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Interest rates have a significant role to play in any economy.
The growth of the economy and interest rates tend to be
inversely related with the latter amongst other things being
used as a tool to contain inflation. Globally, Central Banks
rely extensively on the interest rates to lead the economy
in the desired direction, with a few also resorting to reserve
management for quicker results. The Central Banks administer
the interest rates through the banking sector, whose intermediation
activities have a direct impact on the economy.
The Indian economy was on a roll for the last three years,
with the GDP growth rate of 9% plus, inflation declining
from 6.37% in January 2007 to a low of 3.07% in October
2007 and the yield on the 10-year GoI benchmarks going below
7.50% in January 2008. The Indian growth story funneled
increased inflow of funds in the form of Foreign Direct
Investments (FDI). Foreign Institutional Investors (FII)
also stepped up activity and the stock market touched frenzied
heights. Forex reserves, which were at abysmally low levels
during the 1990s, touched a high of $316 bn.
The
continuous growth stoked inflation to a 16-year high of 12.63%.
The inflation was more a supply side one, contagion of the
global phenomenon, and hence fiscal steps had limited effect.
Commodity prices soared, particularly the oil seeds, pulses,
edible oils and other agricultural produces, affecting the
common man. RBI was faced with the dichotomy of containing
inflation at the cost of growth and considering the wider
ramifications of inflation, RBI chose to moderate inflation.
The Central Bank had to step in with both quantitative and
qualitative measures. RBI hiked Cash Reserve Ratio (CRR—on
which no interest is paid) on bank deposits, from 5.50% in
January 2007 to 9.00%. Repo rate, the rate at which banks
can borrow funds from RBI against eligible securities, was
raised from 7.25% in January 2007 to 9.00%. |
