28 May 2012
The maximum decline in GDP growth occurs with a lag of two quarters with the overall impact continuing through six-eight quarters ahead. The worst of the economic slowdown could still be ahead of us, according to a new RBI working paper. The paper ‘‘Evidence of Interest Rate Channel of Monetary Policy Transmission in India'', has suggested that an increase in policy interest rates is associated with a fall in real GDP growth rate. The maximum decline in GDP growth occurs with a lag of two quarters with the overall impact continuing through six-eight quarters ahead. The RBI adopted an aggressive monetary tightening strategy to tame inflation between March 2010 and October 2011, hiking policy rates 13 times by a total of 3.50 percentage points. However, it slashed the rates by 0.50 per percentage points in April. Given the lag in transmission of monetary signals and persisting effect, as suggested by the working paper, India's economic growth rate could slow down further over the next few quarters. However, the benefits of the recent rate cut should be felt by the end of the year. In 2009-10, India's GDP grew by 8 per cent. This rose to 8.5 per cent in 2010-11, the same year the monetary tightening drive began, though there was a marked slowdown from 8.9 per cent growth in the first half to about 8.1 per cent in the second half. Subsequently, GDP growth fell sharply to 6.1 per cent in the third quarter of 2011-12 from 6.9 per cent in the second quarter and 7.7 per cent in the first quarter of the fiscal. RATE CUTS IMPACT INFLATION The RBI paper also claims that empirical evidence indicates that policy interest rates have a negative impact on inflation, with the maximum decline observed with a lag of three quarters and the overall impact continuing through 8-10 quarters. At the start of its monetary tightening spree in March, 2010, wholesale price index (WPI)-based inflation stood at 10.36 per cent. Subsequently, inflation rose in the next month, but then registered a sustained decline to 8.2 per cent in November, 2010. However, it then rose again to 9.68 per cent in March, 2011, prompting the central bank to effect more rate hikes at subsequent monetary policy reviews. The RBI's rate actions caused the inflation rate to dip to 9.36 per cent in July 2011, following which it rose to 10 per cent in November 2011. By March 2012, it fell to 6.89 per cent, but rose to 7.23 per cent in April. With the development of domestic financial markets and gradual deregulation of interest rates, the monetary policy operating procedure in India in recent years has evolved towards greater reliance on interest rates to signal the stance of monetary policy. On the output side, these changes affect the spending, saving and investment behaviour of individuals and firms in the economy. On the inflation front, the level of demand relative to domestic supply capacity is a key influence on domestic inflationary pressure. CREDIT FLOWS AND OUTPUT It can be noted that a slowdown in industrial output expansion in 2011-12 was accompanied by reduced growth in domestic credit flows amid high interest rates. Index of Industrial Production (IIP) growth slowed to 2.8 per cent in FY12, down from 7.8 per cent in the previous year. During the year, commercial banks ramped up the quantum of loans provided to Indian industry by 21.3 per cent. But this was slower than the 23.6 per cent growth in the previous fiscal. :: Business Line
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