Interest Rate Policy in India

CHAPTER-6
INTEREST RATE POLICY IN INDIA

Interest rate policy has been considered very crucial for central banks for ensuring
smooth functioning of the transmission mechanism of monetary policy. From a stringent
administered regime to a virtually complete liberalization, the evolution of interest rate
policy in India has been a gradual process. Since 1964, RBI had been fixing all the
deposit rates of commercial banks and since 1969 their lending rates. Moreover, the
ceiling on call rates had been fixed by Indian Bank Association since 1973.Over the
years, an elaborate system of fixing either the maximum or minimum or differential
interest rates had evolved in India. The ruling level and structure of interest rates in India
was an administered one. Though the interest rates in our country were to a large extent
administered, they were revised from time to time in the context of emerging needs and
trends. In this chapter, an attempt has been made to chart out the history of the
deregulation of interest rates in India since the Chakravarty Committee Report was
submitted to the Reserve Bank of India. This chapter has been divided into different
sections depending on the progress of degree of interest rate liberalization.

6.1 SEMI-ADMINISTERED INTEREST RATE POLICY: 1986-87 to 1989-90

Uptil 1985, administered interest rate policy prevailed. From 1986 onwards, semi-
administered or process of liberalization began. Following the Chakravarty
recommendations, with effect from April 8,1985, scheduled commercial banks were
given the freedom to fix interest rates on deposits of maturities of less than 1 year.
Changes were made effective 1 April 1987 with a view to imparting flexibility in interest
rate policy. Ceiling on the call rate was withdrawn with effect from May 1, 1989 and
most of the market rates were made flexible and market oriented. The lending rates of
banks were deregulated and significantly increased since 1989. The process of
liberalization of interest rates, was further followed up by Narasimham Committee
(1991).

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6.2 RESTRICTIVE INTEREST RATE POLICY OR HIGH INTEREST RATES

REGIME: 1990-91 to 1992-93
The monetary policy adopted by the Reserve Bank of India during 1990-91 to the
1st quarter of 1991-92 had the basic thrust on controlled expansion of money and credit.
Deteriorated balance of payment position and liquidity built-up caused by higher order of
monetary growth in 1988-89 and 1989-90 contributed to acceleration of inflationary
pressure in 1990-91. Further, a notable feature of Indian financial system during 1980`s
was one of the administered interest rates. Both the deposit as well as lending rates of
banks were determined by the Reserve bank. The structure of interest rates on bank
advances taking into account all stipulations had a plethora of different rates that varied
according to characteristics of loans, such as type of loan, location size, class and
efficiency of borrowers. Plethora of interest rates often meant uncertainty and posed
difficulties in administration. It was, therefore, considered necessary to undertake a
rationalisation of the existing structure of interest rates on bank advances. Some changes
were made in the interest rate regime to impart greater flexibility.
The most significant step taken with regard to the administered interest rates in
1990-91 „by the Reserve Bank of India‟ was the rationalisation of the lending rate of
scheduled commercial banks. The revised structure of interest rates was introduced with
effect from September 22, 1990. Deposit rates were rationalised by substantially
narrowing the spread of rates of different maturities. On the lending side, floor rate
(minimum rate) was maintained, which enabled banks to vary interest rates according to
market conditions. The commercial interest rate of 16 per cent (minimum) was retained
but applicable to loans of over Rs. 2 lakh, while the lowest lending rate was stipulated at
10 per cent for advances up to and inclusive of Rs. 7500. Subsequently, effective October
10, 1990, scheduled commercial banks were free to determine the interest rates applicable
on various categories of loans.
A new category of deposits of 3 years and above was introduced w.e.f. October
10, 1990 at an „interest rate of 11 per cent‟ p.a. In tune with the rationalisation of interest
rates and maturities on domestic term deposits for period under one year initiated in
1988-89, the term deposit rates, and maturities on Non Resident Rupee (NRE) accounts
were also rationalized. The maturity range of 15 days to 45 days for these accounts was

