Administred Interest Rates in India

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Administered Interest Rates in IndiaAuthor(s): L. M. BholeSource: Economic and Political Weekly, Vol. 20, No. 25/26 (Jun. 22-29, 1985), pp. 1089-1104Published by: Economic and Political WeeklyStable URL: http://www.jstor.org/stable/4374543 .

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Administered nterest R a t e s i n I n d i aL M Bhole

Therateof interest s an importantprice in anyecqjiomy. f it is determinedmainly by the marketorces, itmay hetp n takingappropriate ecisionsaboutsaving, nvestment, llocationof resources,inancialand monetarypolicy, etc. However, he level and structureof interestrates n India have remainedvery closely regulatedbythe authorities.Thepresent tudyexamines he working f thisadministeredystemof interest ates,anddiscussesthe issues and considerationswhichneedto form the basis of future interest ate and monetarypoliciesfor theIndianeconomy.THE plan of the study is as follows: InSection I, after stating the backgroundand the content of the present system, webriefly refer to the nature, criteria, andfeasibilityof an alternative system of in-terestrates which, according to us, wouldbe appropriate for India. Section IIdiscusses the features and rationale of thepresent system by reconstructing ts scope,techniques, authority, timing, and its ef-fects on interest rates and credit controlmechanism. The reasoning and empiricalevidence in support of the case for analternative ystem arepresented n SectionIII. The lessons from experiencesof somecountries in operating the similar systemsof controlled interest rates are mentionedin Section IV. Summary and conclusionsare presented in Section V.

IThe Background and Anticipatory

RemarksThe performance of the Indianeconomy duringthe past threedecades ofeconomic planninghas been farbelowtheneeds and expectations. There has beenratcheting upwards of inflation and un-employmentaccompanied by nearstagna-tion in the rate of growth. It has beencharacteristicof the Indian economy thatinstead of experiencing 'trade offs' bet-ween different economic objectives, therehas been a deterioration on all fronts. Allthis has happened in spite of the adop-tion of economic planning, and a fairlyhigh rise in the rates of saving and capitalformation. Such a poor outcome of ourtryst with destiny is naturally making

many a people restless and compellingthem to seek solutions to the predicamentjust described.,To the extent the monetary and finan-cial factors arerelevant n economic deve-lopment, efforts arebeing made to under-stand better the working of the Indianmonetary systemso that appropriate poli-cies can be devised for maximising ts con-tribution to the development process,Among other things, a clear consensus isnow energing in favourof the urgent needfor an increase in the productivity of in-vestment in place of the earlier emphasison the increase in merely the quantum ofinvestment. Everybodynow appearsto be

concerned about the high and increasingcapital-output and capital-labour ratios,widespread low rates of utilisation of thealreadyexisting productioncapacities,un-duly long lags between investmentexpen-ditures and flows of output, and themisuse of capital in other ways.It is in this context that we have under-takena comprehensivereviewof the work-ing of the present interest rates policy inIndia in all its major aspects. Over the

period of time, more and more interestrates have been brought under more andmore detailed administrative and discre-tionary controls. As a result, the systemwith the following characteristics hasevolved during the past many years:(i) The rates of interesthave been kept atunnaturally low levels. (ii) The regulationof one interest rate has led to the regula-tion of another rate. In other words,a ceil-ing on one interest rate has begottenanother ceiling. For example, the regula-tion of banks' lending rates hasnecessitat-ed the regulation of their deposit rates;and the latter, n turn, has forcedthe regu-lation of interest rates on deposits withnon-banking companies. (iii) Because theinterest rates have been controlled andkept low, the need has arisen for the im-position of widespread and detailedquantitative ceilings or restrictions as ameans of allocation or distribution offinance and fighting inflationary pres-sures. Thus, the system of administeredinterest rates comprises the presence ofdiscretionary controls on the level andvariations of interest rates, the mainte-nance of these rates at lower levels thanwhat they would otherwise have been, andthe existence of the quantitative restric-tions on the disbursements of credit.

