Real interest Vs Nominal Interest

Subject : Economy

Why in the news?

India’s real interest rate has turned positive after headline retail inflation eased below 6% for the first time this year.

Details

Inflation had stayed above the central bank’s repo rate for this year, implying a negative real rate.
India’s retail inflation was at 5.88% in November, as against 6.25% of terminal repo rate.
The central bank does not target real but is expected to keep the inflation-adjusted rate close to 1% to support growth.

Real interest Vs Nominal Interest

Interest rates represent the cost of borrowing or the return on saving, expressed as a percentage of the total amount of a loan or investment.
A nominal interest rate refers to the total of the real interest rate plus a projected rate of inflation.
- Nominal Interest Rate = Real Interest Rate + Projected Rate of Inflation
A real interest rate provides the actual return on a loan (to the lender) and on a bond (to the investor).
- Real Interest Rate = Nominal Interest Rate – Projected Rate of Inflation
- The formula above is derived from the Fisher Effect.
- It suggests that the real interest rate—or the return received by lenders and borrowers—drops as inflation rises, until nominal interest rates rise in conjunction with inflation.
Nominal interest rates can indicate current market and economic conditions while real interest rates represent the purchasing power of investors.

Terminal repo rate:

Technically, the terminal rate is defined as the peak spot where the benchmark interest rate–the repo rate (in case of India)— will come to rest before the central bank begins trimming it back.
This terminal rate is not just a number, but a planning point for an uncertain time as the repo rate carries all kinds of financial consequences.
- Example- For households, the rate can directly or indirectly influence the rates on credit cards, savings accounts, auto loans and mortgages.