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http://www.ideasmakemarket.co m/2013/07/rbis-interest-rate-po licy-and-its.html
RBI’s Interest Rate Policy and Its Impact on Indian Economy
Reserve Bank of India(RBI) is the central bank of India. Its main f unction is to establish monetary stability in the country. For this, it is equipped with independence in f ormulating and implementing monetary policies in order to maintain price stability and adequate money supply in the system. RBI takes dif f erent expansionary and contractionary steps to achieve the same and utilizes its tools such as Cash Reserve Ratio(CRR), Statutory Liquidity Ratio(SLR), Bank Rate, Open Market Operation(OMO) and Liquidity Adjustment Facility(LAF) f or this. T he use of these tools varies the supply of money in the system. Whenever RBI wants to reduce money supply i.e. curb inf lation in the country it f ollows contractionary measures, whereas when achieving growth is the target it takes expansionary measures. Why are interest rates important for an economy? Amongst all the rates, it is the Repo rate which inf luences most the given money supply in the economy. Repo rate is the rate at which the banks borrow short-term f unds f rom the RBI. It is a secured nature of borrowing similar to a loan against f ixed deposits availed by individuals during emergencies. RBI raises repo rate to increase the overall cost of f unds in the banking system. Higher costs will keep in check the demand f or f unds. If the central bank hikes its repo rate, it becomes costly f or banks to borrow money f rom RBI so they in turn hike the loan interest rates at which customers borrow money f rom them to compensate f or the hike in repo rate.
In the f ollowing graph, the trend in inf lation, growth and interest rates have been plotted f or the past seven f inancial years f rom 2006-07 to 2012-13 have been plotted.
Interest rates have high inf luence on both growth and inf lation. Higher the interest rate, higher is the cost of capital and contributes to slowdown investment in the economy. Interest rates are a signif icant f actor in determining the economic environment in which investment has to take place, especially when many companies are not cash rich. High interest rates also impact FDI due to the uncertainty in the exchange rate as the market expects interest rates to eventually f all.
5%.32 6.09% of weight age in WPI has its contribution decreased by 4. Given that f ood price are still high. higher is the supply of money in the economy and greater purchasing power of individuals. most recently on account of uncertainty over policies of systemic central banks.74% has lowered its contribution in growth of WPI by 1. along with supply constraints. Many high weightage items f rom the basket had lowered its price as compared to previous year.32 9. T he similar has been the trend with Iron and Semis. T his will result in increase in the price of Goods. Historic data of growth.80 8. macroeconomic conditions remain weak.00 6. T hus Interest rate is amongst the most signif icant components of the cost of many companies and uncertainty of this variable only amplif ies overall uncertainty in which investment decisions have to be made. Central Bank in 2011-12 had to theref ore increase Repo rate to control inf lation.59 9.75 8. RBI has to maintain a balance between these two f actors which runs the economy. the inf lation f igures will be inf luenced by ef f orts to break f ood inf lation persistence and also the impact of the ordinance passed f or the f ood security bill. Inf lation has moderated as projected however the depreciation in rupee value and imbalances in the commodity markets pose a big challenge.7% in the month of May.43% due to global f alling in prices.00 5.10 9.80 Interest Rate 7. Manipulating interest rates thus creates a variation in growth and inf lation in the economy. the inf lation rose by almost 4 percent and the repo rate was reduced by 2. Annual inf lation rate. Year 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 Growth 9.21 4. Due to the remarkable economic growth of India over the recent years compared to other nations.57 9.96 inf lation 6.50 Source: Planning Commission Table 1.75% as the growth rate was steady at 9% whereas f rom 2011 to 2012 the inf lation as compared to previous year lowered its pace to 8. On the domestic f ront. f rom 2008 to 2009. Comaparison with other Economies: . lacklustre domestic demand and weak investment sentiment. Also the global gold prices are f alling. RBI's interest rate policy can help anchor expectations and reduce uncertainty.89% in April 2013 to 4. Petrol that occupies around 1. increase in f oreign currency inf low caused the demand in multiples in India.80% and growth suf f ered.Lower the interest rate. Basic metal and alloy products occupies a huge position of 10. based on WPI has been currently showing a downward trend f rom 4.00 8. Current Indian Scenario T he global economic activities have slowed and risks remain high.50 7.75 5.00 4. since there is more demand and less supply of the goods. inf lation and Interest Rate As per Table 1.50 4.80 7.60 8.75 7. All this provides central bank a room to lower down the interest rate to prosper growth in the economy.