We have attempted to establish in thisstudy a -connection between this sytemand the financial and realperformanceofthe Indian economy. It has been argued,with some empirical evidence, that it hasresulted n an inappropriate avingand in-vestment behaviour, maldistribution offinancial resources, the accentuation ofthe problemsof inflation, unemployment,etc, and the weakeningof the effectivenessof monetary policy. Therefore, a case hasbeen made for freeing interest rates fromthe administrative controls, and for the

neea to establish their appropriate levelwhich at present would be much higherthan what it has been so far. It is not acase for usurious or exhorbitantlyhigh in-terest rates, but for 'appropriately'or 'cor-rectly' high rates of interest. In doing this,we are sharing the perspective developedin this respect by Myrdal, Shaw, Mckin-non, and Brahmananda,I and restatingthe case for free and higher interest rates.This restatementmay be regardedas valu-able and useful because it is far morecom-prehensive, up-t-o-date,and based on em-pirical evidence from the Indian economyas never before.

The system of administered interestrates is a special case of the wider systemof prices and physical controls which havecome to pervade most of the developingeconomies. It is hoped that our analysiswould be useful in re-evaluating he utilityand advisability of the continuation ofthese other controls also.Before we proceed to explain our posi-tion, it is necessary to referbriefly to the

criteria which can help to determine theappropriateness or otherwise of a givensystemof interestrates,what are the alter-native systems which can take the placeof the present system, and the feasibilityof the system chosen from them.In a wider sense, the objectives of eco-nomic planning should serve as goodcriteria for judging the suitability of anygiven sub-system in the economy. How-ever, from the point of view of the im-mediate relevance and concern, given thecapital scarcity, nterestratespolicy shouldbe such (a) that savings areadequate, andthey areheld in formswhich are conducivefor both their use in the growth processand control by monetary authorities forthe purpose of economic stabilisation;(b) that available savings capacity isharnessed for investment in essential andproductive purposes,and the efficiency ofinvestment is maintained consistently ata high level. Interest rates should inducesocially desirable allocation of resourcesand pattern of investment.Stated slightly differently,interest ratessystem should be such as to help thefinancial system to adapt flexibly to theevolution of the requirementsupon it, andto meet theserequirementsadequatel and

Economic and Political WeeklyVol XX, Nos 25 and 26, June 22-29, 1985 1089

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June 22-29, 1985 ECONOMIC AND POLITICAL WEEKLYequitablyso that individualgroups of bor-rowersand lendersare not arbitrarilydiscriminatednd disadvantaged,ll thepossible conomniesn administrativendothercosts are realised,antd he oppor-tunities or corruptionandarbitrarinessare absolutelyminimised.2The systemshouldbe simpleand open also.It is possibleto thihkof at leastthreetypes of system of free interestrates:(i) a completely laissez-faire, (ii) a systemin which hequantityof money s closelycontrolledbythe authorities ndinterestratesare eft to findtheirown evelsasad-vocatedby the 'monetarists',nd (iii) asystem f 'indicative'egulationf interestratesaccompaniedby the minimumofdiscretionaryontrols.It is this lasttypewhichwe have nmindwhenweargue orfreeand flexible nterest atessystem orIndia.I A completely laissez-faire system offreely loating nterest ates,withoutanyt;ypef governmentnterventionn finan-cialmarkets,s obviouslyunrealisticorIndia whereformal economicplanninghas been of much higher degree andserioushue. At the sametime,it is to befirmly raspedhat t is equallyunrealisticto expectthat direct,discretionary, ll-pervasivetate ntervention ouldhelptodeal with the imperfectionsn financialmarkets.A policyof discretionaryon-trols o dealwith marketmperfectionssa logicalcontradiction,t is a surewayofperpetuatingmperfections, lbiet romadifferent ource.