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abolished and a uniform rate of 8.5 per cent was stipulated on all deposits for maturities
of 46 days to less than a year. Upward revisions were made in the interest rates on
deposits of „3 years and above‟ from „11per cent to 12 per cent‟ with effect from April
12, 1991. On similar lines, upward revision was made on interest rates on bank advances
of „over Rs. 2 lakh from 16 per cent (minimum) to 17 per cent (minimum)‟ w.e.f. April,
13, 1991.
With effect from July 4, 1991, the Reserve Bank introduced a fresh set of
monetary measures-
Upward revision in the bank rate from 10 per cent to 11 percent. Bank rate had
remained at 10 per cent since 1981.
Some interest rates on RBI credit were linked to this rate and consequently these
interest rates went up by one percentage point.
Thirdly, RBI raised interest rate on bank advances of over Rs. 2 lakh from 17 per
cent to 18.5 per cent per annum.
Finally, the interest rates on term deposits of scheduled commercial banks were
raised by one percentage point.
The financial year 1991-92 began with serious problems - as of inflation, large
budget deficit and growing current account deficit on balance of payments. Hence,
overall stance of the monetary and credit policy was one of very restrictive, aiming at
containing overall demand. Interest rates on bank deposits were revised upwards three
times in the current financial year in keeping with high inflation rate. As a part of its
credit policy during the first half of 1991-92, the highest deposit rate „was raised from 11
per cent to 12 per cent effective April 13, 1991‟.
Such a revision was effected for the second time on July 4, 1991 when all the
term deposit rates of the scheduled commercial banks were raised by one percentage
point each. “Interest rates on term deposits of 46 days to less than 1 year was raised by
two percentage points from 9 per cent to 11 per cent. Bank rate was raised again from 11
per cent to 12 per cent w.e.f October 8, 1991”(www.rbi.org.in). All other rates linked to
bank rate also underwent similar upward revisions. Upward revisions were also made in
the lending rates of the scheduled commercial banks. The rate of interest on bank
advances „of over Rs. 2 lakh which was‟ made flexible with the introduction of only a
floor level from October 10, 1988 was raised thrice in the current financial year.

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During 1992-93, the overall policy stance continued to be restrictive to check

inflation. The structure of interest rates was rationalised to a considerable extent during
1992-93 and in the first half of 1993-94. The numbers of prescribed lending rates were
brought down from 6 in 1991-92 to 3 in 1993-94. The floor interest rate for bank credit of
„over Rs. 2 lakh was reduced from 20 per cent to 18 per cent‟ in two stages. Moreover,
freedom was given to banks to determine interest rates on term deposits, subject to a cap
of 13 percent (reduced later to 12 per cent). They were also free to set interest rates on
NRE Accounts subject to a cap of 13%. Interest rate on saving deposits was raised to 6
percent. Banks were advised to fix their deposit rate on the basis of their perception of
inflation, cost of and return on funds and inter-bank borrowing and lending status.

6.3 DEREGULATED INTEREST RATE POLICY: 1993-94 to 1995-96

In the financial year 1993-94, the Reserve Bank following financial sector
reforms continued reducing both cash reserves as well as statutory liquidity ratio. These
measures released resources for scheduled commercial banks to lend more at commercial
rates.
Policy changes introduced in the year 1993-94 included :
1. Effective April 8, 1993, the prescribed lending rates were reduced from 4 to 3.
2. The interest rate on advances of scheduled commercial banks with credit limits of
„over Rs. 2 lakh‟ was lowered „from 18 per cent to 17 per cent‟ from March 1,
1993.
3. Effective September 2, 1993, this rate was further reduced from 16 per cent to 15
per cent.
4. The lending rate for advances below Rs 25,000 was maintained at 12 per cent and
for advances above 25,000 but less than Rs. 2 lakh was maintained at 15 per cent
and a floor rate of 15 per cent for advances above Rs. 2 lakh.
5. CRR was reduced in two stages-from „15 per cent to 14.5 per cent‟ effective April
17, 1993 and „further to 14 per cent‟ effective May 15, 1993.
6. In regard to deposit rates, „banks were allowed to fix‟ the maturities and rates for
term deposits which are subject to ceiling. The maximum deposit rate was
reduced in stages from 12 per cent to 10 per cent, while that on domestic saving
deposits was reduced from 6 per cent to 5 per cent.

