This article aims at finding out the possible determinants of liquidity and subsequently interest rate. Global as well as Indian scenario is fast changing in the finance sector. Oil prices are rising. Fed rate is increasing moderately in the US. FII and FDI funds are flowing to India in abundance. This study is centered on understanding the `friction' or the `push', these items may have, on the overall liquidity. It also tries to find an answer to whether they have any effect on interest rate or not.
There is a heavy flow of funds from FIIs and FDIs. India’s forex reserves also have reached
US$137 bn, up by US$6 bn. Stock markets are booming. During April 2005 to August 2005, bank
deposits have shot up by a whopping Rs. 1,38,000 cr. Out of this, Rs. 85,000 cr was disbursed as loan
and Rs. 28,000 cr was invested in government securities. Still an amount of Rs. 25,000 cr is at the
disposal of banks enhancing liquidity significantly [1].
The global oil prices are on the rise. The Union Cabinet hiked retail prices of petrol and diesel by
Rs. 3 and Rs. 2 per litre which were earlier underpriced by Rs. 7.45 and Rs. 5.15 a litre respectively.
The Cabinet discussed the need to raise domestic fuel prices. When global oil prices hit US$70 per
barrel, the Indian crude was hovering around US$62 per barrel. An increase in petrol prices is bound
to give a push to the inflation rate [1].
Inflation has a bearing on interest rates. Increase in inflation rates would tend to push up the
prevailing interest rates—both lending as well as deposit interest rates. One major factor which would
tend to counter the increase in interest rates is the liquidity position in the system. Liquidity reflects
money supply in the economy. It is believed that more the liquidity less should be the interest rate or
vice versa. But the relation is not all that simple as it seems to be. There are several factors which affect
liquidity and interest rate. Since the reforms process initiated in 1992, several major changes have
taken place in our economy. These changes have introduced an element of competition in the financial
system, marking the gradual end of State directed economy. Liquidity is one of the key factors which
are driving our economy leading to a significant fall in the interest rate. In this study, an effort has been made
to identify the quantifiable factors which are affecting the liquidity. Also the relationship between liquidity
and interest rate has been put to trial. Let us briefly recall the concepts of liquidity and interest rate. |
