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Govt borrowing may hike interest rates

July 23, 2009 14:09 IST
The government's huge borrowing to fund the high fiscal deficit could jack up interest rates, but if used efficiently, this could boost the Indian economy, reeling under a global meltdown, according to economists.

According to them, the fiscal deficit is understandable as investments in the private sector have been subdued and steps taken by the government to increase expenditure in industry could prop up the economy.

"The government borrowing will put upward pressure on the market interest rate," economic think-tank Indian Council of Research in International Economic Relations (ICRIER) Director Rajiv Kumar said.

As the fiscal deficit is projected to balloon to 6.8 per cent of GDP in fiscal 2009-10, the government has pegged its market borrowings at around Rs 4 lakh crore.

The National Council for Applied Economic Research (NCAER) Senior Fellow Shashanka Bhide added, "There is enough liquidity in the system in terms of funds. It is only if private expenditure and demand for funds also increase sharply that the higher borrowing by the government would increase, leading to higher interest rates."

Bhide further said he expects interest rates would be higher as a result of the borrowing and the impact would be gradual.

Financial Services Company KASSA economist Siddharth Shankar said, "I would not be surprised to see prime lending rates touching 16 per cent in about 6-8 months."

He expects interest rates to go up in another three months, mainly due to supply-side constraints, higher money supply and huge government borrowing.

Recently Rajya Sabha MP and former RBI governor C Rangarajan said that the huge government borrowing is likely to put pressure on interest rates in the remaining part of this fiscal.

This year government borrowing will be four times more than projected in the 2008-09 Budget. It will put some pressure on interest rates, Rangarajan said.

Asked about the effect of the huge deficit on the economy, Rajiv Kumar said, "It will depend upon how this deficit is used. For example, if it is in infrastructure sector expansion, the real economy will benefit. However, the higher interest cost may defer private investment." He further said that higher FDI and FII could mitigate resource constraints.

Bhide said that higher government spending is expected because private expenditure is not buoyant and low interest rates alone may not be enough to stimulate demand.

Radha Raman Mishra in New Delhi
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