The monetarists avebeenrecommen-dingthatinterest atesshouldbe allowedto floatfreelyn themarkets, ndthetaskof regulationhouldbeperformed ytheCentralBankby fixinga monetary ule.It willbe shown aterhow sucha systemis beset with certainpractical perationaldifficultiesbecauseof which,apart romother weaknessesof the monetaristap-proach, he acceptance f such a systemis also inadvisable.Our plea, therefore, s for a esystemwherein,nstead f fLxing lmost achandevery nterest ate, he authorities peratemore through he instruments f mone-tarycontrol-not this or that techniquebuta whole et of themused na mutuallyreinforcingmanner-such as the bankrate,openmarketoperations, hanges nthe quantityof money,etc, to determinethe marketratesof interestand flows ofmoneyand credit. Sucha systemworksthrough utomaticallyunctioning pera-tional controls,and changes n interestrates hereinare inducedrather han ad-ministrativelyixed There s, as Myrdalhaspointedout, a fargreater seof pricemechanismand a very high degreeof

automatism, e, people'sbehaviour smostlyguidedby relative atesof costandreturns ather hanadministrative iscre-tions. However, rice mechanisms firstadjusted,againmostly throughchangesin price signals under the control ofauthorities, o that now it provides hespecific inducements and inhibitionswhich are 'correct'with reference o thegoals and targetsof economic policy.3Such a system s quitefeasibleand intune with the philosophyof economicplanning.As, OscarLange has pointedout, the price system, ncluding nterestrates, s an importantncentive erving oinduce he private ector o do thingsre-quiredof it in the plan. But also in thepublic sector, he needfor incentives x-ists which againrequires properpricesystem.4 t mayalso be remindedhatinthe initialyearsof planningn our coun-try, therewas a clearpreference or andemphasison maximumrelianceon thepricemechanism ndthe minimum se ofphysical ontrols or mplementingcono-micplans. t is, therefore, misconceptionthat plannedorsocialistic ountriesneedto keep interest rates low and operatethrough mazeof discretionaryontrols.The over-reliancen the present ystem finterest ates s an aberration hichdefini-tely needs to be corrected ooner thanlater.

IIThe Reconstruction of the PresentSystem-Its Features andRationale

EVOLUTION,COPE,TECHNIQUES,TCA large varietyof interestrates existsin anyeconomyat anygiven ime.Forex-ample, n India, herearedepositratesofcommercialbanks, co-operativebanks,postalsavingsorganisation, on-bankingcompanies,henthereare ending atesofthese andterm-lendinginancial nstitu-tions; urther,herearerateson industrialandgovernmentecurities.All theseratescan be classifiedas loan rates and ratesof returnon savings(in case of 'directsecurities',oan and savingsrate are thesame) or as short-termand long-termrates. Under perfect competition, therespectiveevelsof all theserates,and theinterrelationshipsetween hem(i e, theirstructure)would be determinedon thebasisof market orcesreflectingproduc-tivityof borrowedapital, iskand uncer-tainty, premiumfor abstinenceand li-quiditypreference,maturity, ime prefe-rence,etc. The variousdegreesof im-perfectionsin the money and capitalmarketswouldmodifythe ratesbutthey

wouldstill be determinedmainly by the

market forces.Under the administered interest ratessystemthe interestrates are fixed or madeto, rule at a given level through fiat ordiscretionaryadministrativecontrols withalmost no reference to the factors em-bodied in the supply of and demand forfunds. Such a system has now come toprevail in India, through gradual evolu-tion over the period of time. Till about1958, all the interest rates were more orless free; in the month of October of thatyear, however, a ceiling on the depositratesof commercialbanks was introducedthrough the voluntary agreement betweensome lIfdian and foreign banks. Underthis agreement, a separate maximum ratewas fixed for deposits of different maturi-ties. Even then, there was a great deal offlexibility and variations in the depositrates paid by different banks which wereparty to the agreement; the rates paid byother banks naturally differed from oneanother,and from the banks bound by theagreement. This system lasted for sixyears.In September 1964, it was replaced bythe regulation of deposit rates by the RBIin terms of the Banking Regulation Act,1949. With this change, the system ofregulation became more general and it in-volved, unlike previously, the fixation ofboth the minimum and maximum rates.Under this system which continues toprevailnow also, while the maximum rateis prescribed on deposits of maturitiesupto 90 days, the minimum rate is pres-cribed on deposits of maturities beyond90 days. In practice, the minimum andmaximumrateshavemostly turned out tobe the fixed rates actually paid by thebanks on regpective maturities, i e, nobank paysless than the maximum or morethan the minimum ratesstipulated by theRBI'5The deposit ratesof co-operative bankscame under the perview of these regula-tory measures not until 1974. Since then,co-operative banks also have been payingon their deposits interest rates prescribedby the RBI. They are now allowed to payinterest rates which are higher by certainpercentagepoint(s) (normally, one-half ofone per cent) over the ratesprescribedforthe respective maturity of deposits ofcommercial banks. As a result of thispolicy interestratesof commercial and co-operative banks have come to be linked,and changes in them have been effectedsimultaneously since 1974.