10% whereas European Central Bank has kept its key interest rate to 0.2 trillion f rom the central bank in December 2012. T he Reserve Bank’s monetary policy stance will be determined by how growth and inf lation trajectories and the balance of payments situation evolve in the months ahead.Various steps were taken by other developing nations in order to control their monetary policy and economy. Due to tight cash conditions in the system. T hus there has been not much investment on the growth f ront. the same has not been transf erred to the consumer by banks. 1.the f irst Asian central bank to do so since 2011 . banks have been borrowing an average Rs. T he main challenge is to reduce the current account def icit to a sustainable level and the short term challenge is to f inance it through stable money f low.000 crore daily f rom RBI.1. Interest Rate and Reserve Bank of India: Historically.5%. bank borrowing shot up to Rs.1. f rom 2000 until 2013. Again with continuous depreciation of Rupee in last f ew weeks. but again the central bank must have a control on money supply in order to curb high inf lation.in a bid to support its currency.23 lakh crore in the economy in the name of f ood security bill . Indonesia responded to outf lows and market volatility by unexpectedly raising interest rates . banks have also been tapping the ref inance f acility of RBI. Given that f ood price are still high. To achieve an open economy. T he big question still remains to be seen is that with an inf low of Rs. RBI (Reserve Bank of India) had to control this excess liquidity in our economic system. T he lending rates have not decreased by the same percentage as expected by RBI. Due to worsening liquidity conditions. T he RBI in its last review meeting decided to keep the repo rate under the liquidity adjustment f acility (LAF) unchanged at 7. will it boost the money supply and decrease prices or will the spending in the . Among the developing nations.5 Percent in August of 2000 and a record low of 4. the inf lation f igures will be inf luenced by ef f orts to break f ood inf lation persistence and also the impact of the ordinance passed f or the f ood security bill. indirectly the level of employment and investments prospects in the country(in the f orm of DII. T his shows to achieve growth we need to keep these rates low. Conclusion Interest Rates are very important tool f or an economy. US Fed has kept its f und rate to as low between 0-0. Inf lation has moderated as projected however the depreciation in rupee value and imbalances in the commodity markets pose a big challenge.0 per cent of their net demand and time liabilities. while Brazil said it would scrap a tax on f oreign exchange derivatives as the real weakened. FII. indicates the need to absorb liquity in terms of Rupee to stabilize the currency. Also if we see the trend. T his leads to a question as to whether f urther reduction in interest rate by Central Bank would provide a helping hand to growth of the country or will merely increase the money supply(causing inf lation) and providing high prof it making opportunities to banks. value of its currency. Japan’s call is between 0-0.6 Percent reaching an all time high of 14. its inf lation. India should be open to investments thereby reducing prevailing interest rates taking into consideration the inf lation. If we check the current scenario of developed nations. Recent measures to dampen gold imports are expected to moderate the current account def icit in 2013-14 f rom its level last year. India Interest Rate averaged 6. FDI).3 trillion into the system last f iscal through so-called open market operations. Also.3 Percent in April of 2009.25 per cent and to keep the cash reserve ratio (CRR) of banks unchanged at 4. Other major developing countries with large f oreign f inancing needs such as South Af rica and Poland are also seen at risk. they have a very low interest rate. RBI has inf used about Rs.80.25%. It determines country’s growth. even though Central Bank reduced its repo rate. T hat apart. T he Central Bank warned of upward risks to inf lation posed by a f alling rupee and increases in f ood prices.
] .elections cause f urther create a hole in government’s treasury! [The article has been written by Neha Agarwal and Utkarsh Tathagath . They are presently pursuing their MBA from NMIMS. Mumbai.
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