An interest rate in the market is the value given to the flow of money in the economy at a given point in time. It acts as a central intermediary between lenders and borrowers. Basically, the interest rate is determined by the demand and supply of money, i.e. the need and availability of funds. In an efficient market, it moves in parallel with the activity in the bazaar. However, it can be inefficient in a local bazaar depending on the strength of the business, seasonality, individual risk, size of funding, and availability of lenders and borrowers.
The setting of the interest rate in a country is decided by the central banks. In India, it is based on the repo rate, the short-term repurchase rate that the RBI allows banks to buy government securities. This rate depends on aspects such as the status of the domestic economy, global monetary policy, inflation and liquidity. Based on the repo rate, the next set of rates is determined, such as bank rate and MCLR. The discount rate is the lending rate that central banks charge banks, while the MCLR (marginal cost rate) is the minimum rate that banks should charge customers.
India’s current repo rate is 5.4%, while the bank rate is at a small premium of 5.65%. MCLR varies depending on the cost structure of the banks. The RBI’s MCLR (overnight) rate, the lending rate between two banks, is 6.7% to 7.5%.
Here we might feel that the RBI controls India’s financial and interest rate. Otherwise, it serves as an intellectual mediator of a growing democratic economy. The RBI must balance global financial market sentiment, the position of the domestic economy, the management of the government’s financial needs and the strength of the INR. A country’s monetary strength depends on the effectiveness of a central bank, otherwise it has a dire impact on the country’s prospects, currency, inflation and interest rate.
In general, assuming the world is in a state of equilibrium, the higher a country’s interest rate, the stronger the economy and currency will be due to the heavy flow of money. However, the globe consists of balancing markets from developing to emerging and industrialized countries. Geopolitical, climate, economic and domestic risk bubbles in financial markets. The risk of the world and country is constantly changing and determines the strength of the economy and currency. The higher the risk, the higher the interest rate and vice versa.
In general, the daily risk is the deviation of the parameter factor or the measurement of the standard deviation over a period of time. The higher the variation, the higher the risk. Qualitatively, it will depend on macroeconomic factors such as the size and strength of the economy, growth, the socio-political scenario and monetary policy. A country’s interest rate cycle moves in a negative direction (downtrend) when the economy recovers.
Taking an example from a developed market like the US, the 10-year Treasury yield peaked at 16% in 1980, then fell to ~6% in 2000 and to 2.7% today. This is supported by the fact that the US is the strongest economy and the USD is the world’s reverse currency. Likewise, we can expect a similar long-term trend for India’s rate cycle as the economy recovers going forward. In the short term it will be volatile due to local and global factors.
(Vinod Nair is director of research at Geojit Financial Services.)
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