Globalization has integrated the Indian economy with the world economy. This linkage has made it mandatory for the country to follow an interest rate policy that is in alignment with the other world economies. With the Federal Reserve in the US and the ECB in Europe bringing down the interest rates, India also has taken a stance towards a softer interest rate regime. The banks are now permitted to fix their own prime-lending rates across various tenors for lending funds. However, softer interest rates have not led to any major credit off-take nor provided the much-required boost to industrial production.

Traditionally, India had a regulated interest rate regime, with the Central Bank deciding most of the interest rates such as deposit and lending rates, gilt yields, T-Bill yields etc., apart from the bank rate. It is only in the early nineties that the financial sector reforms brought about a sea change in the economy. Slowly, The Reserve Bank of India let banks decide their own deposit and lending rates. RBI's stance in its monetary and credit policy changed towards a market-determined interest rate structure.

It is interesting to note that inflation, which is determined by demand pull as well as cost push, usually used to be in the double digits before the advent of the financial reforms. A major part of the demand-pull could be attributed to the "licence raj" which protected various industries. This led to a situation where demand for goods far exceeded the actual supply available, leading to exorbitant pricing or what may be termed as exploitative pricing. With the dismantling of the licence raj, the supply in the economy increased as there were greater scales to economy and increased competition.

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