In recent years, here are the trends in Commercial Bank Prime Lending Rates:
What do you notice in the graph? What might be the factors that keep India's interest rates at a level where it becomes noncompetitive? Whys is it that all developed countries have low interest rates whereas the underdeveloped countries have high interest rates?
Participate in the discussion and know more...
28 comments:
Having a high-interest rate would mean not allowing people who cannot afford to pay that interest to take loans. A low-interest rate would help in a better flow of money in the economy as people in need of money will be able to have it in an easier manner consequently, the purchasing power of people will increase.
Interest is the cost of the depreciation of the value of money with time. In developed countries the inflation is lower and hence, the rate of interest is lower.
In developed countries, I feel that they have less demand for high-interest loans
In unstable environments, the value of the currency might be unpredictable and might not be worth tomorrow what it’s worth today. Because of that, people tend to spend money as soon as they get it, which is one of the contributing factors to inflation.
To struggle with people’s desire to immediately spend money, the government or money authority might raise interest rates. Raising interest rates sends the message that it’s better to hold on to the money, as you could get it back with a lot of interest in the future.the reason for high interest rates are due to continuous inflation.
The price rises because the people in India always seem to have more money than the goods available in the market.And people have money because government allows banks to give them money as loan.They create money by approving our loan, they know that you will use the loan to make some purchases and the money ultimately gets back to the bank through the buyer.India and many other similar under developed countries choose to manipulate money to provide capital to its industry so that it's citizen can get the opportunity to get better paid jobs. That is why the prices keep rising an the interest rates stay high.
Inflation-The main reason interest rates are high in India is because inflation is so high in India. Interest rates on bank loans will almost be higher than inflation, otherwise what you pay back would actually be worthless than what you borrowed.
Availability of capital-If there is a lot of money coming in for investment, the interest rate goes down. Germany and China get a lot of investments from abroad and this extra money pushes their currency up and interest rate down. India gets comparatively less inflow through bonds.
The interest rates are affected by various factors like inflation ,currency and capital availability.
* So, interest rate should be more than the inflation rate otherwise money lenders will not lend money and we will have to pay back much more the what we have borrowed from them.But India has a more inflation so interest rate is also more.
*If the interest rate is higher then higher foreign money will come and the currency will become stronger and in India RBI still worries about drop in our currency (rupee)so the interest rate is higher here and other countries like U.S.A. and Germany don't mind much if their currency drops little.
*If more money is coming in then interest rate will go down because this money will make the currency stronger but India get less inflow of bonds.
So these are the reasons why Interest rate of developed countries like of U.S.A. (0.75%) and Japan(0.50%) is than comparing to other countries.
Value of money depends upon the inflation rate persistent in an economy i.e. higher the inflation, lower will be the value of currency. Interest rate is nothing but the time value of money. Interest is the compensation paid for depreciation in the value of currency with time. Thus, higher the inflation rate, higher would be the interest rate. Since inflation is lower in the developed economies, a lower interest rate follows and vice versa.
In the graph, we observe that the prime lending rates in India are significantly higher than the PL rates in the developed countries (Germany, Canada, US etc) while developing countries such as China and Australia have mediocre PL rates.
Major factors that affect interest rates in a country are:
Inflation- usually there is inflation in underdeveloped economies so the money supply remains high. To get a hold on inflation, interest rates are usually kept high in such economies whereas in the developed economics the inflation is low so the interest rates are also likewise.
Value of currency- If a currency has a comparatively lower value in international market, there will be comparatively more money flow in the country having the lower value of currency which will result in inflation. so the interest rates will be high.
similar is the case with India which makes it remain non-competitive in the international market.
India has higher prime lending rates as compared to developed countries.
Some reasons for higher interest rates in India –
One of the major reasons for higher interest rates in India is inflation. Inflation is a rise in the general price level of goods and services in an economy over a period of time. When the price level rises, each unit of currency can buy fewer goods and services than before, implying a reduction in the purchasing power of the currency. So, people with surplus funds demand higher interest rates, as they want to protect the returns of their investment against the adverse impact of higher inflation.
As a result, with rising inflation, interest rates tend to rise.
