Stability of Lending Rate Stickiness: A Case Study of India

Abstract

The paper postulates that in an environment of continuous financial reforms, the lending rate stickiness in an economy could be changing over the period. The financial reforms (of which deregulation of interest rates formed a major part) during the 1990s and the early 2000s and the changing role attributed to different policy rates during the reforms make India an interesting case study. The paper finds evidence of diminishing lending rate stickiness in case of India. During the major part of the study, Indian policymakers used the discount rate for policy signaling. The paper observes that as a result, the long-term rates like the lending rates did not react sufficiently to the changes in the short-term rates (e.g., repo rate) in this period unless the discount rate was also changed. Such behavior changed when policymakers started to use short-term rates like repo rates for policy signaling. Results in this paper suggest that when the impacts are added together, a change of 100 basis points in all policy rates towards the end of the reference period could change the lending rate in India almost by similar magnitude. These findings help to reconcile some of the contrasting findings on lending rate stickiness in case of India. Among possible factors still responsible for lending rate stickiness, the study identifies inelastic credit demand in India as an important factor. From policymaking perspective, however, it is postulated that as demand for personal and housing loans in India are likely to increase in future due to demographic factor, it is likely that such increase could tend to increase inflexibility in loan rates.Lending Rate Stickiness, Discount Rate Addiction, Monetary Policy Transmission