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The year 1994-95 marked the third year of banking sector reforms, which were
undertaken as a critical part of the financial sector reforms:
“The ongoing process of rationalizing the interest rate structure received a major
impetus with the abolition of minimum lending rate (MLR) for credit limits of
over Rs. 2 lakh effective October 18, 1994”(www.rbi.org.in).This constituted a
major step towards deregulation of bank interest rates in India.
Scheduled Commercial banks were now free to fix their prime lending rate (PLR),
which is the minimum rate charged by banks from prime borrowers for such
credit.
Lending and deposit rates of all cooperative banks excluding primary cooperative
banks were totally deregulated in October 1994 subject to Minimum Lending
Rate of 12 per cent.
Each bank was required to declare a PLR, which would be uniformly applicable at
all branches.
As regards deposit rates, scheduled commercial banks were allowed to fix the
maturities and rates for term deposits subject to ceiling. “The maximum deposit
rate was raised to not exceeding 11 per cent per annum effective February 10,
1995 to not exceeding 12 per cent per annum effective April 18,
1995”(www.rbi.org.in)
Consequent upon deregulation of „interest rates on domestic term deposits of 2
years maturity‟, effective October 1, 1995, the majority of banks revised these
interest rates „to 12.5 per cent and 13 per cent‟ in October and November 1995,
respectively.
Indian banking faced several challenges in 1995-96. The process of financial
sector reforms continued. An important area in which reforms progressed during
1995-96 related to further deregulation of interest rates especially on the deposit
side of banks. As a part of interest rate reforms, “with effect from October 1,
1995, Scheduled Commercial banks were allowed freedom to fix their own
interest rates on domestic term deposits of maturity of over 2
years”(finmin.nic.in). Effective July 1996, the minimum maturity structure
subject to such regulation was reduced to one year. The minimum maturity period

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for term deposits „was reduced from 46 to 30 days‟, with maximum interest rate
on term deposits lowered to 11.0 per cent per annum. Effective October 21, 1996,
this maximum rate was reduced further to 10 per cent with a view to bringing
about better alignment of maturity structure of NRE term deposits with that of
domestic term deposits. Interest rate on NRE term deposits of over 2 years was
freed from April 4, 1996. The maximum deposit rate for NRE Accounts for
maturity of 6 months to 3 years and above was raised from 8 per cent to 10 per
cent, and further to 12 per cent effective October 31, 1995.

6.4 LOW AND DOWNWARD STICKY INTEREST RATE REGIME: 1996-97

to 2001-02
As per RBI Annual Report (1996-97), “The financial year 1996-97 was
characterized by improvement in several spheres of economic activity”:
i) “There took place a considerable softening of interest rates”.
ii) “Improvement in the overall liquidity situation”.
iii) “The situation on inflation front was under control despite supply side pressures”
Despite “these favourable developments, there were areas of concern which
needed concerted policy actions”:
Although interest rates declined considerably at shorter end, there was discernible
downward rigidity at the longer end, thereby widening term spread.
In an increasingly open environment, the pressure of developments in external
sector was increasingly felt in the conduct of monetary policy.
Changes with regard to interest rates
1. Bank Rate : Effective April 16, 1997, the reactivation of bank rate took place.
With that all interest rates on advances were linked to it. Now it acted as a
“reference rate” for the entire financial system. “With effect from 15 April, 1997,
the bank rate was reduced from 12 per cent per annum to 11 per cent per annum,
and further to 10 per cent per annum effective from June 25, 1997”(RBI Annual
Report, 1996-97).
2. Deposit Rates:
(i) Effective from July 2, 1996, the domain of prescribed ceiling rate on deposits was
made applicable only to maturities up to one year. As a result, „the minimum
maturity period was reduced from 46 days to 30 days‟.

