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Real interest rates move up sharply

LiveMint logoLiveMint 03-06-2014 Krishna Merchant

Real interest rate has inched close to 4%, the pre-crisis level in 2008, according to India Ratings and Research. The real interest rate has been calculated by taking the bank lending rate minus inflation using the gross domestic product (GDP) deflator.

“India had a real interest rate of 2% below the pre-crisis level in 2008,” India Ratings and Research said in a 2 June note. The agency expects the GDP deflator to have fallen around 2 percentage points year-on-year since then. “Due to the improved transmission of the real interest rate in the lending system, the systemic lending rate has increased 25 bps (basis points) since August 2013. This is likely to improve India’s real interest rate,” it said.

While the real interest rate may not have reached pre-crisis levels, it may have inched closer to it. With inflation according to the GDP deflator falling from 7.8% in the December quarter to 5.3% in the March quarter, real interest rates on the deposit side too are much higher now. Seen together with the fall in gold prices, this should lead to higher financial savings by households, improving liquidity and providing the money to fund investments.

Will the rise in real lending rates affect investments by firms? It won’t, if the returns from investments also improve, which will depend to a large extent on the policy steps taken by the new government. High real lending rates during the boom of 2003-08 did not prevent firms from borrowing and investing.

“As such, it provides the RBI (Reserve Bank of India) more elbow room to at least consider reducing the interest rate,” the rating agency said. But it is early days yet and much depends on the trajectory of inflation in the months ahead, especially the impact of El Niño on monsoon rainfall.

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