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Abstract
The subprime crises triggered by a dramatic rise in mortgage delinquencies and foreclosures
in the United States ,lead to major adverse consequences for banks and financial
markets around the globe. Administered interest rates are one of the major measures
for controlling the money supply in an economy. Bank rate, repo rate and reverse repo rate
are administered by The Reserve Bank of India. The records show high fluctuation in the
interest rates in the past in India. The reserve bank of India made drastic cuts in interest rates
during the recession period to make sure that the banks and individuals get the benefit of
higher credit availability. The Government of India had the stimulus package for the India
Inc., where as the Banking sector has been successfully managed by RBI measures. The paper
provides a picture of Indian economy before and during the recessionary period. The paper
shows the changes made by RBI in the bank rate from 2006-09 and their impact on Indian
economy.

INTRODUCTION

MEANING OF INETEREST RATES/POLICY RATES

Interest rates can be defined from different perspectives, for an Individual
an interest rate is the price a borrower pays for the use of money, they do
not own. For an Organization, Interest is a fee paid on borrowed
funds/assets. It is the price paid for the use of borrowed money or, money
earned by deposited funds. For General Banking, An interest rate is the
amount received in relation to an amount loaned. An interest rate is the
amount received in relation to an amount loaned, generally expressed as a
ratio of rupees received per hundred rupees lent. Interest rates can be
classified as specific interest rates and interest rates in general. Specific
interest rates area interest rates on a particular financial instrument
market, these rates are driven by market forces (i.e. Demand and supply).
General interest rates, such as bank rate are administered interest rates
i.e. re set by some established group ( bank rate is administered by central
bank of a country, RBI in India ).

BANK RATE, REPO AND REVERSE REPO RATE

Every central bank functions as a controller of credit in an economy. One of
the measures to control credit is by the way of monitoring the bank rate,
repo rate and reverse repo rate. Bank rate is the rate at which the central
bank (RESERVE BANK OF INDIA in INDIA) lends to commercial banks [1] and
acts an important benchmark in determination of interest rates charged by

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banks from the ultimate borrowers. In brief, raising bank rates by raising
bank rate, central bank raises the cost of borrowing. This forces the
commercial banks to raise in turn the rate of interest from the public and
vice versa. Changes in bank rate are generally referred in terms of basis
points. A basis point (often denoted as bp) is a unit relating to interest rates
that is equal to 1/100th of a percentage point per annum. It is frequently
but not exclusively used to express differences in interest rates of less than
1% pa. It avoids the ambiguity between relative and absolute discussions
about rates. For example, a "1% increase" from a 10% interest rate could
refer to an increase either from 10% to 10.1% (relative), or from 10% to
11%. Similar, are the repo and reverse repo rates. Whenever the banks
have any shortage of funds they can borrow it either from Reserve Bank of
India (RBI) or from other banks. The repo rate is the rate at which the banks
borrow these excess funds. The borrowing bank mortgages its government
securities to carry out this loan transaction. A reduction in the repo rate will
help banks to get money at a cheaper rate. When the repo rate increases
borrowing from RBI becomes more expensive. Reverse Repo rate is the rate
at which Reserve Bank of India (RBI) borrows money from the various
commercial banks. An increase in Reverse repo rate can cause the banks to
transfer more funds to RBI due to attractive interest rates. It can cause the
money to be drawn out of the banking system.

INDIAN ECONOMY

a. 2006-07
Economy grew by 9.4% during 2006-07. The six core infrastructure
industries grew at a high of 8.6%.Telephone connections in the country
crossed the 200 million mark and an addition of about 67 million phones
was made during the year 2006-07. Indian exports growing at 20.9% as
against the high growth of 24% in 2005-06 in US dollar terms. Stock market
had touched the score of 14267 points.

b. 2008-09 (JULY)
GDP growth for 2008-09 was estimated at 6.7%.Investments in government
and approved securities stepped up by 6% in the month of April 2009 from
4%.Foreign direct investment flows were observed to increase every month
and in April of 2009 it totaled USD 2.3 billion. The Indian stock market
plunged below ( BSE –Sensex) 10 K points in December 2008 from a high

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20K in January 2008 and it took more than a quarter to get the index back
to above 10K level.

1. THE SUBPRIME MORTGAGE CRISIS – THE GLOBAL

RECESSION
The subprime mortgage crisis is an ongoing real estate and financial
crisis triggered by dramatic consequences for banks and financial markets
around the globe. The crisis, which has its roots in the closing years of the
20th century, became apparent in 2007 and has exposed pervasive
weaknesses in financial industry regulation and the global financial system.