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(ii) Further, the interest rate on domestic term deposits of maturity of 30 days and up
to 1 year was stipulated at „not exceeding 11 per cent per annum‟. Effective April
16, 1997, this rate was prescribed at „not exceeding the Bank Rate minus two
percentage points per annum‟. This implied a rate of „not exceeding 9 per cent per
annum‟.
(iii) With prior approval of their respective Boards, banks could offer different interest
rates on deposits of varying maturities.
(iv) “In order to give full freedom to banks to determine the interest rates on term
deposits, effective Oct 22, 1997, banks were allowed to fix their own interest rates
on term deposits of 30 days and above”(Report on Trend and Progress of Banking
in India ,1996-97).
3. Lending Rates
i) Despite the comfortable liquidity situation brought about by strong growth in
bank deposits and substantial reduction in CRR, lending rates remained sticky
downwards during the first half of 1996-97.
ii) In the second half of the year, however, following a sizeable cut in CRR, prime
lending rates (PLRs) of public sector banks softened to a range of 14.0-15.5 per
cent by end March 1997 from 16.5 per cent at end March 1996.
iii) “Effective July 5, 1996, banks were free to decide the interest rate on post-
shipment export credit on medium and long-term base” (RBI Annual Report,
1996-97).
iv) With effect from Oct, 22, 1997 “prescription of a fixed lending rate of 13.5 per
cent for credit limit of over Rs. 25,000 and upto Rs. 2 lakh was changed to
prescription of a ceiling rate of not exceeding 13.5 per cent”(Report on Trend and
Progress of Banking in India, 1996-97).
As given in Economic Survey (1997-98), “Rationalisation of the interest rate
regime continued in 1997-98. To achieve greater allignment across the overall interest
rate structure, further changes were made”:
i) “With effect from April 15, 1997, all interest rates on advances from the Reserve
Bank were linked to the bank rate. The one percentage point reduction in the bank
rate each in April, June and October 1997 signalled the beginning of a low

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interest rate regime as these downward movements resulted in similar reductions

in lending and deposit rates”.
ii) “This was followed by full freedom to banks to determine the interest rates on
term deposits of 30 days and over w.e.f. October 22, 1997”.
(iii) “Further, the interest rates on NRE term deposits of over 1 year were freed w.e.f.
16 April, 1997”.
iv) With effect from September 13, 1997, “interest rates on NRE deposits of 6
months and above were completely freed”.
During 1998-99, while the overall liquidity condition in the economy showed a
substantial improvement, the yield on government securities in the primary
market remained relatively firm. Interest rates on deposits and bank loans,
however, showed a general downward trend, responding to the overall slack in
aggregate demand as well as to the monetary policy measures announced during
the year.
It was decided w.e.f. April 29, 1998 that the interest rates on loans up to Rs. 2
lakh should not exceed the prime lending rate (PLR) applicable to prime
borrowers of over Rs. 2 lakh.
“The Reserve Bank signalled the need for lowering of interest rates in April 1998
in order to give stimuli to investment and to promote industrial
recovery”(www.rbi.org.in).
The bank rate was reduced in 2 stages by 0.5 percentage point on April 3 1998
and one percentage point on April 29, 1998, thus bringing it down to 9.0 per cent,
the rate prevailing before mid-January 1998.
Interest rates linked to the bank rate were also revised downwards.
Further the fixed repo rate „was reduced in 3 stages of one percentage point each‟
to 5 per cent by mid June 1998.
According to RBI Annual Report (1999-2000), “The overall liquidity and interest
rate condition in the economy exhibited a marked improvement in 1999-2000. Interest
rate on bank deposit and loans, which exhibited relative stickiness during the greater part
of 1999-2000, declined significantly during April 2000 following the liquidity enhancing
measures. Responding to monetary policy signals and liquidity enhancing measures, long