Second is uncertainty. Due to unpredictability of future of economic growth, the lenders tend to cut down on their lending or demand higher interest rates from individuals or companies borrowing from them as compensation for higher default risks that arise at the time of uncertainties. Thus, interest rates generally tend to rise at times of uncertainty.
There are various reasons why the interest rate in India is higher when compared to that of developed nations -
1) Developed nations have enough capital that they can offer loans to many people but when it is compared to India Banks and NBFCs rely on foreign capital. Hence, this is the reason why the bank' interest rates are comparatively higher.
2)One of the reason for higher bank interest rates is INFLATION, as a measure to correct this problem of Inflation the central Bank of India that is RBI come up with strict policies of high interest thereby increasing the bank interest rates as well.
3) There is Instability or risk factor associated with Indian Economy which more and this leads to higher interest rates.
Thus , we see there are numerous reasons why interest rate of India higher when compared to that of developed nations.
-Chitransh Sharma
16BAL018
Its clear from the graph that India has much higher prime lending rates than other developed and developing countries.
Reasons why underdeveloped countries have high interest rates are - 1) Inflation - to curb inflation the RBI has to keep the interest rates high otherwise further decrease in interest rates will foster the inflation.
2) second reason is the exchange rate of the currency of a country. higher the exchange rate, higher will be the money flow and hence the inflation. So as a result the interest rates will also be kept high.
3) third factor that can account for high interest rates is FDI. more the FDI more will be the money flow. and things will follow as explained above.
hence we can conclude why INDIA has high interest rates and hence is comparatively non-competitive.
16bal068
Interest rates depend on key factors:
1.Inflation expectations: By rule interest rates have to be above the inflation rate. Otherwise, the lenders would not lend money. Usually, the long term interest rate is about 2-3% above the inflation rate. India historically had inflation above 6%, while in developed world it is about 2%. Thus, long term interest rates in India is typically above 9% while in the developed world it is about 4%.
2. Availability of capital: If there is a lot of money coming in for investment, the interest rate goes down. US and Europe get a lot of investments from abroad [like Chinese & Japanese governments buying their bonds] and this extra money pushes their currency up and interest rate down. India gets comparatively less inflow through bonds.
3.Currency movements: Higher the interest, higher the inflow of foreign money and a stronger currency. Countries that fear a large drop in their currency strength would avoid reducing the interest rate. India's RBI worries about a drop in rupee, while countries like Japan and US would not mind their currencies going down a little.
From the figure, it can be clearly inferred that the lending rate of commercial banks in India is almost double in comparison to the developed nations.
It is also interesting to note that China, which is the 2nd most populated country in the world after India, even though being a developing country, provides lending rates which are approximately half that of India. According to me, what it signals is that the government wants to step up support for the slowing economy.
As to the question, why India has high interest rates?
It is majorly because of inflation and the risks associated with investment in the country.
Developed countries have less demand for high interest loans. Moreover, they have other facilities for generating cash flows for people. This creates less demand for high interest rate loans because citizen can generate returns from the above situation.
Among other factors, it is important to note that interest rates also depend on the culture of a country, to an extent, in the sense that in a country which lacks probity and doesn’t respect contract laws will have a high interest rate and so is the case vice-versa.
- Vatsal Patel
16BAL057
The Factors which leads to increase in interest of developing countries like India to that of developed countries like USA are due to following reasons:
1) Supply and Demand-
The demand and supply of loan in the country will defined the interest rate of that particular country. In India , the rate is higher because everyone want to be better off and want to satisfy his needs for which he needs money or capital and due to less availability of capital in the country the demand of loan is more than the supply of loan in the market and thus interest in the country reaches to a non competitive level which is never meant for the poor person .
2) Risk
Another important factor which leads to the India in this position is the risk associated of giving a loan . Trust towards people in the country is less because of various instances of non- payment of loan by the citizen of the country so they provide high interest rate for bearing that risk or covering of the principal amount or risk associated with it.
3) INFLATION
Inflation will also affect interest rate levels. The higher the inflation rate, the more interest rates are likely to rise. This occurs because lenders will demand higher interest rates as compensation for the decrease in purchasing power of the money they will be repaid in the future.
4) GOVERNMENT
The government has a say in how interest rates are affected. The Reserve Bank of India often makes announcements about how monetary policy will affect interest rates.