1. BANK RATE 2006

BANK RATE
YEAR
JAN FEB MAR APR MAY JUN JUL AUG SEPT OCT NOV DEC
2006 5.25 5.50 5.50 5.50 5.50 5.50 5.75 6.00 6.00 6.00 6.00 6.00

The year 2006 witnessed a fluctuating bank rate, with three changes ranging
between 5.25- 6 %

2. BANK RATE 2007

BANK RATE
YEAR
JAN FEB MAR APR MAY JUN JUL AUG SEPT OCT NOV DEC
2007 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.00

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The year 2007 had a constant bank rate at 6% throughout the year.

3. BANK RATE 2008

BANK RATE
YEAR
JAN FEB MAR APR MAY JUN JUL AUG SEPT OCT NOV DEC
2008 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.00 5.00

The year 2008 was witnessed a similar bank rate as in 2007. But there was
a hint that the economy will be heading towards a downturn. The global
economy was hinting a downturn.

4. BANK RATE 2009

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BANK RATE
YEAR
JAN FEB MAR APR MAY JUN JUL AUG SEPT OCT NOV DEC
2009 4.00 4.00 3.50 3.25 3.25 3.25 3.25 3.25 3.25

5. OVERALL GRAPH

Figure Bank Rate 2006-09

YEAR BANK RATE

5.2 5.5 5.5 5.5 5.5 5.5 5.7 6.0 6.0 6.0 6.0 6.0
2006
5 0 0 0 0 0 5 0 0 0 0 0
6.0 6.0 6.0 6.0 6.0 6.0 6.0 6.0 6.0 6.0 6.0 6.0
2007
0 0 0 0 0 0 0 0 0 0 0 0
6.0 6.0 6.0 6.0 6.0 6.0 6.0 6.0 6.0 6.0 6.0 5.0
2008
0 0 0 0 0 0 0 0 0 0 0 0
4.0 4.0 3.5 3.2 3.2 3.2 3.2 3.2 3.2
2009
0 0 0 5 5 5 5 5 5

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6. REPO RATE

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Date Repo Reverse repo

26-oct-05 5.25 6.25
24-jan-06 5.50 6.50
9-jun-06 5.75 6.75
25-jul-06 6.00 7.00
31-oct-06 6 7.25
23-dec-06 6 7.25
6-jan-07 6 7.25
31-jan-07 6 7.50
17-feb-07 6 7.5
3-mar-07 6 7.5
30-mar-07 6 7.75
14-apr-07 6 7.75
28-apr-07 6 7.75
4-aug-07 6 7.75
10-nov-07 6 7.75
26-apr-08 6 7.75
10-may-08 6 7.75
24-may-08 6 7.75
11-jun-08 6 8.00
25-jun-08 6 8.50
5-jul-08 6 8.5
19-jul-08 6 8.5
30-jul-08 6 9.00
30-aug-08 6 9

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11-oct-08 6 9
20-oct-08 6 8.00
25-oct-08 6 8
3-nov-08 6 7.50
8-nov-08 6 7.5
8-dec-08 5.00 6.50
January 05,2009 4.00 5.50
January 17,2009 4 5.5
March 05,2009 3.50 5.00
April 21,2009 3.25 4.75

RBI ACTIONS
Since September 2008, RBI has taken multiple actions in order to ensure
that the economy does not suffer a massive downturn. The RBI has cut the
repo rate by 400 basis points from 9% to 5%, reverse repo rate by 250 basis
points from 6% to 3.5% and the CRR by 400 basis points from a high of 9% to
the current 5%. Where as the Statutory Liquidity Ratio (SLR) was reduced from
25% to 24%. The RBI has also reprimanded the Banks which have been slow in
passing on the benefits of the lower interest rate onto the borrower. It clearly
pointed out that the interest rate cuts by the public sector banks have been in
the range of 1.25%-2.25%, 1%-1.25% for private banks and 1% for foreign
banks. The slackness in passing on benefits to the consumers can be seen in a
comparison between reactions of banks to RBI policies in 2004 and 2008.
Towards the beginning of 2004 the RBI key policy rates were at approximately
similar levels although private banks were charging about 7.5-8% during that
time and are currently charging approximately 10-11% for home loans.

