Seldom in the recent past has the interest rate become such a politically sensitive issue with North Blocklobbying for a cut from every conceivable fora. If it was not finance minister Yashwant Sinha speaking at a CII seminar in Delhi, it had to be finance secretary Vijay Laxman Kelkar at some other forum in Mumbai. The politics of an interest rate cut, which gained momentum with the presentation of the economic survey and the Union budget, was set for a climax on April 20, the day the credit policy is to be announced. But the sudden collapse of the BJP government has led to anti-climax.

Till the political uncertainty loomed, Yashwant Sinha's agenda was clear: the RBI should lower interest rate to fuel economic growth. Even now, a change of Government does not necessarily mean a change in the policy stance. The logic of an expansionary monetary policy is clear: since no Government is in a position to really ease the fiscal side given the runaway growth in expenditure, the only way to keep industry growing in a difficult year is to easy up on the monetary side. Logically, the RBI would have liked the Governmentto go easy on borrowing so that interest rates can be brought down; but this is near impossible given the huge expenditure pressures. In other words, an expansionary monetary policy needs to complement the reasonably tight fisc.

This is why the RBI faithfully toed the line of the Government in March. Within 48 hours of the presentation of the budget, it had cut the bank rate by one per cent, the repo rate by two per cent and banks' cash reserve ratio (CRR) by half a percentage point, releasing over Rs 3,000 crore into the system.

Taking the cue, the State Bank of India and a few mega nationalised banks cut their prime lending rates by one percentage point each immediately while the financial institutions took a fortnight to effect a half percentage point cut. The lowering of interest rates has certainly improved the sentiment but a corporate rush to lift bank funds is nowhere in sight. There is no disputing the need to bring down interest rates. But the moot point is: is the time ripe for another cut?And, who will decide on the timing of the cut? The finance ministry or the country's central bank? With Raisina Hill no longer overshadowing the Mint Road--at least for the time being--Jalan will get breathing space to take stock of the situation.

Theoretically speaking, the RBI should bite the bullet now. One view is that with inflation ruling at around five per cent, the RBI can take the risk and bring down real interest rates to realistic levels. But the fall of the Government has queered the pitch. The rupee is likely to come under pressure and till such time a stable Government assumes office at the centre, Jalan can hardly afford to bring down interest rates or release additional liquidity into the system which could spill over into the forex market.

Another question is: Can the central bank really force commercial banks to cut their lending rates in a liberalised era? It cannot. At best, it can create an environment by lowering the bank rate and cutting CRR to release liquidity into the system.Ultimately, it is up to the banks and institutions to respond to the signal. Significantly, none of the foreign banks and very few private sector banks cut their lending rates in response to the bank rate and repo rate cuts in March. Even among public sector banks, there was no overwhelming response while the financial institutions dragged their feet before realigning their lending rates. If senior bankers are to be believed, even the one percentage point cut in lending rate by public sector banks was not a commercially prudent decision.

It will not be surprising if banks decline to cut lending rates further even if the RBI sends a signal by cutting the benchmark bank rate. Reason: cutting lending rates without affecting profitability would require cuts in deposit rates as well. That once again brings us back to square one: the politics of interest rates. Banks cannot push down deposit rates as long as government continues to pay 12 per cent on public provident fund (PF) and employees' provident fund (PPF).A one percentage point cut in small savings earlier this year became a major political issue with left parties opposing it. With PF and PPF offering high returns and investment in mutual funds becoming attractive with a gamut of tax sops, banks will not be able to bring down their deposit rates either. And hence they will not be able to offer finer lending rates as that will put pressure on the dwindling spread.

This perhaps explains why the central bank is resisting the pressure of the finance ministry on a rate cut. While banks need to learn to do business on a thinner spread, the central bank cannot force them overnight to cut interest rates to spur economic growth unless the entire matrix is changed. We cannot have two sets of rates: one for PF and PPF and another for corporate borrowers. Or, look at from a different perspective, one cannot have two sets of rules: one for depositors (who will get higher rates as otherwise gross domestic savings will take a hit) and another for corporate borrowers (whoneed cheap money to invest in industry).

If the first round in the battle to cut interest rates went to the finance ministry, the RBI held its own in the second even before the political crisis intervened. By doing this, the central bank has been able to claw back some freedom on monetary issues, a process which was triggered off by the March 1997 agreement between the Reserve Bank and the government to phase out ad-hoc treasury bills.

Finance secretary Kelkar hit the nail of the head when he said: "Large government borrowings are hampering the ability of the monetary authority to cut interest rates....As long as the Government is a large borrower, it reduces the effect of monetary policy."

The statement was in contrast to what Kelkar had said earlier that "interest rates should continue to move southwards" and made a strong pitch for a further lowering of interest rates as a key to industrial recovery.

The finance secretary virtually admitted that the finance ministry had no business to meddle withinterest rates: "Interest rate policy is the domain of the Reserve Bank of India and I can see what problems the governor faces... The Reserve Bank's manoeuvrability in respect of interest rates is restricted by the central government's huge fiscal deficit."

The governor also managed to convince former commerce minister Ramakrishna Hegde that it was not possible to continue with the special export refinance rates that were in force until March 31.

Hegde had blamed the finance ministry and the RBI for sacrificing long-term goals to achieve short-term targets.

But now the ballgame is different. With political instability casting doubts on which way the fisc is headed, Jalan knows that monetary policy has become the key to currency and economic stability.