Apr 9, 2003|
Real interest rates: Worrying picture
The banking sector has seen a slew of activity in the last two years. This has led to a re-rating of banking sector stocks, especially the public sector banks. One of the major structural changes one could observe was the falling interest rates. But despite these falling interest rates, the benefits of low interest rates have not been fully passed on to the smaller borrowers.
In all the milieu of falling interest rates, we often tend to forget the ‘real’ interest rate scenario. Real interest rate is the interest paid by the borrower after accounting for inflation. In this article we look at the movement of real interest rates in the economy and the reasons behind the same.
India’s ability to maintain low inflation has been one of the main features of economic reforms in the second half of the decade. Inflation had fallen to nearly 2% in FY02 compared to highs of 12% seen in the middle of the decade. With this perspective in mind one would expect real interest rates to follow the sharp downward movement seen in inflation rates. But the table indicates that real rates for borrowers have actually increased in the last decade. This means that borrowers are worse off currently than they were a decade ago. Lending rates have not fallen at a similar rate compared to the fall in the inflation rate. For a country like India this is a cause of concern because in India the interest cost, as a proportion to sales is very high compared to other emerging economies.
At the same time for the government, real interest rates have been largely subdued in the last decade. This is due to the better pricing it gets for its borrowings in the market. For the lenders or depositors on the other hand, average real interest in the second half of the decade stood at nearly 2%. This is in comparison to an average real interest rate of –0.3% in the first half of the decade. The real interest rate scenario in the last 3 years has been even better averaging nearly 4.5%.
So what is in store for the lenders and the borrowers going forward? The RBI’s stated policy of maintaining low interest rates have gone a long way in helping maintain low interest rates in the economy. Temporary fluctuations (impact of war on oil) apart, inflation too looks to be under control. In the recent budget the government has indicated that it will take steps to rationalise lending rates to small and medium enterprises, as the cost of borrowing for them is still high. All these factors indicate that real interest rates are expected to come down even further.
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