Interest Rate direction

October 13, 2008

Dear Friends, My take on Interest Rate –
Almost every indian Investor/saver have deposits in Banks. Over the last 18-24 months, the banks r offering higher rates on deposits (test case , now mojority of investors are thinking to join the SBI @ 11% FD). Add 2.25-2.5% administrative cost & profit margin for banks on these deposit rates. The effective lending rate works out to around 12-13% but wait there is another twist in the tale named as CRR (Cash reserve ratio). For every 100 Rs. accepted by bank as deposit, it `ll have to keep 7.5 Rs. (after recent reduction of 1.5%) mandatorilly with RBI & it `ll be non income earning.So from the 100 Rs. deposited by u, the bank `ll be able to lend only 92.5 Rs. & before the CRR cur the same figure was 91 Rs. only. So the effective lending rate comes around 14-15%. Now add at least 1-2% NPAs (non performing assets), the same lending rate `ll move on to on more higher level around 15.5-16%.
Now change ur shoes from depositor to borrower, R u ready to borrow at such higher rates to purchase
1. That Plasma Panel
2. That High speed Mobike for ur son
3. That Grand new sedan costing 10+L
4. That sweet little (lavish) home costing anywhere from 20L to some crores depending upon in which place of india u r.
5. That drean swiss vacation.
The list goes on & on, but one thing is certain u `ll certainly cutback some of the above mentioned purchases or delay the same.

Now imagine u r not a domestic borrower but a corporate borrower. To increase ur capacities or starting a new factory or any other business requirement, after taking loans at such higher rates, how `ll u earn profits when the sale of ur products (CAR, Bike, Consumer goods, Homes….) is going down.

Sooner or later, the interest rate `ll go down, how much I DON`T KNOW, by when, again I DON`T KNOW.

I know only one thing, for a healthy growth, low interest rates r essential.