PRESENTED BY:HASHEEN ARORAJASMINE KAUR &SAUMYA CHABBRA

Relationship between Interest Rate, Inflation and Growth

Interest rate and GDP

INTEREST RATE GDP

MONEY INECONOMY

INDUSTRIAL GROWTH

Interest rate and Inflation

Interest rate Credit flow

MS<MD

INFLATION

MS>MD

Interest rate Credit flow INFLATION

FINANCIAL SECTOR

UNORGANISED ORGANISED

MONEY LENDER

LOCAL BANKER

TRADER

LANDLORDS

BANKS

MFI

GOVT. SECURITIES

INTEREST RATE ON UNORGANISED SECTOR

• Lenders in the unorganised sector mostly operate with their own funds.

• Imperfections in the loanable funds market & the existence of monopolistic elements leads to high rate of interest in this sector.

• It appears that there has been a decline in the interest rate in the informal credit market over the years.

Why are the informal marketinterest rate so high ?

• Knowledge of the borrowers

• Risk faced by creditor is not reduced by obtaining the good collateral.

• Conventions established over a long period.

• Default experience over time.

• Sectoral supply of & demand for loanable funds .

INTEREST RATE ON GOVERNMANT SECURITIES

What are gilt edged securities?

The gilt-edged market refers to the market for government and semi-government securities, backed by the Reserve Bank of India (RBI).

These are highly liquid & safe, that’s why they are known as gilt edged securities.

Govt. keeps low cost for these securities.

• The price of bonds, such as government securities, is inversely related to interest rates. So, when interest rates are expected to increase, the price of bonds drops (and vice versa).

• Although gilt funds invest primarily in low-risk securities, they are not entirely immune from risk. Interest rate increase can cause poor performance and return from these securities.

• In 2009, even some of India's highest-returning gilt funds saw negative returns in their first months due to interest rate hikes. Longer average maturity periods can balance out fluctuations and minimize these risks.

Interest rate & NBFC• NBFC is an institutional company whose principle business is to

accept deposits under any scheme or arrangement or in any other manner & to lend in any manner.

• They help to bridge the credit gaps in several sectors which banks are unable to fulfill.

• Interest rate on public deposits with companies are higher than those of bank deposits & deposits with post offices.

• The high interest rates essentially reflect their high costs of borrowing and operational costs

• The level of rate offered by different companies depends on : Dividend Financial position Reputation Management Size Overall profitability

Recent trends in NBFC

• The earnings of NBFCs come mainly from the interest spread

between loans and borrowings. • 1) RBI re assessed its policy on interest rates of NBFC which was

implemented last year 2) Although RBI cant raise the NBFC min. level of NOF from present level of Rs.25lacs set in Jan 9,19973) Last year , RBI announced a policy of deregulated int.rates for registered NBFCs certificates were issued allowing NBFC to fix int.rates on deposits watever level they desired .Other NBFC offered int.rates upto 15%4) RBI is re assessing system whether it is necessary to grant certificates allowing them to set int.rates

Interest rate & MFI

What is MFI ? A microfinance institution (MFI) is an organization that provides

financial services to the clients who are poor and more vulnerable than traditional bank clients.

Why do MFIs charge high interest rates to poor people?

• The issue is cost: the administrative cost of making tiny loans is much higher in percentage terms than the cost of making a large loan.

• It takes a lot less staff time to make a single loan of Rs. 10,00,000

than 1,000 loans of Rs 1000 each. • Borrowers neither have collateral nor a salary which eventually

increases the risk, thereby making the microcredit more expensive. • MFIs may operate in areas that are remote or have low population

density, making lending more expensive.

Although Microcredit interest rates can be legitimately high, inefficient operations can

make them higher than necessary.

On July 28, 2010, SKS Microfinance, India's biggest Microfinance Institution (MFI), made its debut on Bombay Stock Exchange, offering its shares to the general public. SKS's Chairperson and Founder, VIKRAM AKULA, claimed that initial public offering(IPO) has been made to raise more funds so that SKS could reach out to a larger number of poor people. However, others, most notably the father of microfinance Muhammad Yunus, expressed doubt that Vikram Akula will be able to juggle SKS's social mission with the demands of a traditional profit-maximizing business. The main obligation of any public company is to make dividends for its shareholders, while the main obligation of an MFI is to serve the poor. Yunus is afraid that in the end SKS will have to put its shareholders' interests above the ones of the poor. "By offering an IPO, you are sending a message to the people buying the IPO there is an exciting chance of making money out of poor people. This is an idea that is repulsive to me. Microfinance is in the direction of helping the poor retain their money rather than redirecting it in the direction of rich people," Yunus said.

