The Industrial Development Bank of India (IDBI) and ICICI have slashed the coupons on their forthcoming bond issues by about 50 basis points. Among public-sector banks, Bank of India (BoI) on Monday also cut its deposit rates by an identical margin on shorter maturities--between 15 days and 179 days--and by 1 per cent on deposits between one and two years.

On the back of a historic low inflation rate, bond prices have been rising by 5-20 paise across all maturities over the last few days pulling down the yield on government securities. Call rates continue to remain unaffected around 8-8.5 per cent.

Banks and financial institutions are not ready as yet to cut rates on their advances even though corporates are lobbying hard for a rate cut. Says Ficcisecretary-general Amit Mitra: "The prime lending rate (currently at 12 per cent) should be reduced by at least 2 per cent immediately. If the current situation, where inflation remains in the region of 1-2 per cent, prevails for five-six months, the interest rates should be brought down further by 2 per cent."

Ballarpur Industries chairman LM Thapar also feels that "it would be in the fitness of things if this achievement (of low inflation) is accompanied by a cut in lending rates to give impetus to the industry."

However, bankers are not ready to cut lending rates. "When we talk about real interest rates, we normally refer to one-year deposit rates which is about 8 per cent now. In effect, the real interest rate is around 6 per cent which is not too high. Not many banks will be able to offer lower rates on deposits," says State Bank of India managing director V Janakiraman.

However, the real interest rate as calculated on the difference between PLR and the wholesale prices index is a whopping 10.2 percent. In the last 10 years, this is the fourth time real interest rates have risen above 10 per cent (see chart).

Bank of Baroda's deputy general manager KC Chakraborty says there is a strong case for deposit rate cuts. "After the deposit rate cuts, there could be a cut in lending rates," Chakraborty points out.

Janakirman points out that the inflation rate is low only on the basis of the WPI, not the consumer price index. Besides, in the Indian context, the inflation rate is not the only factor to determine interest rates. "There has not been any change in the supply of funds while the demand for funds has also not picked up. May be, a cut in cash reserve ratio (CRR) will trigger a lending rate cut," he points out.

Bankers across the line rule out any immediate lending rate cut as liquidity is set to tighten with the elections round the corner. Elections traditionally witness an outflow of funds from the banking system. By the time the elections are over, the busy season will set in with demand forfunds picking up and hence there is not much for a scope of a rate cut now.

However, if the low inflation rate continues over the next few months banks may be forced to cut the lending rates as well as deposit rates across the board, banking analysts point out. They do not rule out even a bank rate cut over the next few weeks.

According to the Confederation of Indian Industry (CII), "It is high time for interest rates to come down. Industry has to be competitive at the international level and now that India's inflation has touched international inflation levels, the lending rate should be brought down. Interest cost is a key factor in deciding viability of industrial projects."

Real interest rates in the US are at present ruling at 6.5 per cent with banks' PLR pegged at 8 per cent and producer price (PP) inflation at 1.5 per cent. Among major trading partners of India, Japan accounts for the lowest real interest rate at 2.08 (PLR 1.38 per cent and PP -1.7 per cent) followed by the UK's five per cent(PLR six per cent and PP one per cent) and Euroland 5.55 per cent (PLR 4.15 per cent and PP -1.4 per cent).

Says Usha group chairman Vinay Rai: "Domestic interest rates must follow international lending rates and money market rates. A few years ago a lending rate of 20 per cent was justified on the ground that the inflation was around 15 per cent. Now, when inflation is less than 2 per cent, lending rates should be brought down accordingly."

IDBI chairman GP Gupta says the real interest will have to come down since inflation has drastically fallen. Though in the short-term the rate will stay stable, in the long-term rates will come down, he points out.

Last week, the chairman of India's largest commercial bank, the State Bank of India, expressed a similar view on the outlook for interest rates. "In the short term, for the next six to eight months, interest rates should be stable," SBI Chairman GG Vaidya had said.

But some investment bankers have said it is a good time for the Reserve Bank of India tofurther boost the economy by cutting rates. Good industrial growth, a stable currency and the resolution of the Kashmir issue make a strong case for a reduction in Indian interest rates, JP Morgan said on Friday.

Industrial growth in the first two months of this year has been 6.3 per cent, several sectors are showing concrete signs of recovery, the Kargil issue has been resolved and sentiment towards the currency is positive, a JP Morgan report argues. "All these factors have increased the chances of the Reserve Bank implementing a reduction in the bank rate and/or repo rate in the near future," it said.

Grasim Industries' chief financial officer DD Rathi has, however, a word of caution: "In India, we have this peculiar problem that GDP is low but savings is high. If interest rates fall further, there is a distinct possibility that savings will evaporate."