You have taken a home loan of Rs 1 cr and you are paying a rate of interest (ROI) of say, 9% per annum on it. May be you have taken a car loan of Rs. 10 lacs as well and there you are paying ROI of 8% per annum. These rates are known as Nominal Interest Rates. But then, how much interest rate are you paying on your borrowings, in reality? You will reject this question outright as funny telling 9% and 8% respectively, of course.

No, you are off the mark! You are actually not paying what you are being charged. You are paying much lesser. And the reason is inflation. Rather, the adjustment of inflation. The rate at which our mehengai is increasing (inflation), is to be reduced from ROI and the remainder is the Real Rate of Interest. Generally, the governments (through their central banks) worldwide keep a mark up over inflation rate and determine their countries’ respective ROI. In India, RBI keeps a mark up of 2.5% over rate of inflation and determines ROI. So, if the mehengai (inflation) is low, then the rate of interest will also be low and vice versa. Currently inflation Rate is taken at 4%, add 2.5% and the resultant interest rate in the form of Repo Rate is 6.5%. Had you not taken a loan and saved that Rs. 9 lacs interest outgo, your savings would have been worth Rs. 5 lacs only adjusting after inflation of 4% prevailed during the year.

So Real Rate of Interest adjusts inflation in it. Now, the inflation actually is below 4% thanks to slump in the oil prices. But the Nominal rates have not been reduced. The reason being, it takes time for the inflation figures to reach to the policy makers and secondly, regular adjustment in the Nominal rates may provide disturbances in the comparatively immature and imperfect market such as ours.

Mature economies and countries with very low inflation such as Eurozone and even -ve inflation such as Japan have negative rate of Nominal interest rate. In fact, in Japan, you have to pay to your bank to keep money in the current account.

But low inflation has its own problems too. Ours is a predominantly agrarian economy (no of people wise and not on the basis of GDP contribution) and our inflation index mainly consists of food items. So, reduction in food prices hurts the rural economy. This results in less spending by the farmers and as a result lower GDP growth.

Hence, relax! On your home loan you are in reality, paying an interest rate of only 5% and on your car loan only 4%.