The Central Bank rate, or the rate that institutions charge each other for extremely short-term loans, affects the interest rate that banks set on the money they lend; the rate then eventually trickles down into other short-term lending rates. The RBI influences these rates with "open market transactions, which is basically the buying or selling of previously issued Govt. securities. When the government buys more securities, banks are injected with more money than they can use for lending, and the interest rates decrease. When the government sells securities, money from the banks is drained for the transaction, rendering less funds at the banks'
The reason the interest rate in india is high is because:
The inflation is high in India. When the inflation is high, the interest rate has to be high because if the interest rate is low, the people will have to pay back less than the lending amount. So the bank cannot lend in such scenario.
Also, as the value of money decreases the cost of import increases which would automatically result in high prices for the products, resulting in inflation
From the graph we can clearly come to a conclusion that the Commercial bank prime leading rate is much more higher than the rates of the developed countries.
It is true that the interest rates are higher in India than the interest rates of other developed countries. There are a few factors that are responsible for such huge variations in the range of interest rates between developing countries and developed countries.
Lets take the example of USA.In the US, they have enough capital to offer loans. But in India, banks and NBFCs rely on foreign capital, so the rate of interest is comparatively higher.
Inflation remains high in India. In June 2011, the inflation rate was 9.6%, so, the
interest rate extended up to 11%. Recently in August 2015, the annualized inflation rate in India has come down to 3.78%, which has eventually lowered the interest rates offered by the banks and NBFCs in India. But the inflation rate in the US is around 2%, so their interest rate ranges between 3-4% at max.
The instability or the risk factor associated with Indian economy is more, which leads to higher interest rates.
Reserve Bank of India, the central bank, controls the level of inflation by increasing the base rate, which in turn, increases the interest rate of each bank; whereas, US Central Bank tries to maintain lower interest rates.
Well, if we see the inflation rate is India from 2012-2016 then it has been around 7.38 percent (average), thus a higher interest rate has to be maintained. For example-if my money kept in Bank is loosing it's value then I'd rather invest in real estate or gold or somewhere else ( I hope I'm right)! I simply have no incentive to put my money in Bank with low interest and high inflation. And countries like USA tend to have lower interest rate because the inflation rate their is around or below 2 percent.
When it comes to investment, if we look at Qatar, it has an interest rate nearing 5% which can be seen as an effort to deal with forces that are COMPETING TO INVEST! We shouldn't forget in India WE NEED INVESTMENT...
The other factor can be uncertainty about the future. USA and Western Europe has a much more secure future than a developing country like India, whose future is not so certain. Plus it can also be considered that they may have a BRIGHTER FUTURE BCZ OF BETTER POSSIBILITIES OF TECHNOLOGICAL INVENTION and INDIAN MIGHT NOT!
There are many reason why India is being victim of high interest rates.
1.Inflation- During last years, we have seen inflation is being constantly increasing in India. Interest rate which we pay is nominal interest rate which is summation of inflation plus real rate.Thus greater the inflation, greater the interest rate. We need to look out the things now from different angle.
The repo rate is the interest rate at which central bank (RBI) tries to maintain short term liquidity needs of our banking system. Repo rate decide whether the money should infused into market or not.
But since our growth is sluggish many times, high interest rate adversely affect growth by discouraging industrial and agricultural investment as well as curbing the volumed debt financed to household and consumption. Thus it is negative to growth rate.That is why lower interest rate is expected when growth is low. Then why Interest rate is high?
Simple answer to this inflation.Since already inflation is high in India, if we lower down interest date that will aggravate the inflation which can be more adverse.
2. Foriegn portfolio investment
As noted earlier, repo rate effects the structure of Interest rate. That effect in structure in turn effects on returs. Thus high interest is a factor for encouraging foriegn investment.
Reducing interest rate will discourage investment in India. Little rise in US interest rate have pinching effect on inflows to country like India.Thus RBI governor is bound to worried about the impact of lower interest rate in India can have on such flows(foriegn investement).
Since Govt. is always committed to to prunning expenditures in order to reduce fiscal deficit and commit fiscal consolidation.
Many governments pursue fiscal consolidation to appease foreign financial interests that abhor deficits. A restrictive monetary policy with high interest rates also seems to be influenced by foreign finance. Clearly then, foreign finance is not good for growth because it has been cause high interest rate which seems to CONTRArY WHAT GOVT. BELIEVES..