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term interest rates in all segments of financial market softened during 1999-2000. While
normal interest rates softened considerably since March 1999, several structural and other
factors constrained downward flexibility in interest rate structure. There was a general
softening of interest rates across the maturity spectrum”
The report further stated that “In the Indian context, the movements in market
rates of interest in recent years suggested that the markets had grown with the increase in
interest rate flexibility. In October 1999, the need was underlined to undertake concrete
steps to remove certain inherent rigidities so that interest rate structure could be made
more flexible during different phases of business cycle. Since then, there had taken place
some easing of constraints on the flexibility of interest rate in the financial system as a
whole. The main objective of the monetary policy was to impart greater flexibility to
interest rate regime, to continue with stable interest rate environment with a preference
for softening of interest rates”. In April 2000, „Reserve Bank continued to ease‟ the
monetary conditions. “The policy stance was to provide adequate liquidity to meet credit
growth and support revival of investment demand. Within the overall framework of
imparting greater flexibility to the interest rate regime, the policy was to maintain stable
interest rate environment with a preference for softening to the extent the situation
warranted”(RBI Annual Report, 2000-01)
“The October 1999 Mid-term review of the monetary and credit policy
underscored the need to address the structural constrains hindering the downward
flexibility of interest rates in India. In April 2000, as a part of the efforts to ease rigidities
in the interest rate structure, banks were given the freedom to offer all loans on fixed or
floating rates while complying with the PLR stipulations”(www.rbi.org.in). In its
Statement on Monetary and Credit Policy for the year (2000-01), Bimal Jalan argued that,
“While a significant softening of interest rates had taken place in the last 13 months, the
decline in nominal interest rates did not keep pace with the decline in the rate of inflation.
Hence, there was a debate in the country on the need to bring nominal interest rate down
sharply so that real interest rates would move down correspondingly. It is argued that if
this happened then industrial growth could be accelerated further and India‟s
competitiveness would improve. While much greater flexibility in the structure of interest

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rates in tune with changes in the inflationary environment was desirable, there was no
“quick fix” solution to sharp fall in nominal deposit and lending rates of banks”. During
2001-02, the Reserve Bank continued its policy of imparting greater flexibility to the
interest rate regime with a bias towards softer interest rates. There was a focus on
imparting greater flexibility to the rate structure so that interest rates could evolve in
alignment with the behavior of domestic economic activity and international
macroeconomic and financial conditions. Stable and preferably low interest rate regime
was considered as a condition for stable inflationary expectations which in turn depended
on price stability.

6.5 SOFT AND FLEXIBLE INTEREST RATE POLICY: 2002-03 to 2004-05

„A policy bias for soft interest rates and a flexible interest rate structure‟ for
revival of investment was indicated for the current year. Bank rate changes, combined
with CRR and repo rate changes emerged as important tools of liquidity and monetary
management. CRR was reduced in 3 stages from 5.5 per cent to 4.5 per cent. “Following
this, bank rate and repo rate were also reduced by 25 basis points. Comfortable liquidity
condition engendered by large capital flows enabled a general reduction in market
interest rates. Lending rates of banks exhibited somewhat sluggish downward
movements. The softening of interest rates was enabled by the benign inflation
environment”(www.rbi.org.in)
Following important changes during the period took place:-
Bank Rate
According to RBI Annual Report (2002-03), “Since 1997, the bank rate had been
reactivated as the principal signaling device of the monetary policy stance across the
interest rate structure in consonance with inflationary expectations and the liquidity
situation. The bank rate was reduced in stages to 6.25 per cent in October 2002, the
lowest rate since May 1973 and by a further 25 basis points in April 2003. The bank rate
had been reduced by 500 basis points in the last 5 years. This is the sharpest reduction in
the bank rate since independence”.

