Slashed Interest Rates Predicted to Trigger Inflation
In the latest monetary review offered by the Reserve Bank of India on 30th September 2014, the repo rate was kept unchanged at 8% since it was last announced in January 2014.
The unchanged repo rate announced by the Reserve Bank of India on 30th September, 2014 at the rate of 8% has been viewed as a measure to cut interest rate and invigorate growth. However, analysts report whether the high policy interest rates have turned out to be a major constraint to growth in recent times. CRISIL Research states that it is not so.
Past Studies:
- Macro level data from the past decade have been gathered for the study and it indicates that interest rates appear to have had a lesser impact on GDP Growth and investments in the post-crisis period.
- Policy uncertainty, lack of clearances and weak demand has been cited as the reasons for the weak investment growth during the time period when interest rates have been negative.
- The Real Policy Rates (repo rate adjusted for CPI Inflation) in India have remained negative since September 2008 at an average rate of -3.1% till the month of September, 2014.
Slow investment growth rate: In spite of such a scenario, there remain two major factors that have contributed to stifling the growth of the economy. Rate of lending has remained high due to risks involved in investment projects as a result of regulatory uncertainty and policy bottlenecks. The transmission of lower policy rates to the lending rates in the economy received a blow due to reasons cited as:
- Tighter banking sector liquidity – the deposit growth was low due to negative real interest rates
- Bank funds were offered at higher costs while deposit rates were kept high.
These non-monetary factors have made significant impact on the risk premium and thus many believe that the changes in lending rates are unable to truly capture the prevailing monetary policy stance in the economy. Some analysts also suggest that 50% of the slowdown in investment growth in the fiscal year of 2012-2014 can be considered to be a result of the rising policy uncertainty and slow domestic demand. The real policy rates hinder the investment growth rate at the rate of 1% by 66 basis points.
It can thus be concluded that merely lowering policy interest rates in such a scenario may not be the only solution for the poor growth rates of the economy.
Source: VC Circle
