Determinants of Nominal Interest Rates in India

This paper examines the role of monetary factors in the variation of nominal interest rates in India for the deregulated regime of interest rates and the exchange rates. Empirical analysis involves quarterly time series dataset including interest rates on 91-day, 364-day treasury bills (TBs), call money rate, money supply (both narrow and broad money), income and exchange rate over the period 1996–97:Q1 to 2015–16:Q4. In the short-run and the long-run variations of interest rates on TBs, role of the broad money supply, income and exchange rate are established; where the broad money negatively affects interest rates indicating the Liquidity effect view. Income and depreciation of exchange rate lead to raise interest rates. In the variations of the call money rate income, the narrow money and the broad money have significant role but the role of exchange rate is not established. The paper also finds evidence that interest rates on TBs are related to the relative growth of money supply and anticipated nominal income. Theatrical base of such relation is discussed based on some seminal work of Friedman. Based on these findings the paper concludes that it would be effective to control interest rate through a comprehensive monetary management.