The RBI has adopted a comparatively more conservative target of 6%,

as compared to the Government’s 7% GDP growth target for the current fiscal,
in light of the global downturn resulting in moderation of growth and muted
inflationary pressures that are being experienced currently by the Indian
economy. The policy announced a cut in repo and reverse repo by 25 bps in
order to encourage lowering of lending rates, increased lending and stimulate
aggregate demand within the economy in order to mitigate downside risks.
After the additional 25 bps cut, currently the repo rate has lowered down to
4.75% and reverse repo rate to 3.25%.There is also a clear indication that the
central bank will continue to monitor the economic performance as downside
risks continue to persist in the economy and necessary action will be
undertaken as deemed favorable which translates to possibly more rate cuts
in the short term.

IMPACT

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Lowering of the interest rates would first impact the deposit rates offered by
banks as they bring down their cost of funds and then pass on the benefits to
the borrowers by lowering lending rates. The impact of lower deposit rates will
make fixed income instruments less attractive in the short to medium term.
The sharp recent correction in real estate prices that has led to rationalization
in property prices has now made real estate a relatively more attractive
option. As the fixed deposit rates continue to fall real estate as an asset class
will start attracting more investments and become a more preferred
investment vehicle.

The cut in both reverse repo and repo is expected to induce banks to reduce
their lending rates as seen with the immediate cut in lending rates by certain
private banks of 50 bps. This reduction in turn will add more spending power
of the borrowers as existing loans get cheaper resulting in increased
discretionary income which will start to draw the consumer to spend again and
help in boosting demand. The new loans generation will also be done at a
lower rate which will in turn increase the borrowers’ affordability. As
developers procure additional loans at a lower rate they would be able to pass
this benefit on to the end user with lower capital values. The lower lending
rates will also result in lower EMI payment resulting in higher affordability, as
the interest rates continue to soften in the short to medium term. As per the
policy the credit to housing by banks has reduced from 12% on Feb. 15, 2008
to 7.5% on Feb. 27, 2009 from the previous year. Showing the abating
demand which has impacted real estate prices resulting in a correction of 20-
30% across India from the peak levels established in 2008.

On the commercial real estate front, developers who were facing a liquidity
crunch will be able to abate the stringent cash flows as there is already
sufficient liquidity in the banking system and as the lending rate reduces, the
cost of funds for the developers would decrease leading to improved cash
flows. This in turn would help many in completing their unfinished projects and
meet their expected deadlines. Although fears in the system remain that
adequate lending might not occur to the real estate sector due to risk aversion
that has developed by banks to control rising NPAs.

The only dampener to the lower interest rates would be the government
borrowings which the RBI has assured will be carried out smoothly with
sufficient liquidity in the system being provided. During the first half of the
current fiscal year, planned open market operations (OMO) purchases and
Market Stabilization Scheme (MSS) are expected to add further liquidity of
approximately INR 1,20,000 crore in the financial sector during in the short
term. This expected liquidity along with the rate cuts lead to the long term

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yields falling after the policy announcement and analysts are expecting the
long term yield to drop below 6% in the short term. The dropping of long term
yields and increasing liquidity is expected to keep the cost of funds relatively
low for the banks amounting to lower lending rates in the short to medium
term. A regime of similar components namely low lending rates, ample
liquidity was found during the year 2003-04 which led to the start of the real
estate Bull Run. Thus we find that the seeds for the next growth cycle being
sowed in the current downturn.

As experienced in 2002-03 the real estate market remained subdued due to

lower economic growth, India is again expected to witness moderate growth
during the current financial year which will translate to suppressed real estate
prices. International agencies such as the IMF and World Bank etc are pegging
revival of the economy in the first half of 2010 and momentum is likely to be
gained only in the second half of calendar year 2010. Due to the economic
uncertainty with forecast ranging from 5%-7% one cannot presently foresee
the start of the next real estate bull run, however, the market is likely to
bottom out during the first half of the next financial year, making it apt for the
investor to invest in properties at a discounted prices during the year with a
long term investment horizon.

REFERENCES
[1]SACHDEVA, C.B, Introductory Micro And Macro Economics ,2005

[2]BERNANKE, Four Questions, 2009

[3]OPEN SOURCE -http://www.ficci.com/indian-economy

[4]OPEN SOURCE DATA FROM-http://in.reuters.com/article/domestic News

[5]Impact of Monetary Policy 2009, A Cushman & Wakefield Research

Publication, APRIL 09.

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