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Deposit Rates
“Banks had the freedom to fix interest rates on term deposits, with flexibility in
offering interest rate as approved by their boards”.
“The only regulated rate was on saving deposit account with cheque facility”.
“The reduction in administered interest rates on small savings announced in the
Union Budget 2003-04 and moderate inflation enabled a 50 basis point reduction
in the saving deposit rate to 3.5 per cent per annum from March 1, 2003”.
Lending Rates
The downward rigidity in lending rates was reflected in spreads over the prime
lending rates.
Banks were required to announce the maximum spread over the PLR for all
advances except consumer credit.
In order to enhance transparency, a Benchmark Prime Lending Rate (BPLR) was
advocated for banks, taking into account their actual cost of funds, operating
expenses and a minimum margin to cover regulatory environment.
Since all other lending rates could be determined with reference to the benchmark
PLR, the system of tenor linked PLR was discontinued.
The RBI in its mid term review proposed deregulation of interest rate on rupee
export credit in two phases.
One noticeable development was the sub-PLR lending by the commercial banks
on a large scale. With sub-PLR lending and reduction in maximum spread over
PLR, lending rates effectively softened during the year.
„These initiatives‟ were „expected to bring flexibility to the interest rate structure
in India‟.
The RBI continued its policy stance of “soft interest rates and imparting greater
flexibility to the interest rate structure during 2003-2004. In consonance with this policy,
RBI reduced the bank rate from 6.25 per cent to 6.0 per cent from April 29, 2003 and the
CRR from 4.75 per cent to 4.50 cent from June 14, 2003”(Economic survey, 2003-04).
Over the years, repo rate was also softened. The repo rate witnessed moderation „from
8.0 per cent in March 1999 to 4.5 per cent in‟ September 2004.. Lower rates of inflation
in recent years greatly facilitated the transition to a „low interest rate regime‟ The RBI

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reduced the interest rate on savings account, the only domestic deposit rate which
continued to remain administered from 4.0 per cent to 3.5 per cent from March 1, 2003.
“Between March 2002 and March 2004, deposit rates offered by major commercial banks
on term deposits of more than one year maturity, were reduced from a range of 7.50-8.50
per cent to range of 5.00-5.50 per cent. In contrast, the Prime Lending Rates (PLRs) of 5
major commercial banks witnessed a smaller decline from a range of 11-12 per cent to
10.25-11.00 per cent in the same period”(www.rbi.org.in).
During the year 2004-05, RBI followed a policy of „flexible interest rate‟ regime.
“Concerned over the downward rigidity of lending rates, even when deposit rates were
coming down, RBI advised banks to announce their benchmark prime lending rates based
on their actual cost of funds, operating expenses and a minimum margin to cover
regulatory environment. In response to this policy directive, all banks put in place a
system of BPLRs in 2003-04. The BPLRs of 5 major banks were lowered by 25 to 50
basis points in December 2004 as compared to the rates prevailing a year ago”(Economic
Survey, 2004-05).The bank rate remained unchanged at 6.0 per cent in the current year.

