Factors influencing interest rates

The factors which govern the interest rates are

mostly economy related and are commonly
referred to as macroeconomic factors. Some of
these factors are:
1) Demand for money
2) Government borrowings
3) Supply of money
4) Inflation rate
5) The Reserve Bank of India and the Government policies
which determine some of the variables mentioned above.
 Introduction
 Steep decline in the interest rates during the period
1995-2004 deeply impacted the common man and
industries.
 2004-2005 a low interest regime for the Indian economy
 Rates had been kept artificially high by offering high-
administered rates on small savings and PFs
 Gap between short and long-term rates tend to remain
high
 Interest rates continue to be very high relative to the
rates prevailing in global markets
 A Case Analysis
From Bank Rate to Inflation
 Change in the bank rate affects interest rates set by
commercial banks for savers and borrowers
 Tends to affect the price of financial assets viz bonds
and the exchange rate
 Affects consumer and business demand
 Affects output
 Impact on the labour market, employment level and
wage cost
 Influence producer and consumer prices
Bank Rate to PLR and Deposit rates

Positive correlation between cut in

bank rate and movement in interest
rate
Effects on Demand-Spending and
Saving decisions
 Decrease in interest rates
-Attractiveness of spending today
relative to spending tomorrow
 Increase in interest rates
-Saving more attractive and borrowing
less attractive
-Reduce current spending-consumers
(shopping) and firms (capex)
 Cash Flow
 Rise in interest rates
- Savers-higher cash in flow
- Borrowers-higher cash out flow (for
variable interest rates)

 Fall in interest rates-Opposite effect

 Asset Prices
 Change in interest rates affects value of houses and share
prices
 Increase in interest rates-increase the returns on saving in
banks and PPFs
 Encourage savers to invest less money in houses and
company shares
 Fall in demand-likely to reduce their prices
 Reduce the wealth of individuals holding these assets
 Influence willingness to spend

Low interest rates have reverse effect

 Stock Prices
 Normally fall in interest rates reflect in higher
stock prices
 Long-term interest rates had declined more than
25 percent
 Commensurate increase in stock price has failed
to happen
 Probable reason might be uncertainty in the
Indian and global markets
 Investor prefer to stay liquid
 Exchange Rates
 Influence on prices comes through exchange rate
 Investors are attracted to the higher interest
rates (present and future expectations)
 That results in appreciation of exchange rate
against the other currencies
 Increase in value of rupee reduce the price of
imports but
 Higher rupee will reduce the demand abroad for
Indian goods and services
 Impact of Low Interest Rates
 India’s real interest rates have been one of the
highest in the world

 It results in inflating cost of production and

making industry less competitive in the world
market

 Govt. brought down the interest rates which has

two-fold effect
- Lowering the interest burden of corporate there by
reducing the cost of capital

- Stimulate industrial growth and

investment
 Feel Good Factor

Low interest regime

A right policy
Low cost economy
High growth trajectory
Positive activism in the industry
Enthusiasm in the financial sector
Positive impact on market sentiments

In India, interest rates have been started

moving upwards, with the high growth
rate of the economy
 Real Effect
Current Scenario
 Blue-chip corporate have de-linked themselves from PLRs

 Access to the funds through bonds and NCDs

 Reduction in deposit rates and limited safe investment option led corporate to
raise cheap capital through CDs and NCDs

 Average borrowing rate is 11 percent

 Tightening of prudential and capital adequacy norms in

 RBI added the caution to banks

 RBI stipulated maximum spread above PLR

 Banks do not want to lower their rates at the same time they can lend at sub-PLR
to blue-chip companies
 Limited utility of bank borrowing for working capital purposes

 Growth in money supply of 17-18 percent led to sharp growth in bank

deposits recently

 Poor credit off takes results in large investment in Govt. securities by

banks

 Bull run in G-Sec. market leading to interest rates touching new lows
every fortnight

 Thus lower interest rates are not reaching to industries

Interest rate cut is neither the end nor the ultimate objective

Focus should be on improving the general level of productivity,

efficiency and bringing down the fiscal deficit.
 Interest Rate and the Common Man
 India has no social security support

 Life expectancy is increasing

 Medical costs are rising

 Career spans are shortening

 Inflation could erode saving

 Willing to have high returns and high risk tap equity

market but one may burn fingers