RBI rate hike hits investment growth the most

Moneycontrol Bureau

The impact of policy rate hike is more severe on the growth in investment demand and imports rather than the demand expansion in private and government consumptions and exports, revealed a RBI research paper.

"An interest rate hike has a significant negative impact on the growth of aggregate demand. However, the maximum impact is borne by growth in investment demand and in imports," said the RBI working paper series on "Estimating impacts of moneytary policy on aggregate demand in India" authored by Jeevan Kumar Khundrakpam.

"Impact on private consumption growth and exports growth is relatively far more subdued, while there is hardly any cumulative impact on growth of government consumption. Interest rate accounts for a significant percentage of the fluctuation in the growth of all the components of aggregate demand, except government consumption, while exchange rate has very little impact."

RBI had last hiked its interest rates by 25 basis points to 8.50% on October 25, 2011. Since then, the central bank shifted its gear to lower interest rate regime and slashed the repo rate by 50 bps till now. Repo is the rate at which banks borrow money from RBI.

The research paper pointed to a consensus that the credit policy affects real economy in the short run. Hence, it felt the urge to gauge as to which sectors of the economy are affected the most. At the same time, it tried to explore the impact of interest rate on each segment of aggregate demand including private consumption, government consumption, investment, exports and imports in India.

"Macroeconomic implications of reduction in aggregate demand due to slowdown in investment following monetary tightening would be different than those due to the reduction on account of slowdown in consumption demand," it cited.

RBI introduced the Working Papers series in March 2011. These papers present research in progress of the staff members of RBI and are disseminated to elicit comments and further debate. The views expressed in the working series papers are of authors only. The research was done taking quarterly data from 2000Q1 to 2011Q1.