6.6 HIGH INTEREST RATE REGIME: 2005-06 to 2007-08

As per RBI Annual Report 2005-06, “The stance of monetary policy during
2005-06 depended on several factors including macroeconomics prospects, global
developments and the balance of risks. Barring the emergence of any adverse and
unexpected developments in various sectors of the economy and keeping in view the
inflationary situation, the overall stance of monetary policy for the year 2005-06 was to
pursue an interest rate environment that was considered conducive to macroeconomic and
price stability and maintaining the momentum of growth”
“Progressive deregulation of interest rates in those segments that remained
regulated for reasons relevant at different times had been engaging the attention of
Reserve Bank and wide consultations had been held with various stakeholders”. In order
to contain the inflationary expectations and tightening of liquidity in the system, “the
Reserve Bank raised the reverse repo rate by 75 basis points to 5.50 per cent by end
March 2006 and repo rate by 50 basis points to 6.5 per cent by end March 2006. The
bank rate was retained at the existing level of 6.0 per cent , unchanged since April
2003”(www.rbi.org.in)

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“The high credit demand during 2005-06 exerted an upward pressure on lending
rates as well as deposit rates of banks. Interest rates offered on deposits by banks in
general firmed up during 2005-06. However, the increase was more pronounced at the
shorter end of the maturity”(Report on Trend and Progress of Banking in India, 2005-06).
“The conduct of monetary policy during 2006-07 faced various challenges due to
persistent inflationary pressures and continuing large capital inflows. The major policy
challenge was to manage transition to a higher growth path while containing inflationary
pressures”(RBI Annual Report, 2006-07). Against this backdrop, Reserve Bank
conducted its policy objective to ensure a monetary and interest rate environment that
would support export and investment demand in the economy so as to enable
continuation of the growth momentum while reinforcing price stability with a view to
anchoring inflation expectations. In view of the prevailing environment, RBI raised
“reverse repo and repo rate by 25 basic points each to 5.75 per cent and 6.75 per cent
from June 8, 2006. Further, these were increased by 25 basis points to 6.00 per cent and
7.00 per cent respectively w.e.f. July 25, 2006. Effective 31st October 2006, fixed repo
rate was raised by 25 basis points to 7.25 per cent, while reverse repo rate was left
unchanged at 6.0 per cent. CRR was raised by 50 basis points in 2 stages effective from
December 23, 2006 to 5.25 per centand January 6, 2007 to 5.5 per cent”(www.rbi.org.in).
“During the financial year 2007-08, the RBI after reviewing the macroeconomic
and monetary situation adopted a pre-emptive policy stance to moderate inflationary
expectations by raising policy interest rates. During 2007-08, the RBI used cash reserve
ratio (CRR) as a major policy instrument and so far CRR was hiked four times during the
year with cumulative increase of 150 basis points thereby bringing the level to 7.5 per
cent on November 10, 2007”(RBI Annual Report, 2007-08).
“The continued expansion in bank credit exerted upward pressure on lending rates
as well as on deposit rates of banks. Although some interest rates like interest rates on
saving bank deposits, NRE deposits and FCNR deposits and those on export credit and
small loans upto Rs. 2 lakh were still regulated by the Reserve Bank, it was the
endeavour of the Reserve Bank to modify them in line with the changing
scenario”(www.rbi.org.in)

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6.7 RESTRICTIVE CUM EXPANSIONARY INTEREST RATE POLICY:

2008-09 to 2011-12
“During 2008-09, the conduct of monetary policy was confronted with several
new challenges thrown out by the global financial and economic crisis. The stance of
monetary policy underwent a shift from „monetary tightening‟ in the first half of 2008-09
reflecting the response to rising inflationary expectations to aggressive „monetary easing‟
in the second half using conventional tools so as to minimize the impact of global crisis
on India. Following the deepening of the global financial crisis since September 2008, the
Reserve Bank took several measures to bring down the policy rates to step up the
liquidity in the system”(Report on Trend and Progress of Banking in India, 2008-09).
There prevailed low interest rate regime required in the existing situation to revive
economic growth. In this policy stance, the cash reserve ratio (CRR) was reduced by 400
basis points, repo rate by 425 basis points and reverse repo rate by 275 basis points.
Deposit rates of scheduled commercial banks across various bank groups showed a
generally „upward movement during the first half of the year 2008-09. Taking cue from
the Reserve Bank‟s monetary policy actions, the scheduled commercial banks reduced
their deposit rates in the second half of 2008-09. In tandem with the „deposit rates‟, the
lending rates of scheduled commercial banks also exhibited similiar trend during this
year.
The „accommodative‟ monetary policy stance, which „aimed at stimulating a
faster recovery in growth‟, continued through the first half of 2009-10. “The stance of
monetary policy emphasized the need to ensure a monetary and interest rate policy
regime that would enable credit expansion at viable rates while preserving credit quality
so as to support the return of the economy to a high growth path. It was observed that
there was a scope for the overall interest rate structure to move down within the policy
rate easing as effected earlier by the Reserve Bank”(Economic Survey, 2009-10).
“Easy access to liquidity at low cost was the critical component of the overall
policy response during 2009-10. The most important concern that dominated the credit
markets was weak transmission of policy rates to lending rates and deceleration in the
pace of credit growth”(www.rbi.org.in). “The major factors weakening the transmission
in India were”:

