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Lower inflation means higher real interest rates

BS Reporter  |  Mumbai 

With the inflation measured by the ruling close to zero, real interest rates have shot up to around 12 per cent, as against around 4.5 per cent a year ago, prompting bankers to say that there was more room for the Reserve Bank of India to lower rates.

Real interest rate is the difference between WPI-based inflation and the prevailing benchmark prime lending rate (BPLR).

While inflation dropped to 0.44 per cent for the week-ended March 7, the BPLR of the top five Indian banks was in the range of 12.25-16.75 per cent. In the corresponding period last year, inflation was estimated at 7.78 per cent, while lending rates were in the range of 12.25-12.75 per cent.

On the deposit side, with inflation at near zero levels, you can hope to earn around 7.5 per cent on an one-year deposit. In contrast, the returns were negative when inflation was close to 13 per cent in August.

The International Monetary Fund, which released its assessment on India on Tuesday noted that real interest rates have increased over the last few months, as inflation declined, and added that there was room for RBI to lower rates.

Since the global credit crisis intensified in September, RBI has pared the cash reserve ratio, or the proportion of deposits that banks set aside, and the repo rate, the rate at which it lends to banks, by 400 basis points to inject liquidity and signal a soft interest rate bias.

With growth also moderating, economists are expecting the central bank to initiate further measures to boost activity. "Supported by the coming deflationary patch in the WPI as well as continued weakness in incremental data, we expect to see further monetary easing of 100 basis points in the coming months," Citi India economist Rohini Malkani said.

While RBI’s measures have injected more than Rs 3,88,000 crore into the system, foreign and private banks have been reluctant to lower interest rates.

Public sector banks, which cut lending rates by up to 200 basis points, said that further cuts would depend on additional adjustment in the cost of funds as they were saddled with high-cost deposits.

“Inflation at close to zero is a matter of concern in the sense that consumption is less and possibility of further rate cuts cannot be ruled out,” said Central Bank of India Executive Director Pradeep Ramnath on the central bank’s future moves.

Pointing to the base effect for sharp fall in inflation, a treasury executive with State Bank of India said, for taking a call on interest rates relevant inflation numbers based on the consumer price index (CPI) needed to be factored in.

CPI-based inflation is hovering around 10 per cent.

First Published: Fri, March 20 2009. 00:48 IST