Are you planning to take a large loan to buy a house or a car? Don’t rush to the bank now, wait till the end of this month. There is a strong possibility that interest rates will soon go down leading to a saving in your loan repayment.

Experts in the banking circle feel that on January 29, 2008 when Reserve Bank of India (RBI) releases its Review of the Monetary Policy it will announce a cut in Bank Rate between 0.25 to 0.50 per cent. It is also expected that Cash Reserve Ratio (CRR) will be lowered freeing more cash  for lending. The net effect will be softening of interest rates. Agreed Chairman of a Bangalore-based public sector bank who did not want to named “All factors, domestic and international, are favourable for a reduction in interest rate in the country. It is only a matter of time when it happens.”

He is right. The stage has been set by the United States' Federal Reserve which has slashed interest rate in USA last Tuesday by 0.75 per cent, from 4.25 per cent to 3.5 per cent. This was immediately followed by lowering of rates by the Central banks in Canada, UK and in European Union.

Ripple effect

Would RBI follow Uncle Sam? It has a little choice not to. When global interest rates tumble, countries flush with reserve funds will have to cut interest rates to narrow the difference. Otherwise the arbitrage opportunity, borrow cheap from one country  and invest in another where interest rates are higher, will see huge inflow of foreign money into India. Then there are NRIs for whom an investment in an Indian term deposit is even more attractive. Besides, the currency risk is zero as  rupee is appreciating. Since India has already piled up a huge foreign exchange reserve (close to $270 billion), more inflow of foreign capital will add to the problem.

The other compelling reason for a rate cut is that we need to moderate foreign capital inflow to keep rupee appreciation under check. Our export sector is already suffering due to strong rupee and exports from India in 2007-08 is slated to be $10 billion lower than the target. Lower interest rate will make parking foreign funds in India less attractive. 

Boosting demand

Cheaper money will boost consumer spending as buying a home, car, or a TV or planning for a foreign holiday will be relatively more affordable. When consumers spend more, overall economy gets a demand-induced boost. Moreover, lower interest rates will reduce the current borrowing costs for the business. At present our prime lending rate (PLR) at around 13 per cent is expensive compared to most large countries in the world. The cost of fund for most business entities,  is even more because they borrow at PLR-plus rates.

The only apprehension to slashing interest rates is the fear that it will increase liquidity in the financial system and result in price rise. But given the sustained low rate of inflation between 3.5 and 4 per cent, we have room to take a bit of price knock. If the agriculture, manufacturing and services sectors rise to the occasion with greater supply, there may not be any price rise at all.