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Friday, January 04, 2019

What is Real Interest Rate?

What is Real Interest Rate?

From ET Joel.Rebello@timesgroup.com

India’s real interest rate, or the difference between the central bank repo rate and consumer price inflation (CPI), is at its highest in 18 months and ranks among the top in the emerging markets, suggesting that a persistent decline in inflation helped enhance the returns.

CPI fell to 2.33% in November  2018 from 3.38% a month earlier, and down from 4.88% in November 2017, mainly due to a sharp fall in food prices and boosted by a favourable base effect.

The decline in the CPI, the broad gauge for assessing consumer inflation, has widened the difference between the central bank’s benchmark repo rate  currently at 6.50% and the CPI to the highest since June 2017.

Mr. B Prasanna, Head (Global Markets), ICICI Bank, said the past few benign inflation prints increased real rates in India to among the highest among major emerging markets.

“High real rates indicate attractive returns, which over a long period of time would help boost the capital pool for a capital deficit country like ours,” Prasanna said. “But it could also imply that the general cost of borrowing for investment and industrial activity is high. Most countries would have to navigate this trade-off between generating savings and at the same time not making incremental investments costlier to undertake.”

The last time the real rate went above 4% was in June 2017, when it hit 4.79%. That peak was followed by a reduction in the repo rate from 6.25% to 6% in August 2017.
So, will history repeat itself this time? Not likely, say bankers and economists.

“Although inflation has fallen, it is probably at its lower end. It is expected that inflation will only rise from here and will probably inch up beyond 4% one year hence, which is why the expectation is that the RBI is on an extended pause,” said Mr. Saugata Bhattacharya, Chief Economist , Axis Bank.

“However, to ease the pressure on rates, the RBI is likely to release more liquidity into the system.”

Foreign institutional investors (FIIs) pulled Rs. 80,919 crore out of Indian debt and equity investments in 2018 after investing Rs. 2 lakh crore in 2017.

Benign inflation and a stable rupee could attract these funds back to India in 2019.

“Foreign funds are guided by several factors , the long-term view on inflation, the state of fiscal deficit and its funding, global risk sentiment, currency volatility etc,” Prasanna said.
“On a standalone basis, sustained levels of higher real rates would imply that Indian assets look attractive on a relative basis, as we would have to increasingly compete for capital flows in a global environment where liquidity is shrinking. But this would not be the sole factor driving flows at any given point of time.”

The central bank RBI’s monetary policy committee next meets on 2019 February 7 when Mint Road is widely expected to change its policy stance to neutral from calibrated tightening, citing weaker than expected inflation.

What is Real Interest Rate? Reviewed by Investment Guru on January 04, 2019 Rating: 5 What is Real Interest Rate? From ET  Joel.Rebello@timesgroup.com India’s real interest rate, or the difference between the central b...

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