3. Risk factor- Since in India, there is great turbulency in India market and trust breach manytime. Thus high risk is involved so Foriegn investment has not ready to our page that is foriegn companies hates fiscal deficits.
Reserve bank of India, central bank of India main priority is presently to tame stubborn inflation In order to tame inflation and to stem the depreciation of currency value central bank,RBI is keeping in pace with the inflatory pressures to take on themThough maintaining such high interest rates also effect the growth rate adversely in short and medium term but in long term growth can be achieved when inflation is under control, to explain this taking the example of an consumer who earns amount "X" per year. When the inflation is high he will have less amount remaining in discretionary and non-basic spend and to meet his basic needs like food,oil etc. So obviously when the inflation was high consumption cycle bottoms out which adversely effect growth rate. By the acts of reserve bank in maintaining appropriate liquidity will contain the inflation and intern effect the growth positively in long term.
Most of the people may be arguing on maintaining such high interest rates, let me go into insides of inflation data
Inflation data consists has 2 broad categories, core inflation or manufacturing inflation & food inflation. Though the interest rates cannot effect or contain food inflation effectively but rising core inflation part can be tamed with increasing intreast rates
But the scenario in USAwascompletely different, here the central bank top priority was growth rate and to increase inflation rate. In order to increase consumption federal reserve,central banker of USA is letting out the loose money into the system which intern will cause for growth. Though it was not such advisable for longer periods. We can say it as short cut method for accelerating growth.
for data, I want to mention when the inflation rate touched 20% in USA in 90's then the federal reserve raised interest rates over night.
A general perception that is being built these days that lower interest rate is the only solution to slow growth. Theoretically and logically this sounds correct, but going into a little depth we would find why this is not as it sounds.
This could be understood by two logics.
Firstly, inflation in India is higher (5.22% acc. to cpi 2016) than the economic comfort zone. So RBI targets inflation with higher interest rates. After the inflation in curbed, it could then think of economic growth. Now talking about US, the target of Federal Reserve is economic growth (and not curbing inflation). So Fed tries to attain it with lower interest rates. Also, to substitute this logic, we can take the example of US during 90's when it's inflation rate touched 20% and how Fed raised it's interest rates overnight.
Secondly, India is a developing economy which requires more funds for the investment purposes, so Government looks at more savings by Public. When more interest rate is offered by the RBI to Commercial banks and Commercial banks to Public, then Public will be interested to deposit their money in the banks and hence more savings. When banks offer higher interest rate for the deposits by the public, then the same banks lend money to the people at higher interest rate. The same is even applcable to the developed economies. But, those countries are having enough funds so they'll not pay more interest on the deposits like in India. And in contrast they'll not charge more interest on the loans also like in India.
As per my understanding why the interest rate in India is higher than the other developed country is because
1.Non-availability of enough capital as compared to what the other developed nation are getting much more investment than our country however there are some measure taken by the government which are commendable like increasing the Foreign Direct Investment in some sector .
2.India as a economy is vulnerable with nearly 6% inflation rate which is one other reason why we have such high interest rate.
3. one another aspect is unaccounted hidden income.
If the tax rates will be low it will discourage public from saving their money in banks
key factors that effect the interest rate are :
1 AVAILABILITY OF CAPITAL
if there is more money to lend then the interest rate will be low where as if less money is there then the interest rate will be high this is basically a demand supply of money in the economy . In India there is less investment specially from foreign countries due to which there is scarcity of money in the market.Also in India poor are more and poor people have high propensity to consume due to which they save less , bank accounts are empty and therefore there is less money in the bank to lend .In India people have habit of tax evasion and many Indians have kept there money in the Swiss bank due to which again money does not come to market.
2 INFLATION
It has been said that the interest rate should be higher then the inflated rate this is because to control inflation. When interest rates are low , people borrow more money and increase their consumption this leads to more money in the market and thus inflation increase.In case if the interest rate is high , people will borrow less money ,they will spend less and save more which leads to reduction in inflation rate .Country like India have high inflation rate as compared to other countries due to which it needs to maintain high interest rate in order to control the inflation.
