Will interest rates be cut? - Views on News from Equitymaster

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Will interest rates be cut?

Mar 2, 2000

According to newspaper reports, the deputy governor of the Reserve Bank of India (RBI) has stated that the central bank will initiate purchases of treasury bills in an attempt to impart liquidity in the markets and prevent a hardening of rates. Speculation that the RBI will respond to the budget with a cut in the cash reserve ratio (CRR) or the bank rate has been doing the rounds. The rationale is that the RBI needs to support the growth thrust that is implied in the budget for FY01 while projecting a nominal GDP growth of 12%.

What does the interest rate cut mean for the economy. Well, for the industrial sector interest costs come down and this makes borrowing cheaper for new investment plans. Also, the cost of bank finance for working capital purposes reduces. Both these factor help improve the investment climate and the profitability of the manufacturing sector. Infact all net users of funds benefit from such a move.

Banks and financial institutions also benefit in a manner that they pass on only a part of the decline in borrowing costs to the end user. This helps them improve their spreads.

Looking at it from the stock market point of view, a lowering of interest rates benefit companies in terms of valuations (as discounting rates are reduced). Apart from that, borrowing costs for investing in the markets also reduce. Both these factors perk up activity in stock markets.

Whether a decline in interest rates is sustainable is questionable in view of the government's large borrowing programme, which is in excess of Rs 1,100 bn. Unless fiscal deficits are reduced, it is unlikely that interest rates would continue to be marked down in the future.

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