MPC decision could turn real interest rates negative

Real interest rates -- the interest rates adjusted for inflation -- seem to be headed to negative territory after the December policy meeting by the Reserve Bank of India, depicting the grim situation facing the economy.

According to a DH poll of economists, the consensus seems to be that the central bank will again slash the key repo rate by 25 basis points (bps), while an overwhelming majority expect the inflation rate to be above 5% in November.

Of the 13 economists polled by the DH, all of them are of the opinion that the central bank will slash the repo rate by 25 bps. In case the RBI slashes the repo rate by 25 bps, it will bring down the repo rate to 4.9% from the current 5.15%.

On the other hand, of the 13 economists, 11 are of the opinion that the inflation numbers would be in excess of 5%. “As a result of low economic growth, I believe, by slashing repo rates by 25 bps, the RBI will convey a message of being accommodative,” noted economist Govinda Rao said.

This, in turn, brings the real interest rate into the negative territory.

Aimed at stimulating lending in adverse economic conditions, a negative real interest rate means the lender is paying the individual or business to borrow money from them, which means that borrowers get paid and savers are penalised.

The phenomenon of negative real interest rates, if it happens would be, according to the economists, triggered by the stagflation -- a situation where the prices keep rising despite muted economic growth.

The last time India witnessed negative interest rates was the two-year period between March 2012 and January 2014, when the surge in crude oil prices had led to the situation of galloping inflation in the country. During that period, the inflation numbers peaked at 11.51% in November 2013.

As a result of a surge in inflation driven by the spike in food prices, many believe that the RBI shouldn’t go ahead with the rate cut this time. “I think there should be a pause. Inflation is high and will be over 5% in the next two months. Besides one should wait for 135 bps to work it’s way first. But, going by how MPC members have reacted so far we do expect 25 bps cut this time,” said Madan Sabnavis, Chief Economist at CARE Ratings.

In the current financial year, RBI has doled out five consecutive rate cuts -- slashing the key policy rates by 135 bps. However, there has been a lack of transmission.