3 CURRENCY
High interest rate in a country will increase the value of currency of that particular country and also due to which more foreign currency come into that country and the currency become stronger.All These are required by the developing country therefore India needs to maintain higher interest rate as compared to developed country ( U.S.A , CHINA) .
we all know that 'Price increases when there is lesser supply and price decreases with increase in supply.’
now considering this let us try to answer 'why are interest and lending rates so high in India?'
The vicious cycle of Population and Poverty:
We are a nation of 125 crore plus individuals. Not just this, our population is growing at a very fast rate of approximately 2% p.a.Excess population is increasing pressure over the existing resources and hence there is increase in unemployment as the industries are not sufficient to absorb the jobs for the excess population.Hence there is high incidence of poverty in India. In fact one third of the world’s poor population lives in India. In other words one out of three poor people is from India.Poor people have high propensity to consume. Which simply means the percentage of income spent on consumption is higher as compared to rich. Hence owing to this there is lesser savings and hence banks have lesser amount as deposits.
If we go to with the rule 'Price increases when there is lesser supply and price decreases with increase in supply.’ we can deduce that since the banks have so less amount for circulation, there will be increase in interest rates.
This is not the case with other developed nations as the poverty is not as big a problem as it is for India.
As a matter of fact the combined population of Uttar Pradesh and Maharashtra is more than that of United States of America. Uttar Pradesh would be the 5th most populous country in the world if it were a seperate country.
Black money in Swiss banks-
Black money in Swiss banks
it is blocking the money supply in Indian economy and hence Indian banks will get lesser amount causing shortage of money supply and increase in interest rates again as per Rule.
Unaccounted income in India-
There is huge tax evasion and unaccounted income in India. Only 3% of India’s population pays tax.This again causes lesser amount of money as deposits in banks.
Interest rates depend on key factors:
Inflation expectations: By rule interest rates have to be above the inflation rate. Otherwise, the lenders would not lend money. Usually, the long term interest rate is about 2-3% above the inflation rate. India historically had inflation above 6%, while in developed world it is about 2%. Thus, long term interest rates in India is typically above 9% while in the developed world it is about 4%.
Availability of capital: If there is a lot of money coming in for investment, the interest rate goes down. US and Europe get a lot of investments from abroad [like Chinese & Japanese governments buying their bonds] and this extra money pushes their currency up and interest rate down. India gets comparatively less inflow through bonds.
Currency movements: Higher the interest, higher the inflow of foreign money and a stronger currency. Countries that fear a large drop in their currency strength would avoid reducing the interest rate. India's RBI worries about a drop in rupee, while countries like Japan and US would not mind their currencies going down a little.
Its evidently clear from the graph that India has almost double interest rate to that of developed countries but if we consider China it being a developing country has managed to keep its interest rates low. The only possible reason I can see is Currency movements: Higher the interest, higher the inflow of foreign money and a stronger currency. Countries that fear a large drop in their currency strength would avoid reducing the interest rate. India's RBI worries about a drop in rupee whereas China doesn't need to worry about that.
Other reason is market demand and supply forces in a country like India where demand for capital is very high but the generation of capital is not enough to meet the demands hence interest rates are kept high so that it can balance the demand and supply forces .Whereas in developed countries there is enough capital to meet the demands hence interest rates are kept low.
Interest rates mainly depends upon what's the top priority of central bank.
Reserve bank of India, central bank of India main priority is presently to tame stubborn inflation. Presently inflation rate in India is 5.2%(WPI, Jan 2014),
& 8.85%( CPI,Jan 2014). This means that the value for money in India is depreciating at faster pace than the economic comfort zone of 2-3%. In order to tame inflation and to stem the depreciation of currency value central bank,RBI is keeping in pace with the inflatory pressures to take on them.
Though maintaining such high-interest rates also effect the growth rate adversely in short and medium term but in long term growth can be achieved when inflation is under control.
Inflation data consists has 2 broad categories, core inflation or manufacturing inflation & food inflation. Though the interest rates cannot effect or contain food inflation effectively but rising core inflation part can be tamed with increasing interest rates
But the scenario in USA was completely different, here the central bank top priority was growth rate and to increase inflation rate. In order to increase consumption federal reserve, central banker of USA is letting out the loose money into the system which intern will cause for growth. Though it was not such advisable for longer periods. We can say it as short cut method for accelerating growth.
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