What does the prevailing market interest rate mean?
Interest rate has many aspects and could refer to different rates depending on the context in which it is used. The most common indicator of interest rate is the bank rate – the rate at which the banks borrow from the RBI. The RBI regulates this rate and is the benchmark for all the existing interest rates in the economy. Currently, this rate is fixed at 6 per cent per annum. Most other interest rates in the country are in some way linked to this.
Any revision in the bank rate by RBI is a signal to banks to revise deposit rates as well as Prime Lending Rate (PLR). The individual bank fixes both deposit rate and PLR, hence, these rates vary with banks. Fixed deposit rate is the rate of interest you earn on your bank deposits. Currently, the State Bank of India offers 5.25 per cent interest per annum on over three-year bank fixed deposits.
PLR, on the other hand, is the indicative rate at which each bank lends to its borrowers. However, the effective lending rate varies with the creditworthiness of the borrower. It could be either below or above the PLR. Each bank usually follows an internal credit rating system and charges a spread or discount over the PLR.
A downward (upward) revision in bank rate would also prompt companies to lower (increase) interest rates offered on fresh bond issues. Similarly, government bonds will be issued at a lower coupon. In the bond markets, the yield on the government securities also denotes the movement of interest rate on a day-to-day basis. The yield on a particular bond reflects the rate of interest you would earn on that bond if you hold it till maturity. The yield movement depends on various macro-economic factors like inflation, liquidity, government's borrowing program and the economic growth.
Then we have repo rate—the rate at which the banks lend money to the RBI. This rate is fixed by the RBI and acts as the benchmark for all short-term rates in India. For example, call rate – the rate at which inter-bank transactions take place – largely hovers around the repo rate. Currently, the repo rate is 4.5 per cent.
Another important rate is the interest on small savings instruments, which largely include post office schemes like NSC, NSS, MIS, etc. These rates are governed by the government. Last year, in Budget 2003-04, the rate of interest on these instruments was cut by 1 per cent. At present, NSC offers an interest of 8 per cent per annum.
And lastly, the most common rate of interest is the bank savings account rate. The RBI fixes this rate, which is currently pegged at 3.5 per cent per annum.