'We cannot sustain zero real interest rates': ISB professor warns of risks from RBI's monetary easing

Prasanna Tantri, associate professor of finance at the Indian School of Business, has warned that India cannot sustain zero real interest rates for too long. He warned that the RBI's efforts to defend the rupee and keep interest rates artificially low through monetary easing risk fuelling inflation and undermining financial stability.

"We have already lost $43 billion of the $143 billion in borrowed money raised under RBI guarantee to defend the rupee," Tantri wrote on Monday. "Blaming speculators and resorting to Band-Aid solutions cannot prevent inflationary pressures when broad money supply has reached nearly 90% of GDP, a level last seen during COVID, and the RBI's balance sheet has also swelled substantially."

The professor also warned that the 10-year government bond yield was rising independently of RBI policy, putting at risk the stability in long-term yields achieved at considerable cost.

"If policymakers do not act now, they will be forced to act much more aggressively later. We cannot sustain zero real interest rates when much of the world offers positive real returns," he said.

Tantri flags excessive monetary expansion

The finance professor had raised similar concerns in a post on October 7, when the RBI's monetary policy committee announced a 25-basis-point increase in the benchmark repo rate. He welcomed the move but said it came "9–12 months late".

While the RBI appeared to be attributing inflation to external factors such as crude oil, Tantri argued that excessive monetary expansion was the central problem.

By his estimates, the RBI's balance sheet had expanded from around ₹70 lakh crore to nearly ₹100 lakh crore over the preceding year. He estimated that monetary easing had added ₹20–30 lakh crore to broad money, which he put at roughly ₹330 lakh crore, or more than 90% of the previous financial year's GDP.

"This is, in substance, quantitative easing in an economy growing around 7%. Such extraordinary measures are typically deployed against recession or deflation. What justifies them here?" he asked.

Tantri also argued that the FCNR(B) deposit mobilisation had compounded the problem. Through subsequent credit expansion, he estimated it could add another ₹30–40 lakh crore to broad money.

He warned that prolonged monetary easing could be difficult to reverse, citing the experience of Europe and Japan. He also expressed concern that the additional money could finance consumption loans, raising household debt, financial fragility and inflationary pressure.

Tantri called on the RBI to bring its balance sheet back to 25% of GDP or less and curb monetary expansion. He acknowledged that this could involve a short-term growth sacrifice but said preserving economic stability was worth the cost.

Forex reserves fall by over $50 billion

The ISB professor's warning comes as India's foreign exchange reserves have fallen by more than $50 billion in about a month, despite record mobilisation of foreign currency through FCNR(B) deposits.

RBI data showed that reserves reached a record $785.71 billion in the week ended September 4, before falling to $734.6 billion by October 2. The decline points to continued pressure on the rupee and intervention by the central bank in the foreign exchange market.

In June this year, the RBI had announced a special concessional swap window to help banks raise FCNR(B) deposits and exchange the foreign currency with the central bank for rupees. Banks raised a record $132.98 billion through these deposits, prompting the RBI to close the window a month ahead of schedule.

The special window for external commercial borrowings and overseas foreign currency borrowings remains open until December 31. As of September 30, $5.32 billion had been raised through overseas foreign currency borrowings and another $5.3 billion through external commercial borrowings.

The inflows were expected to support the rupee, which hit a record low of 96.96 against the US dollar on May 20. But the currency remained under pressure amid geopolitical tensions, the war in West Asia, higher crude oil prices and sustained selling by foreign institutional investors in Indian equities.

On October 7, the rupee touched 96.84 against the dollar before closing at around 96.77. It rebounded on Monday, opening 97 paise higher at 95.76, as the RBI stepped up efforts to support the currency over the weekend.