Fundamentals against interest cut: Tarapore

Inflation rates, have on an average in 90s, not been significantly lower than in the in 80s. The weighted average inflation rate with a distributed lag (higher weight for the latest year with a lower one for the most distant period), has been at around 6 per cent for the past five years. This, would imply a real rate of 4 to 5 per cent based on current deposit rates with the real prime lending rate at around 7 per cent.

Tarapore, while stating that "these real rates are admittedly high and there is a felt-need to bring down interest rates," cited the government’s raising of 10-year money at a rate around 12.25 per cent with FIs doing likewise at 14 per cent, as underlying fundamentals ranged against any significant reduction in interest rates.

"There are, however, ominous voices being made by industry, and heard rather sympathetically by the authorities for lower interest rates. There is, thus, a possibility of a reduction in interest rates in the immediate ensuing period. But it must be appreciated that such a reduction would be induced by the authorities and not by the underlying fundamentals. This, would put interest rates at an unsustainably low level," Tarapore explained.

"I do not see the sustainability of lower interest rates and corporates must be nimble and take advantage of any interest rate reductions. Of course, my unrequited advice to the authorities is that, at the present time, they unequivocally refrain from reducing interest rates," Tarapore said.

The former deputy governor further advised corporates that they should avail of a lowering in interest rates by the authorities.

"Corporates must be dexterous enough to cash in on the lower interest rates as these rates are unlikely to remain low for very long," Tarapore said, adding that "the monetisation of the budget deficit, the unsustainable borrowing programme, a widening of the balance of payments and the current account deficit, and an almost certain pick up in the rate of inflation, would all militate against an interest rate reduction."

Tarapore exhorted corporates that rather than borrowing more in a situation wherein authorities go in for a reduction in interest, they must avail of the opportunity by elongating the maturity of their debts.

Said Tarapore: "It is not suggested that corporates should increase their borrowings. What is suggested is that recognising that interest rates would have reached their nadir, corporates should elongate their maturity spectrum," while further mentioning, "per contra, when interest rates rise sharply, as they did in the 1995-96 period, corporates should minimise longer term borrowings. Many corporates have come to grief as they raised large amounts for long periods and high interest rates in 1995-96."