The lending ratesof commercial bankshave also been controlled by the RBI interms of the Banking Regulation Act,1949 since 1960 in the form of prescrib-ing minimum, maximum, dual, and dif-

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ECONOMIC AND POLITICAL WEEKLY June 22-29, 1985ferential interest rates. It prescribes dif-ferent minimum and maximum ratesdependingupon the size of banks, the sizeand purpose of advance, the type of bor-rower, he natureof security,etc. Similarly,there are separate minimum rates for thegeneral creditand the advancesunder theselective credit controls, respectively.The lending rates of co-operative bankswere regulatedindirectlyor through 'sua-sion' till 1980. As co-operative banks, atall levels of their three-tier structure, de-pend on the RBI for concessional finan-cial resources,while they werealways 'ex-pected' to charge only the 'reasonable'ratesto the borrowers rom the agricultureand allied activities, in case of finance forproductionand marketingactivitiesof thecottage and small-scale industries, thetermsof concessional refinancestipulatedcertain conditions about the rates to becharged by them to these borrowers. In1980,the loan rates of co-operative banksalso came to be statutorily regulatedandnow all the lending rates of these banksare under the direct statutory control ofthe RBI.Interest rates on deposits accepted bynon-banking non-financial companies,and non-banking financial and miscella-neous companies, which were completelyfree till recently, have become subject toa ceiling fixed by the Governmentof Indiaand the RBI, respectivelywith effect fromthe beginning of the financial year, 1981-82. There arecertain notable points aboutthis regulation. Firstly, unlike in the caseof bank deposits, in place of differentceil-ing rates for deposits of different maturi-ties, there is only one ceiling rate whichis stipulated, and the companies are free

to pay any interestrateupto the ceiling ir-respective of the maturityof deposits. Asa result, the companies have a greaterdegree of flexibility than the banks inrespect of the mobilisation of deposits.Secondly, while the cost of deposit-resources of non-banking financial com-panies is regulated,' their lending rates,unlike banks, are not subject to regula-tion. This also puts such companie$ in afavourable position vis-a-vis banks.,There is a ceilingon the level of call ratealso which is imposed by the IndianBanks' Association since 1973. Interestrateson post-office saving bank, time,andother deposits, other small savingsmedia,Theasury bills and government datedsecurities are all directly fixed by theGovernmentof India. Interestrateson in-dustrial debentures and dividends onpreference shares are subject to a ceilingprescribed by the Controller of, CapitalIssues. The.loan rates of the statutoryfinancial institutions, although not sub-ject to any directcontrol, also can be saidto be regulated through 'suasion' To theextent that these institutions supply creditto the public sector, small scale units, unitsin the backward regions, and for otherpriority purposes, their interest rates arebound to be influenced by the thinkingof the authorities about the 'appropriatecost of finance; and this influence mustbe strong because of the governmentownershipof these institutions, Similarly,institutions like IDBI impose ceilings onratesto be chargedby the primary enderswho obtain refinance and rediscountingfacilities 'fromthem. It is only the ratesof return on ordinary shares and units,bazar bill rate, and hundi rate which ap-

pearto be free from any formal and directcontrol of the authorities in India.Thus, almost every nterest rate in Indiais now very closely administered in theform of fixation of either the specific, orminimum or maximum (ceiling) or dualor differential level by the government orRBI or Controllerof Capital Issues or theIndian Banks' Association, etc, throughthe exerciseof statutory powers or volun-tary agreements or suasion. While the ef-fect of such a policy on the behaviour ofinterestrates themselves s discussed n thefollowing subsection, its wider effects onthe economic activity as a whole will beanalysed subsequently.EFFECTSONINTERESTRATESANDCREDIT

