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Is policy interest rates set to be cut by a meaningful amount?
Since April 2012, India lowered its interest rates for the first time in January 2013, in an attempt to boost the level of investments in the country. In January, the Reserve Bank of India cut the interest rates from 8 percent to 7.75 percent. In addition, the Reserve Bank of India cut the cash reserve ratio from 4.25 percent to 4 percent from February 9, 2013.
This resulted in the addition of Rs 180 billion (US$ 3.4 billion) into the reserves of the India’s banking system.
India’s inflation rate had been skyrocketing for the past three years, and last year, the average rate of inflation was above 7 percent. This year, in January, the inflation rate fell slightly from 7.18 percent to 6.62 percent. However, in February 2013, the inflation rate rose once again to 6.84 percent.
To curb the rate of inflation, the Reserve Bank of India is continuously reducing the interest rates, and it once again reduced the rate by 25 basis points to 7.5 percent in March. Recently, the governor of the Reserve Bank of India, Duvvuri Subbarao, announced that the organization will not reduce the interest rates further until the rate of inflation comes down.
So, we will have to wait and see if the rate of inflation will decrease in the coming months. Based on this, we will be able to predict the movement of interest rates.
A rise in the rate of inflation is caused by an increase in at least one of these three elements – food prices, global commodity prices, and demand pressures. Currently, India is facing a current account deficit because of the widening gap between exports and imports, with the country’s import value rising at a significant level compared to the export value.
To increase the value of exports, the Reserve Bank of India is reducing the cost of borrowing so that more investors set up firms in India. However, banks recently made it clear that they are unlikely to cut interest rates even if the Reserve Bank of India did. Many banks in India, including the State Bank of India, Karnataka Bank and the Punjab National Bank increased their interest rates for deposits last month by as much as 1.25 percent, to keep retail prices attractive.
Retail banks are struggling to acquire public deposits, and this is only possible by offering attractive interest rates. So, it is unlikely that retail banks will follow the approach undertaken by the Reserve Bank of India.
Retail banks are not likely to reduce interest rates on loans, despite the recent reduction in the interest rate by the Reserve Bank of India by 25 basis points. Therefore, there will be no immediate relief to equated monthly installments (EMIs) for home and automobile loans.
According to the Diwakar Gupta, MD and CFO of State Bank of India, banks cannot afford to cut the rates of interest rates on loans because it will put immense pressure on the high-cost bulk deposits.
So, we are likely to see a reduction in the interest rates set by the Reserve Bank of India only if the rate of inflation decreases in the coming months. As of now, retail banks have no intention of reducing the interest rate on loans.
However, they are offering attractive interest rates on deposits to get more customers to open up savings accounts in the respective banks.