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Monday, April 1, 2013

Why interest rates in India are not going down?

Indians are highly perturbed with high interest rates prevailing in the country. From corporates to individual loan subscribers, all are feeling the heat of high interest rates.
Earlier all eyes were on the RBI to cut policy rates but even after it slashing the repo rate by 50 basis points (or .5 %) in this calendar year banks and other financial institutions were unable to cut the lending rates significantly. Higher interest rates are resulting in piling NPAs (Non Performing Asset or bad debt) besides lower NIMs (Net Interest Margin).

Why banks are not slashing interest rates significantly?

Mere RBI slashing policy rates shall not enable banks to drop interest rates significantly but for that deposit rates too need to be slashed. Deposit rates refer to the interest payable on the deposits of the customers- time deposits (FD, RD etc) or demand deposits (saving account etc).

Now the question becomes- why banks are not reducing the deposit rates?

And the answer is-Sluggish growth in bank-deposits prevents banks from cutting deposit rates.
Rising gold and appreciating real estate in the past few years made investors to pull funds from banks to invest in gold and real-estate.Investments in the aforementioned assets being long term created the scarcity of funds for banks and this scarcity of funds prevented banks from cutting deposit rates.
With retail inflation rate hovering above 10 %, Real-Interest Rate from debt instruments (any instrument on which interest is payable like FD, RD etc) turned negative.

Real interest rate is nothing but the interest rate adjusted for inflation.For example, if your FD pays you 9 % interest per annum and inflation rate is 10% per annum, then your real interest return is – 1%.
This means you are not gaining from your investment but losing money on it due to higher inflation.

Why Gold and real estate gave fantastic returns?

Gold being the best hedge against the inflation, investors started hoarding it. Global economic activities like US quantitative easing and similar money printing measures by European and Japanese economies resulted in ample liquidity which when flew into real estate resulted in sky-rocketing prices.  

Is there any remedy?

This scenario shall not change until inflation becomes benign i.e. lower CPI inflation or retail inflation. Besides this, there should be an improvement in bank deposits, and this shall be possible when gold and real estate shall cease to deliver lucrative returns.
Indian government too needs to do the needful to curb the spiralling inflation in India.
When inflation shall be tamed, RBI too shall proactively reduce the policy rates and thus lending rates shall be reduced.


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