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P. R. Brahmananda

THIS article compares the courses of a number of interest rates and yield rates in the US and in India. The US is the leading paradigm of developed countries. It is the advanced country par excellence. There is a view that the US being a capital-abundant country, interest rates should be lower than in India, which is a capital-deficient country.

After globalisation there is a view that interest rates and yield rates in both developed and developing countries should converge. The arbitraging of the flow of funds from the developed countries to the developing countries on the principle of gravity should tend to equalise the rates.

This proposition has to be expected with numerous qualifications. Capital mobility conditions can only be between homogenous countries. Second, there are substantial inflation rate differences between the developed and developing countries. What we observe is the course of nominal interest rates and yields. The theory of equalisation should apply to real rates.

Another important difference between developed and developing countries is that, by and large, in the former, real growth rates are higher than in the latter. Developing countries have average growth rates ranging from 5 to 8 per cent. Developed countries have growth rates of just 2-3 per cent and even less.

In the US, the growth rates in recent years were 3-4 per cent per annum. But that was an exception. In the latest period — the last year or so — the growth rate has become negative. Probably over the immediate future, the growth rate might revive to 1-2 per cent in the US. The Federal Funds Rate is that which corresponds to the bank rate in India. Graph 1 has information on the above two rates from 1980 to 2002. We may note that the federal funds rate in the early 1980s was very much higher than the Indian bank rate. The difference between the two has been narrowing and closing.

The Indian bank rate changes less frequently than the federal funds rate. Even currently there is a difference of about 5 percentage points between the two. In the mid-1990s the difference was as high as 8 percentage points. This means that the US federal funds rate follows a course of its own. Graph 2 gives the course of the US and Indian treasury securities `yields'. In the early 1980s, the US yields were higher than 12-14 per cent, whereas our yields were well below that. From 1986-87, Indian yields began moving up, and reached the high of above 16 per cent in 1992-93. Thereafter, they started moving down, and in 2001, were about 8 per cent. The US yields have been dropping, though even here there are ups and downs. If we take 1995-96, there is a difference of about 5-7 per cent between the two yields. This might explain the difference in the real growth rate and inflation rates between the two countries.

Graph 3 gives the course of yields of medium term securities in the US and in India. It may be noticed that till 1986-87, the US yields were substantially higher than in India. In 1983 they were about 14 per cent in the US and about 8 per cent in India. From 1986-87, the US yields started declining and are below the Indian yields for the rest of the period. The course is, of course, up and down. In 1993-94, the difference between the two was 9 percentage points. Currently, the US yields are about 5 per cent, while the Indian yields are about 8 per cent.

Graph 4 gives the course of the longer-term yield rates of securities. In the US, till the mid-1980s, they were well above Indian yields. From 1986-87, Indian rates started moving above the US yields. In 1994-95, the difference was as great as 7 percentage points. In 2001, Indian yields were about 8 per cent, while in the US they were about 6 per cent.

Some important conclusions are in order. Interest and yield rates in the US and in India cannot converge. The effective inflation rate in the US is close to zero per cent, whereas in India the effective inflation rate, though it is becoming lower, will tend to be substantially above the US rate, on an average, by 5-8 percentage points. The expected inflation rates in India cannot become zero unless our political leaders and Reserve Bank of India are wholly concerned solely with the well-being of the poor.

Most political leaders and parties, and the economists surrounding them, think that India should always have positive inflation rates of 4-5 per cent per annum. Many of them like to think that they are in the US or that they are American citizens. It will take a long time before Indians realise they are in India and not in the US. Given the difference in inflation rates, even if growth rates are equal, there cannot be convergence.

Second, the Indian growth rates will be always higher for years to come than the US growth rates. Our growth rates will be, at the worst, 4-5 per cent and, at the best, 7-8 per cent. Clearly, capital will be scarcer and more productive in India than in the US. Therefore, for these two reasons — the differences in inflation rates and in growth rates — the monetary environment in the US and in India will be different.

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