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RBI Governor hints at lower interest rates

Feb 4, 2000

The Reserve Bank of India governor has stated that current economic conditions were conducive for a cut in interest rates. The governor has highlighted the high growth rates recorded in recent months even as inflation has remained under check. The sharp rise in foreign exchange reserves, which recently crossed the US$ 35 bn mark, has also been highlighted as signal for lower domestic rates.

The government's recent move to slash returns offered on incremental small savings and public provident fund deposits failed to evoke the much anticipated across the board rate cut. Even the RBI did not respond by cutting key lending and borrowing rates. This has created scenario in which real interest rates (nominal interest rates adjusted for inflation) have become sticky at higher levels. The slack in investment activity has been attributed to this.

The government's large borrowing programme, which is in excess of Rs 600 bn, is one of the key reasons for high interest rates. This has crowded out private sector investment, thus limiting economic growth. For a lower interest rate regime, one key criterion would be a lower fiscal deficit. This would reduce the demand for borrowed funds, thus leaving ample liquidity for the private sector (at possibly lower rates of interest).

Although all interested parties desire lower rates, there may still be reason to go slow on this count. The reason for this is primarily the possibility of a rise in inflation rates in view of higher commodity prices (especially crude oil). (Infact in the last one week the US Federal Reserve, European Central Bank and the Canadian Central Bank have all raised lending rates). Lower interest rates would spur demand, putting pressure on inflation. This may not be desirable.

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