The IPO of SKS MFI, saw it over-subscribed by 15 times; their Ten-Rupee share was priced at a premium of Rs 985 – showing how much the market had confidence on their profitability while “banking with the poor”. MFIs argue that they have to charge high rates to maintain profitability. Profitability, which even private banks couldn’t match! Profitability that permits SKS to pay Rs 1 crore as bonus to their just fired CEO!

Liberalization and de-regulation process started in 1991-92 has made a sea change in the banking system. From a totally regulated environment, we have gradually moved into a market driven competitive system. Our move towards global benchmarks has been, by and large, calibrated and regulator driven. The pace of changes gained momentum in the last few years.

Implications of Deregulation

• Interest rates are likely to be higher than in the past . It has been experienced in India that whenever ceiling on any interest rate was removed , the respective rate had tended to increase .

• The economic units would face a higher degree of risk and earn certainty . The cost of funds would no longer easy to predict.

• Interest rate risk will be higher on both debt & ownership securities .

Certain implications for the likely behaviour of Interest Rates in the near future

Phases of Interest Rates Policy

The period since 1951 can be divided into the following five phases of interest rates policy (system) in India:

i) 1951 – 52 to 1960 – 61 Flexible interest rates system.

ii) 1961 – 62 to 1985 – 86 The system of administered, regulated, and repressed or suppressed (low) interest rates.

iii)1986 – 87 to 1990 – 91 The beginning of liberalization or the system with inclination or intend towards liberalization and flexibility, or a semi-administered system with the inching up of interest rates.

iv)1991 – 92 to 1996 – 97 The system of progressive deregulation and flexibility, and a significant increase in and unprecedentally high interest rates, or the phase of deregulation and dear money.

v) 1997 – 98 to 2003-04 The system of managed flexibility with nearly complete deregulation, and one of the lowest levels of interest rates in India, or the phase of cheap money.

The Reserve Bank of India (RBI), which is India's central bank and in chargeof monetary policy , which has a big impact on liquidity and interest rates in thefinancial system.

Monetary policy involves regulation of money stock or the short term interest rate to attain monetary policy Objectives.

These objectives are as follows:-

I. PRICE STABILITYII. OUTPUT/EMPLOYMENTIII. FINANCIAL STABILTY

.

How the RBI conducts monetary policy The RBI has several goals of which controlling inflation is one of the most important. When inflation is rising and threatening to spin out of control, as it is today, the RBI 'tightens' monetary policy which means reducing the amount of liquidity (floating money) in the economy. Though the RBI's policies may take upto a year to show their Full effect they are perhaps the most effective way of reducing inflation.The RBI has several tools for conducting monetary policy:

Monetary policy instruments

CRR LAFREPO/REVERSE

REPO OMO PLR

INTEREST RATE FALLS

INVESTMENT INCREASES

AGGREGATE DEMANDINCREASES

AGGREGATE OUTPUTINCREASES

PRICE LEVEL INCREASES

MONEY SUPPLYINCREASES

INTEREST RATE RISES

INVESTMENT DECREASES

AGGREGATE DEMANDDECREASES

AGGREGATE OUTPUTDECREASES

PRICE LEVEL DECREASES

MONEY SUPPLYDECREASES

In its annual monetary policy review for 2010-11, RBI increased its policy rates. 

Hike in Repo and Reverse Repo rates by 25 bps with immediate effect Repo rate increased to 6.75% Reverse Repo rate increased to 5.75%

SLR retained at 24%

CRR kept unchanged at 6%

Bank rate retained at 6%

Is the 8.6% target achievable?

GDP:

• RBI has crucial task of balancing between growth and inflation.

• The continued interest rate hikes are likely to slowdown industrial activities, therefore putting pressure on achieving the estimated target of 8.6% growth in GDP.