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Interest rates: Advantage government - Views on News from Equitymaster
 
 
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  • Apr 8, 2003

    Interest rates: Advantage government

    For years we have seen how the effect of interest payments can make or mar the performance of companies, in the short as well as the long-term. That is why the concept of Corporate Debt Restructuring has an important role to play in India Inc. But, here we look at how the government has fared in this scenario of falling interest rates, the soft interest rate regime one can call it. Has the government been able to capitalise on lower interest rates?

    To begin with, if we look at the table, it can be seen that the bank rate has been on a continuous slide since 1994-95. From 12% in 1994-95, it has now come down to 6.25% and with the RBI showing bias towards a soft interest regime, it is quite likely that this trend of lower interest rates is likely to continue.

      Bank Rate (%) PLR (%)
    1994-95 12.00 15.0
    1995-96 12.00 16.5
    1996-97 12.00 15.0
    1997-98 10.50 14.0
    1998-99 8.00 13.0
    1999-00 8.00 12.5
    2000-01 7.00 12.0
    2001-02 6.50 12.0
    2002-03 6.25 11.0*

    *Discretionary

    Elaborating on the above point, bank rate is the rate at which banks can take loans from the RBI. This loan can then be utilised by banks for their activities including sanctioning loans to the public. The banks, however, disburse loans at the Prime Lending Rate (PLR), which is higher than the bank rate. So, in effect, as bank rates continue to slide, the PLR can also be reduced, thus passing on the advantage of lower interest rates, banks get from RBI, to the borrowers, which help reduce their interest outgo. In the table above, this correlation between bank rate and PLR is clearly visible wherein, PLR has fallen from 15% in 1994-95 to the current levels of 11%.


    Note: 2002-03 (Revised Estimate)
            2003-04 (Budget Estimate)

    As can be seen from the chart above, the biggest beneficiary from the consistent fall in interest rate has been none other than the Government of India. It has been able to fund its ever-rising fiscal deficit and thus, has been a huge borrower of money. If we see the increase in interest payments (year-on-year) by the government, there has been a considerable curtailment in the same. While, interest payments were higher by 20% in 1994-95 over 1993-94, the increase has come down to 6% in 2003-04 (budget estimates) over that of the previous year 2002-03 (revised estimates).

    Of the total expenditure of Rs 2.9 trillion in 2002-03 (revised estimates), 40% was accounted by interest payment towards servicing high cost debts of the past. This would have been higher but for a significant decline in interest on government borrowing during the course of the year (the average cost of government debt has come down from 11% to 9.4%).

    Another interesting fact to note here is the share of interest payments as a percentage of GDP of the country. After touching a peak of 4.7% of GDP in 2000-01, the share of interest payments is expected to come down to 4.5% of GDP in 2003-04. This is interesting in relation to the fact that the government’s outstanding debt has steadily risen over the last decade.

    Thus, ideally speaking, the high cost of finance that has been hindering private sector investments is no longer a reason for worry for India Inc. In the backdrop of a lower interest rate scenario, the government should also benefit from retiring high costs debt. That said, the continuation of a softer interest rate regime would largely depend on the government’s willingness to accelerate the reform process. Otherwise, the ever-rising fiscal deficit could fuel inflation and thus push interest rates higher. Over to the government!

     

     

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