CONTROLMECHANISMStatistical series over a long period oftime are available in India only for a few

interest rates, although the situation hereis probably not as bad as in many otherdevelopingcountries.It may be mentionedhere hatthe RBI usedto publishonly a fewmoney rates of interest in its AnnualReport on Currency and Finance till1972-73; this practice underwent a wel-come change with effect from 1974-73when it startedpublishing data on manyshort-term and long-term interestrates inthe 'Structure of Interest Rates in India'Thble.But even now, this Tabledoes notinclude information about interest rateson the post-office and other small savingsmedia including provident fund, interestrates in the co-operative banking andcredit structure, commercial banks' sav-ing deposit rate, interest rate which theRBI pays on excess reserves, etc. Thisshort-coming needs to be corrected. The

TABLE 1: INTERESTDIFFERENTIALSN INDIARates yearon 51-52 55-56 60-61 65-66 70-71 75-76 80-81 81-821) TB-call money 0.17 -0.23 -1.59 -2.76 -2.88 - 5.95 -2.52 -4.362) Bank rate (1 year) deposit 1.46 0.95 0.56 0.0 -0.38 1.0 1.0 1.53) SBI Advances (1 year)deposit 2.27 1.45 1.56 1.50 2.87 6.0 8.5 8.04) Bank deposit:i) (3-year)-(l-year) - - 0.25 0.25 0.50 1.0 2.0 1.5ii) (5-year)-(1-year) - - 0.75 1.0 1.25 2.0 2.0 2.5iii) (5-year)-(3-year) - - 0.50 0.75 0.75 1.0 0.0 1.05) Debenture coupon (5-year)deposit - - 3.0 0.0 0.75 -0.5 3.5 4.06) 5 to 15 years governmentbonds (5-year) deposit - _ -0.62 -1.74 -2.67 -4.25 - 3.73 -4.597) Government bonds:i) Medium term/shortterm - - 0.24 0.11 0.48 0.12 0.9 0.54ii) Long term/medium term - - 0.2 -0.19 0.57 0.0 0.69 0.818) IDBI loans-SBI advances - - - 0.50 0.0 -3.0 -3.58 -2.59) IDBI loans-Debenture

*coupon - - 0 to -0.5 1.0 0.5 0.5 to 1.0 0.5 -1.0Notes: Deposits refer to commercial banks' fixed deposits; IDBI loan rate refers to its prime lending rate; TB is Treasury Bills.

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June 22-29, 1985 ECONOMIC AND POLITICAL WEEKLY

behaviour of a few selected nominal andreal rates of interest over the period. ofmore than a hundred years (1870-1983) sdepicted in Figures 1 and 2.(i) It would be observed from Figure 1that there has been quite a bit of increasein interest rates during the sub-period1950-83, but the major part of this in-crease has occurred after 1974.6 Inciden-tally, it may also be noted that therehavebeen very few marked fluctuations ininterest rates during this period. TheAmerican experience,7 and our own inthe past show that when interest rates arefree, they tend to fluctuate much more inupward and downward directions.,An increase in interest rates just men-tioned has been the result of periodic'mark-ups' but we do not know how theauthoritieshave, from time to time, decid-ed upon the extent, frequency, iming, etc,of these 'mark-ups'.We do not have anyenunciation from the authorities aboutthe principles or considerations and the

weightage ivento them,whichunderlietheir mark-up' ecisions. t appearshatdecisionsn respectof changes n interestratesaremostlybeing akenquitehapha-zardly, in an ad hoc manner, andinadequately. onsequently,helevelsofinterestates,differencesndifferentates,andchangesn both of thesehaveusuallynot beenrelated o the, onsiderations frisk,liquidity,maturity, emand or andsupplyof funds,commodityprices,etc.The concept of adja.cei^cyf differentfinancialassets in the sense of the ex-istence of well-defineddifferentials ninterest ates returns)n themwhen heyare arrangedn the descending r ascen-dingorderon thebasisof theirmajorat-tributesdoes not appearto have muchmeaningn India seeTable1).Forexam-ple, it is difficultto understandwhy in-terestrateson timedepositsof the samematuritywith thepost-officesandbanksshoulddiffermuch,andwhy sucha diffe-rence, f it exists,shouldfluctuategreatly

