Reddy was speaking at the inaugural conference of Fixed Income Money Market and Derivatives Association of India (Fimmda) on ``Interest rates and in India: Status and issues.'' He said: "A relatively high borrowing programme by the government as we have seen is not conducive to the moderation in real interest rates, especially in the light of persisting revenue deficits.

In the current year, the fiscal deficit is being bought down from 6.1 per cent of the GDP in 1997-98 to 5.6 per cent in 1998-99. Similarly, the revenue deficit has been reduced marginally from 3.1 per cent of the GDP in 1997-98 to 3 per cent in 1998-99. However, substantial progress is needed to eliminate the revenue deficit and achieve a much lower sustainable fiscal deficit."

Although theratio of the combined government sector fiscal deficit to the GDP has by and large come down in recent years, the high absolute size of fiscal deficit has exerted pressure on real interest rates in the securities market, he said.

"With markets getting increasingly integrated, the demand for pressure in the government securities market has repercussions on the entire gamut of interest rates in the economy," Reddy said.

Holding forth on the issue of interest tax on loans, the deputy governor called for its elimination.

Reddy said: "Interest tax adds to the cost of borrowing apart from making intermediation through banking channels more expensive than other channels. In fact, the need to dispense with this was accepted and some progress was made in the budget for 1997-98, when an interest tax, which was levied at the rate of 3 per cent on the interest income of lending institutions, including banks and NBFCs, was reduced to 2 per cent. This (interest tax) has to be eliminated to keep down the cost ofborrowing."