Real Interest Rates - India Vs Brazil

With the war of words raged by S.Swamy against RBI Governer R Rajan, I thought it will be interesting to see if R.Rajan has really done anything wrong. Below are two graphs - first representing the WPI Index and Inflation while second showing the Repo Rate.

As and when there has been increase in the the inflation there has been a equal/relative increase in the repo rate to curb the inflation. During 2008/2009 there was sharp reduction of interest rates because inflation was low and industry was in dire need of rate cuts.

Now though the inflation is within the comfortable limits but it has started to pick up (Jan'16-Mar'16) and it does help to cut rates too quickly to increase it later when situation is not as demanding as it was in 2008.

Brazil Case - In Brazil the economy is already undergoing recession but Central bank has decided to keep the interest rates high to curb inflation which is reducing the buying power of households. As it reads, inflation is near 10.5% while interest rates are kept at 14.25%.

http://www.bcb.gov.br/?INTEREST

http://www.ft.com/intl/cms/s/0/6488250e-e0d6-11e5-96b7-9f778349aba2.html#axzz4A3U3OJWE 

Real Interest Rate

Real Interest Rate = Repo Rate - Inflation Rate

More is the difference between the Repo Rate, the more attractive deposits become and attracts more money to banks and further reducing liquidity in the market which can help to reduce inflation.

In case of Brazil it is close to 4% while in our case it is almost 1.5% which outlines how far our governor has gone to reduce the rates and help businesses which as per S.Swamy, has been ruined by him.

Has he(R.Rajan) gone too far since inflation already showing its heads up and rates could be increased soon to be back on track which will further make S.Sway unhappy?? only time will tell. 

Interest Rate Cycle

RBI main objective as shared by Raghuram Rajan, Current Governor multiple times is to keep inflation within the limits so as not to reduce the buying power of poor in the country.RBI does this by controlling the free flow of money in market via changing repo rate which is the rate at which RBI lends to banks.

Whenever there is a increase in the repo rate, FD Rates/Deposit Rates also increases resulting in depositing more money in banks which will lead to less money available to buy goods thus putting a downward pressure on prices. On the other side when rates are decreased then people have less incentive to save but to spend money which will lead to increase money supply/demand/prices.

Whenever the inflation is within the comfortable limits, RBI usually decreases rates to reduce the borrowing cost which shall improve business activity in the market.

Banks does not always move the rates in the same proportion as per RBI does and usually been seen as front runner to decrease deposit rates and increase lending rates. RBI being the boss has come out with a innovative solution to help consumers which is MCLR. It is marginal cost of lending for bank decided for multiple time periods, Banks can add spread/credit risk premium as per their calculations. Full article is available at below link and i will try to explain it more in my next article.

https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=10179&Mode=0