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Explained: Why interest rates aren’t falling


Headline : Explained: Why interest rates aren’t falling

Details :

Context for the article:
Rate cuts by the RBI:
Why does RBI want lower interest rates?
  • Since February, India’s economic growth momentum has rapidly decelerated.
  • Projections of GDP growth rate have come down from roughly 7.2%-7.5% in February to 5.8%-6.0%.
  • There are two key problems in the economy – Consumption and Investment – and a lower interest rate regime is expected to help in resolving both.
  • To this end, RBI has been cutting repo rates, especially since overall retail inflation has been well within the RBI’s comfort zone of 4%.
Lower interest rates could revive consumption:
  • The main issue is that people are not consuming at a high enough rate.
  • Some economists argue that if banks reduce their lending rates, they would also have to reduce their deposit rates (the interest rate banks pay when we park our money with them in a savings bank deposits or a fixed deposit).
  • This, in turn, will incentivise people to save less and spend more.
Lower interest rates could revive private investment:
  • The other problem in the economy at present is that businesses are not investing in existing or new facilities.
  • Part of the reason is also that the interest rate charged on loans is quite high.
  • If banks reduce the interest rates on loans, more businesses are likely to be enthused to borrow new loans for investment.
  • This is particularly relevant with the recent corporate tax rate cuts done in the hope that it will boost the corporate sector’s profitability and get it thinking of investing more.
The ‘transmission’ of rate cuts by RBI to the banking system is not happening:
To force transmission, RBI is linking bank lending rates to repo rate:
Only few banks have cut rates:
Why aren’t interest rates in the banking system coming down?
Difference between lending and deposit rates allows banks to function:
Banks can be profitable only if they cut deposit rates also:
Why are banks not reducing their deposit rates?
What hasn’t linking the lending rate to the repo rate worked?
Is this problem of weak transmission new?
Why doesn’t this happen in developed countries?
Section : Economics
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