Interest Rates – Future Outlook

In fast emerging economies like India, monetary policy management has become even more demanding. A future outlook on interest rates therefore depends on a number of factors, both global as well as domestic.
Global factors influencing interest rates-
1. US Fed rate – A Fed rate cut will trigger a rate cut by the RBI to lower the interest rate differential between the two countries. At present there is a strong perception that the US will follow an easy money policy and cut Fed fund rates. The main reasons for this are-
• There is an urgent need to infuse sufficient cash into financial institutions hit by sub prime crisis.
• The grim employment crisis adds to above need.
2. Benchmark rates of other leading banks.
3. Global growth forecast- global economy is expected to grow at 5.2% for 2008, mainly lead by emerging market economies such as Brazil and India. The crisis in the US housing market as well as increasing crude oil prices are the factors which may lead to a slowdown in the growth rate. The growth is projected to slowdown in euro area, Japan and the UK. With downside risk to global economic growth in force, the indication is towards a decline in interest rates to support world economic growth.
Domestic factors influencing interest rates-
1. Growth in bank credit and deposits- the slowdown in credit growth will reduce money supply to a certain extent and suppress monetary inflation. The low money supply will percolate down to the real sectors and suppress price levels, leading to declining inflationary levels. This will reduce the need for regulatory intervention by the RBI in the form of frequent interest rate changes using monetary policy tools at its disposal.
2. Crude oil price movements- it is estimates that a hike in price of crude oil by $1/bbl will shave off 0.5% from the GDP of an emerging economy like India. If crude oil price is an indicator, if higher OPEC supplies are not forthcoming, there is an upward bias to interest rates.
3. Inflation trends- at present it is very unlikely that inflation will go above 5% even when the affect of rise of crude oil prices shows on the WPI index. Therefore no major interest rate movement is expected due to inflation.
4. Money supply – money supply at 21% is above the desired level of 17% set by RBI. However a rate hike will be prompted only if money supply is high enough to take the inflation beyond the tolerance band ( 4- 4.5 %).