TABLE2: INTERESTRATES IN INDIAAND OTHERCOUNTRIES1977 1981

Country DR MMR GBY DR MMR GBY1) India 9.0 10.18- 6.32 10.0 8.61 7.152) US 6.0 5.54, 7.67 12.0 .16.38 13.723) UK 7.0 8.06 12.73 14.0 13.29 14.744) Germany 3.0 4.37 6.20 7.50 12.11 10.385) France 9.5 9.22 9.61 9.5 15.26 15.666) Canada 7.50 7.33 8.70 14.66 17.72 15.227) Sweden 8.0 9.96 9.74 11.0 14.35 13.498) Italy 11.50 14.03 14.62 19.0 19.60 20.589) Japan 4.25 - 7.33 5.5 7.69 8.6610) New Zealand 10.0 - 9.23 13.0 - 12.8311) South Africa 9.0 7.87 10.96 13.50 9.80 12.5612) Pakistan 10.0 10.87 9.27 10.0 9.27 9.40

Notation: DR = Discount Rate of the Central Bank;MMR = Money Market Rate;GBY = Government Bond Yield.Source: International Monetary Fund, International Financial Statistics, various issues.TABLE3: FEATURESOFSAV,INGS EHAVIOUR.N INDIA (ANNUALAVERAGES)Period 1951-52 1955-56 1960-61 1965-66 1970-71 1975-76

Feature to 54-55 to 59-60 to 64-65 to 69-70 to 74-75 to 79-801) Net savings as percentageof NDP- 5.82 8.34 10.3 11.80 14.28 19.482) Corporate savinga) as percentage of totalsaving 7.91 5.98 8.09 3.17 6.24 3.26

b) as percentage of NDP 0.46 0.49 0.81 0.37 0.91 0.643) Houshold savinga) in financial assetsas percentage of NDP 1.16 3.17 3.65 3.37 4.96 7.48b) in physical assets aspercentage of NDP 2.96 3.31 2.78 6.14 6.23 7.47c) in currency as percentageof total household saving 7.17 20.49 26.20 25.36 19.66 17.74Source: Rao, V K R V, "'India'sNational Income, 1950-80",Sage Publications. New Delhi, 1983.

fromyearto year.The post-office depositsrates have been mostly higher than thebank deposits rates, and their differencehas varied between zero to 2.0, and -0.5to 2.75 percentage points in case of oneto three-year, and five-year deposits,respectively during 1969-70 and 1981-82.Similarly, interest rates on small savingsmedia havebeen higher than those on thegovernment securities of comparablematurities. There is no reason why thecoupon rateson the bonds of IDBI, IFC,EXIM Bank, etc, should be higher thanthose on government securities.Whilethelending rates of the EXIM Bank haverangedbetween 9 to 12 per cent, those ofcommercial banks have rangedbetween4to 18 per cent. The phenomenon of short-term interestratesexceedingthe long-termrates unrelated to the cyclical swings inbusiness activity is also to be explainedintermsof the discretionarycontrols in thiscontext.(ii) In spite of some increase, interestrates during the era of regulation can besaid to have been artificially maintainedat lower levels than what they otherwisewould have been and what they shouldhave been. The following theoretical andempirical evidence supports this view-point:(a) The very objective of imposing dis-cretionary controls has explicitly been tokeep interest ratesat lower levels as in thecases of deposit rates,rateson finance forfixed investment, rates on governmentdebt and loans to the priority sectors, etc.(b) Sometimescontrols were introducedprecisely when interest rates determinedby the market forces reached the levelswhich were 'regarded'as 'unduly' high bythe concerned authorities. In such cases,interest rates have been definitely kept atlowerlevels throughthe imposition of ceil-ings. Forexample,the call money rate.Theexperience in other countries such as UKand US shows that whenever he policy ofpegging of interest rates was abandoned,there was a sharp increase in those rates.