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i. „Administered interest rate structure on small saving deposits‟.

ii. Structural asymmetry faced by banks in fixing interest rate.
iii. „Practice of giving advances at below Benchmark Prime Lending Rate (BPLR)‟
“With a view to imparting transparency to the loan process and improving the
assessment of monetary policy transmission and promoting competition in the credit
market, the Reserve Bank introduced a new system of “base rate” effective from July 1,
2010, which replaced earlier BPLR system”(RBI Annual Report, 2009-10). It is expected
that the base rate system will bring about greater flexibility and strengthen both the
interest rate and credit channels of monetary transmission.
In view of global and financial developments, “the Reserve Bank with an effort to
maintain a soft interest rate regime, reduced the policy rates to their historically lowest
levels. The repo rate was reduced by 25 basis points from 5.00 per cent to 4.75 per cent
with effect from April 21, 2009 while the reverse repo rate was reduced from 3.50 per
cent to 3.25 per cent. There were no major changes in policy rates during
2009”(www.rbi.org.in)
Furthermore, the thrust of monetary policy during the year 2010-11 had been
towards containing inflation. In view of that, the Reserve Bank of India withdrew from its
„accommodative policy stance‟ in April 2010 itself. “Though monetary policy was
tightened throughout the year, inflation remained sticky on the back of new pressures. In
a series of steps, key policy rates were raised. The RBI raised the policy rates six times
during the current fiscal year wherein the repo rate under its LAF was increased by 175
basis points raising it to 6.5 per cent and the reverse repo rate was increased by 225 basis
points raising it to 5.5 per cent. CRR was at 6 per cent of net demand and time liabilities
of banks. Monetary transmission improved considerably in the latter half of 2010-11 after
sustained tight liquidity, and prompted banks to raise deposit and lending rate”(RBI
Annual Report, 2010-11).
As per RBI Annual Report (2011-12), “The policy stance continued to be tight up
to mid December 2011, but policy rates were kept at a pause mode during the remainder
of the year with cuts in cash reserve ratio and open market operations for supporting
liquidity. In response to the prevailing inflationary pressures and anticipated inflation
trajectory during April-November 2011, the Reserve Bank raised the policy rates 5 times

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 Interest Rate Policy in India

by 175 basis points with the increase in May and July of the order of 50 basis points each.
As proposed in the Second Quarter Review of Monetary Policy 2010-11, the Reserve
Bank decided to deregulate the only interest rate that continued to remain regulated, i.e.
the saving deposit interest rate effective October 25, 2011”.
In nutshell, it can be said that interest rate policy in India, over the years, made a
calibrated transition from administered interest rate regime to deregulated interest rate
regime, which further moved towards preferably stable and low interest rate regime.
Keeping in view the adverse economic conditions and inflationary situation, the monetary
policy moved towards restrictive cum expansionary policy with an objective to pursue an
interest rate environment which was considered conducive to the macroeconomic and
price stability in the economy to maintain momentum of growth.

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