Here is a reality check derived from market forces - in 1998-99 and 1999-2000, the finance ministry had offered a liberal foreign borrowing policy to corporates by allowing up to $8 billion of foreign loans. Out of this about $3 billion were offered to corporates in the form of small loans (up to $15 million per company) through an automatic RBI window.

But the actual amount accessed in 1998-99 and 1999-2000 by Indian companies from abroad was less than $2 billion! Barely 25 per cent of what was on offer. Even in 2000-2001, no more than $2.5 billion has been accessed.

So the next logical question should be - if real interest rates in India are way higher than what prevail in the international market, why are Indian companies avoiding borrowing from abroad.

It is the small- and medium-sized businesses that find the cost of borrowing high in India because prime borrowers like the Tatas or the Reliance group manage to get money at close to the prime lending rate of 13 per cent from banks. For the non-prime borrowers it should make sense to borrow medium-term from abroad at about 9 per cent and add to that the average dollar forward premium cost of 5 per cent annually to get cushioned against any exchange fluctuation. Thus small borrowers can get loans from abroad at 14 per cent, which includes the exchange risk. This is not a bad deal at all.

But still Indian corporates are shunning foreign borrowings. So economists who claim high real interest rates as the primary reason for lack of investment demand may be barking up the wrong tree. After all, if over Rs 30,000 crore is available from the international market, it must be explained why barely 25 per cent is being accessed. One reason could lie in a study done in 1998-99 by the National Council for Applied Economic Research (NCAER) which showed that a large number of Indian companies are in a consolidation mode and are preferring use of internal accruals rather than fresh borrowing for expansion.

This behaviour could have something to do with the urgent need to shape up in the face of impending competition from abroad as the economy becomes more globalised. Which is why incremental investment growth in several sectors such as steel, textiles chemicals has decelerated substantially.

The other reason why Indian banks cannot cut interest rates substantially has to do with the compulsion to balance the needs of the savings and investments. With inflation rate at 8 per cent, the deposit rate has to give some real return. True, Indian banks are inefficient and the spreads enjoyed by them are much higher than in the international market. But even after discounting the higher spreads, the lending rate cannot come down to 10 or 11 per cent, as some analysts have suggested.

Finally, before advocating sharp cuts in interest rates one has to look at structural issues such as the precarious capital adequacy of the majority of the Indian banks. So, even if lending rates come down to, say, 10 to 11 per cent, most banks will not be able to lend more due to lack of capital adequacy.

A government study shows that to register normal credit growth, Indian public sector banks need about Rs 20,000 crore over the next four years. Another structural constraint to quantum reduction in interest rate is the fact that the borrowings by the Centre, state governments and municipal bodies amount to over 13 per cent of gross domestic product (GDP) annually. This is almost equal to the transferable household savings accumulating every year.

So a dramatic cut in interest rates is easier said than done.

(The writer is editor, e-indiabiz.com)