(c) The rates which have not been sub-ject or amenable to regulationshave beenconsistently higher than the controlledrates.Forexample,the bazarbill rate,SBIhundi rate, and other rates in the un-organised sector of the financial markets.(d) Whilejudging whether interestratesin a givenperiod arehigh or low. theyhavebeenveryoften comparedwith theirhisto-rical level. The application of the idea ofhistoricism to interest rates has given riseto notions such as the 'band of feasiblerates'8 or the 'gears of interest rates'. Itis arguedthat thereis some 'normal' level

of and changes in interest rates the ideaabout which can be obtained from the1092



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ECONOMIC AND POLITICAL WEEKLY June 22-29, 1985level of and changes in interestrateswhichoccur in quiet times and which areconsis-tent with the maintenance of organisedmarkets.The rates of interest cannot riseor fall in any given period very far fromthis 'normal' level, except for a briefperiod. Some people in India haveconve-niently and successfully made a case forlower interest rates on the basis of suchnotions. They have argued that interestrates n the post-independenceperiodhavebeen higherthan theirhistorical evel, and,therefore, they should be (further)reduced.

The current nterest ratespolicy cannotbe determined mainly on the basis of ahistorical approach because it is a staticone. But even by historical standards,interest rates in India have been held atlower evels after 1950. It would be clearlyobserved from Figure 1that excepting theperiod of 1933-50,10 banks' advancesrate, for example, has been lower during1951-70 and only slightly higher during1970-75 than its own level during1870-1933. The same thing is also moreor less true of other controlled rates such

as banks' deposits rates, governmentbondyield, etc. These rates can justifiably bedeemed to havebeen effectively still lower(than what data show) if we take intoaccount, as we must, the fact that theexpected or planned rates of economicgrowth and capital formation have beenfarhigher after 1950 than in the historicalperiod. Whilethe rate of gross capital for-mation during 1861 to 1929 was about 5to 7 per cent,"I t was about 12to 20 percent during 1951-75. f the relevant actorssuch as the relativedemand for creditandfinance, the size of governmentborrowingprogramme, deficit financing, balance ofpayments difficulties, the rateof inflation,etc, were freely allowed to influence in-terest rates, the latter would have beenmuch higher than their historical as wellas current levels. Further, f the history ofinterest rates is important, how can weforget the history of interest ratdsin theunorganisedand semi-unorganised ectorsof the economy?

(e) If the interest rates are not admini-stered, the secular and cyclical changes inthe commodity prices act as a major

determinant of variations in the nominalinterest rates so that the real interest ratesmaintain appropriatepositive levels. As itwould be seen in Figure2,12 the real ratesof interest in India during the post-1950period have been mostly negative; andwhenever they were positive, they weremostly around the low level of 2 to 4 percent per annum.13

It is likelyto be pointed out that the realrates of interestwere negative n the earlierperiod also when the rates were not con-t-rolled. It has to be accepted thatwhenever the rate of inflation has beenvery high (around 25 per cent and above),it has not been possible for the nominalinterest rates to keep pace with such pricechanges even though there were no con-trols on their movements. This long-termexperience in India suggests that theFisher effect may not be observed in theperiod of hyper-inflation, and the princi-ple stated in the previous'paragraphmaybe valid only in periods of normal mildinflation. Havingaccepted this, it may stillbe noted that before 1951, real interestrateswerenegative only during war-years;

FIGURtE1:NOMINAL INTERESTRATES IN-INDIA, 1870-198316W BANKERSADVANCERATE - X r

YIELD ON GOVTBONDS T15 WHOLE'SALE RICES -.-*- 1 300

COMMERCIALBANKERS | 29014 DEPOSIT RATE | [ f 280POSTALSAVINGBANK _ / ( /27013 DEPOSIT RATE I! | 260BAZARBILL RATE 250/ 25012 // 240

11F (eveV I ! 230

11iz

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Administred Interest Rates in India