is the interest rate at which the RBI lends to banks and has some influence on the overall interest rate environment prevailing in the country.

The message coming across is that interest rates will continue to remain low in the time to come. As the MPC statement put it, they have “decided to continue with the accommodative stance as long as necessary to sustain growth." Accommodative stance is a term used by economists to mean that the central bank will do whatever it takes to maintain low interest rates.

This is in line with RBI policy since February 2019, when the repo rate was at 6.5%. Since then, the repo rate has been cut by 250 basis points and is currently at 4%. One basis point is 0.01 percentage point.

The repo rate was cut aggressively post the covid outbreak in early 2020. It was reduced from 5.15% in February to 4% in May, where it still stands.

Other than cutting the repo rate, the RBI has also printed money and bought bonds. In the process, the central bank has pumped money into the financial system, driving down interest rates further.

The idea, as always, is that at lower interest rates, individuals will borrow and spend. At the same time, corporates will borrow and expand. Further, individuals who already have loans will see their EMIs come down. The money thus saved will be spent elsewhere. Similarly, corporates who had already taken on loans will also see their repayments come down, giving them more breathing space in tough economic times.

Eventually, all this will help in reviving economic growth.

On top of this, the RBI manages the borrowing programme of the government as well. In 2020-21 and 2021-22, the central government is expected to borrow close to 25 trillion. Hence, lower interest rates help the government as well.

The reasons that existed for the RBI to maintain low interest rates one year back continue to exist even now. Hence, in the months to come, the RBI will ensure that interest rates remain on the lower side.

As the second wave of the covid pandemic spreads through the country, the RBI’s need to maintain lower interest rates will only get stronger. As has been seen over the past year, the government’s main weapon to fight the pandemic has been locking down the economy, partially or completely. And that has started happening again, in some parts of the country.

This will hurt the economy. As the MPC statement put it: “The renewed jump in covid-19 infections in certain parts of the country and the associated localized lockdowns could dampen the demand for contact-intensive services, restrain growth impulses and prolong the return to normalcy."

Hence, the need for low interest rates will continue. At the same time, if the second covid wave becomes as big as the first one, the government tax collections will go for a toss again in 2021-22. Hence, the government borrowing requirements will continue to remain high. And as the government’s debt manager, the RBI will have to get the best deal for its client in the form of low interest rates.

Of course, there is a flip side to all this, something that the RBI, economists and analysts seldom mention in their commentaries on the issue.

Low interest rates favour borrowers and prospective borrowers. Nevertheless, they hurt the savers, especially in an environment where inflation is on the slightly high side and can go even higher.

As covid spread through the country in 2020, supply chains broke down, pushing up inflation in the process. The retail inflation or inflation measured by the consumer price index had touched 7.61% in October 2020.

As of February 2021, it stood at 5.03%. Core inflation (or the pace of price rise after excluding food, fuel and light items) was 6%.

In this scenario, the real rate of return (subtracting inflation from the interest rate or the nominal rate of return) from fixed deposits and other fixed-income instruments is either negative or very low. This hurts savers, in particular those whose expenditure is met out of regular income from deposits. They will have to cut down on their expenditure, which will hurt the economy. It is not easy to quantify this, but that doesn’t mean it does not matter.

Further, low interest rates on fixed income instruments have led to a section of savers diverting their savings into the stock market, fueling the stock market bubble even further. RBI governor Shaktikanta Das, writing in the foreword to the latest Financial Stability Report, had pointed out: “The disconnect between certain segments of financial markets and the real economy has been accentuating in recent times, both globally and in India."

Of course, like a good former bureaucrat, he didn’t offer any reasons for it.

The belief that is spread by all the talking heads is that only good things happen because of lower interest rates is incorrect.

Between 27 March 2020 and 12 March 2021, banks have raised deposits worth 13.9 trillion, and they have been able to lend only 4.3 trillion, or around 31% of the deposits. Hence, lending is not just about lower interest rates. The year-on-year growth in bank lending since covid broke out last year has ranged between a very low 5-7%.

This is not to say that interest rates should be high right now. Nevertheless, there are negative impacts of low interest rates as well, and the least that the RBI can do is to talk about it and make some references to it in all the commentary it publishes. It never does.

Vivek Kaul is the author of Bad Money.

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