Real interest rate may be revised upwards

Here is a bit of good news for the savers. The government is planning to take a closer look into the real interest rate (that is nominal interest rate minus the inflation rate) structure across instruments.

The objective is to explore the possibility of offering a decent real rate of interest to the saving community.

Based on the advice of the Economic Advisory Council of the Prime Minister, the government is planning to revisit the recommendations of the Sukhamoy Chakravarty committee report, which reviewed the working of the monetary system in 1985, sources close to the development said.

According to sources, there is a thinking in the government that during the period of low inflation in the past few years, the nominal interest rate has overreacted in its efforts to adjust to the inflation.

As a result, the pace of fall in the real interest rate has been too aggressive leading to negative interest rates in certain zones. This has been a major disincentive for savers.

The Sukhamoy Chakravarty committee had advocated a comprehensive financial sector reforms to enhance and sustain economic growth. The core issue dealt in the report was the role of interest rates.

It had suggested a framework for different types of instruments offering real interest rate in various ranges for the advantage of the saving class.

During the period between 1994-95 and 2003-04, the annual average rate of inflation has gone down by 625 basis points (one basis point is one hundredth of a percentage point) from a high of 10.85 per cent to 4.6 per cent.

On the other hand, the deposit rate in 1-3 year maturity has gone down by 575-700 basis points, from 11 per cent to 4-5.25 per cent.

The annual growth rate of gross domestic product at constant prices has gone down from 7.3 per cent in 1994-95 to 4 per cent in 2002-03 and to 8.2 per cent as per the revised estimates for 2003-04.

Based on the recommendations of the Chakravarty committee, the concept of real interest rate was implicitly practiced by the Reserve Bank of India from 1982 to 1995.

This means, sources said, monetary management was done to contain rate of inflation not only by demand management but also through interest rate signals.

Economists favouring a restructuring of the real interest rate are of the view that proper adjustment of monetary interest rate with respect to inflation potential has other virtues as well.