The Reserve Bank of India (RBI) kept interest rates on hold at its August 5 Monetary Policy Committee (MPC) meeting and maintained a neutral stance. As oil prices have fallen back to $80/barrel on the back of renewed US-Iran peace talks, a better-than-expected July monsoon bodes well for countering El Niño-driven food inflation, and inflation, even if it is rising, is still on the expected path, the hold appears rational. Especially at a time when fiscal capacity is limited to support growth, even if the RBI were to lift rates.
While the RBI’s decision may appear passive, it is very much an active one to keep the real rates — which measure the tightness of policy rate relative to the expected inflation — suppressed to boost credit supply and consumption or investment. With the RBI expecting inflation to inch up to 5.9 per cent in Q3-FY27, a pause in the current policy translates into negative real rates of around 65 basis points. This is considerably low compared to 2 per cent-plus real rates India had during 2016-2018, when it adopted inflation targeting, and even lower relative to the expected real rates in the US, which are anywhere between 1.4 per cent and 2.1 per cent, depending upon how one measures the expected inflation.
And bank and NBFC credit, both to the small and medium sectors and the retail segment, has recovered strongly since Q4-2025, from when the expected real rates started to fall. For an economy aspiring to sustain growth above 7 per cent, that is welcome news.
But monetary policy rarely comes without trade-offs.
An influential study by Gabriel Jiménez, Steven Ongena, José-Luis Peydró and Jesús Saurina, analysing more than 23 million bank loans in Spain, established the risk-taking channel of monetary policy, confirming that extended periods of low real rates after the 2008 financial crisis induced weaker banks to approve riskier borrowers, require less collateral and eventually experience higher defaults. These findings were confirmed by other researchers in the US and other European markets. Our own research using the Ministry of Corporate Affairs (MCA) credit registry establishes similar risk-taking by Indian banks during the first half of the 2010s when real rates were low, which played a role in a full-blown NPA crisis that ensued.
Why does this happen? Lower real lending rates compress banks’ profitability from traditional lending, encouraging a search for higher-yielding borrowers, which are naturally risky. At the same time, as Giovanni Dell’Ariccia and his co-authors argue, when real profitability declines, the bank’s incentive to screen/monitor, which are essentially fixed costs, also falls, leading to a rise in risky lending. Finally, lower interest rates also boost the value of banks’ bond portfolios and collateral, strengthening balance sheets and encouraging greater risk-taking.
None of this suggests that the RBI’s objective of spurring credit-funded growth is misguided. What we are arguing, instead, is that the low real rates may not be the most efficient tool in reducing the cost of credit in India.
The real bottleneck in Indian finance is the cost of finding, evaluating and monitoring creditworthy borrowers, and this loads up into the lending rates. If the objective is to provide cheaper funding, reducing these information asymmetry costs is a more structural solution, which will allow the central bank to respond to inflationary shocks more flexibly. More importantly, it can make the inflation-growth trade-off less severe.
India has already demonstrated what public digital infrastructure can achieve. The National Payments Corporation of India (NPCI) transformed digital payments, created a financial transactions trail for potential borrowers and merchants, and allowed lenders to lend against these verified cash flows. Not only did it expand credit access to borrowers who had no credit history — a classic chicken-and-egg problem that plagued Indian credit markets for long — but also lowered the information asymmetry and ultimately the lending costs substantially, without encouraging risk-taking in the system. The RBI’s Unified Lending Interface (ULI) is an important step that will build on this infrastructure.
That distinction is crucial. Lower real interest rates make all borrowing cheaper, including loans that perhaps should never have been made and constrain the RBI’s ability to respond to inflationary shocks efficiently, as it has to worry about growth constantly. Better financial intermediation makes good borrowing cheaper by reducing the cost of identifying genuinely creditworthy borrowers. One works by making money cheaper. The other works by making finance more efficient.
The RBI’s current stance may well be appropriate given India’s growth needs and the assessed transitory nature of India’s inflation. But policymakers should also recognise the accompanying risks and enhance risk monitoring mechanisms. Ultimately, we would all welcome a flatter Phillips curve—one where stronger growth comes at a smaller inflationary cost.
Javadekar is chief economist, Muthoot FinCorp Ltd and Tantri is associate professor and executive director at the Centre for Analytical Finance, Indian School of Business
The RBI's current stance may well be appropriate given India's growth needs and the assessed transitory nature of India’s inflation. But policymakers should also recognise the accompanying risks and enhance risk monitoring mechanisms 
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