Standing near the window of a
high-rise apartment and looking
at the sea waves, one is never able to identify a pattern as to
when the big one will lash the shore. Similar is the case while predicting
interest rates. It is never easy to analyze the factors and pinpoint the
reasons, as interest rates do not directly follow a `cause and effect' diagram. Here
the cause can become an effect and vice versa. For example, interest rate is
a function of liquidityhigh liquidity gives more money to the system,
thus causing the lowering of interest. But even a slight imbalance on the
supply side causes inflation to go up and could invite the central bank's
intervention for curbing money supply, which could result in an increase of
interest rates.
Movement in interest rates affects banks, corporate world, and the
public. It also influences and is in turn influenced by several other
variables like exchange rate, foreign investment and stock markets. Interest rates
are determined by the market, but the central bank's intervention
can strongly influence short-term interest rates. The curvature of the yield
curve (flat or steep) again depends on several factors. In the financial
market, there are two types of rates. The first type is for treasury operations,
including money market and G-sec rate, which in turn become benchmark
for several other rates. We shall refer to it as
Debt/money market interest rate (Debt/MM rate). The second
type is the interest rates offered by banks/FIs for their products. We shall
refer to it as `product rate', which in turn depends on several factors like
bank's sources of funds, their CASA deposits, internal costing methods, NPAs,
loan profile, etc. Even though lowering of interest rate results in good
treasury profits, banks generally prefer a rising interest rate scenario, since it
gives them a chance to improve the yield on advances and Net Interest
Margin (NIM). Conversely, in a soft interest regime, corporates can
pressurize banks to get best sub-PLR rates, which hurt banks' margins.
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