PRESENTED BY:

HASHEEN ARORA

JASMINE KAUR &

SAUMYA CHABBRA

Relationship between Interest

Rate, Inflation and Growth

Interest rate and GDP

INTEREST

RATE GDP MONEY IN

ECONOMY 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 market

interest 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 9,1997

3) 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 charge

of monetary policy , which has a big impact on liquidity and interest rates in the

financial 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 STABILITY

II. OUTPUT/EMPLOYMENT

III. 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 LAF REPO/REVERSE

REPO OMO PLR

INTEREST RATE

FALLS

INVESTMENT

INCREASES

AGGREGATE DEMAND

INCREASES

AGGREGATE OUTPUT

INCREASES

PRICE LEVEL INCREASES

MONEY SUPPLY

INCREASES

INTEREST RATE

RISES

INVESTMENT

DECREASES

AGGREGATE DEMAND

DECREASES

AGGREGATE OUTPUT

DECREASES

PRICE LEVEL DECREASES

MONEY SUPPLY

DECREASES

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.