How will interest rates behave after the elections? This is what history tells us

As the general election enters its last lap, the business community is keeping its fingers crossed. Will the next government take steps to bring down interest rates in the economy?

RBI Governor Raghuram Rajan has been insisting that inflation is the biggest challenge, indicating that the central bank may not cut policy rates as long as inflation remains high. This, at a time, when corporates are complaining about high interest costs that are weighing on their ability to borrow.

So where are interest rates headed?

In a recent research report, Morgan Stanley compiled the interest rate movements in the economy over the last five general elections.

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Using the SBI (State Bank of India) prime lending rate as a proxy, the brokerage found that elections haven’t really driven a visible change in the rates.

The research report notes that rates have been constant for a few months after the elections, after which they have moved down thrice (11th, 12th and 13th elections) and up twice (14th and 15th). So, there is no clear trend which can be extrapolated to the ongoing elections.

However, it is highly likely that the interest rates will remain steady at the elevated level for some more months. This is because for the RBI to take any rate action, the government will have to take measures to ensure fiscal discipline.

If the next government manages to cut subsidies, the RBI may be able to reduce policy rates. But then how much of a 25 basis point cut is actually transmitted into the economy?

In the past, there have been instances when the central bank felt policy transmission was not happening as effectively as it should. That was because banks were dealing with a slowdown and tight liquidity and could not cut rates in line with the central bank’s actions.

The fact is the situation is no different now.

So, for any fall in interest rates in the economy, even if the government manages to effectively deal with a bad monsoon, the industry may have to some more months. And that will, by default, be in line with the trend seen in the graphic – steady for at least few months.