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Stability of Lending Rate Stickiness: A Case Study of India

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  • Sastry, D. V. S.
  • Singh, Balwant
  • Bhattacharya, Kaushik

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.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 26570.

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Date of creation: 2009
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Handle: RePEc:pra:mprapa:26570

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Related research

Keywords: Lending Rate Stickiness; Discount Rate Addiction; Monetary Policy Transmission;

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References

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  1. Clements,Michael & Hendry,David, 1998. "Forecasting Economic Time Series," Cambridge Books, Cambridge University Press, number 9780521632423, Fall.
  2. Giovanni Ferri & Carlo Cottarelli & Andrea Generale, 1995. "Bank Lending Rates and Financial Structure in Italy," IMF Working Papers 95/38, International Monetary Fund.
  3. Solange Berstein & J. Rodrigo Fuentes, 2004. "Is There Lendign Rate Stickiness in the Chilean Banking Industry?," Central Banking, Analysis, and Economic Policies Book Series, in: Luis Antonio Ahumada & J. Rodrigo Fuentes & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Se (ed.), Banking Market Structure and Monetary Policy, edition 1, volume 7, chapter 6, pages 183-210 Central Bank of Chile.
  4. International Monetary Fund, 2005. "Competition in Indian Banking," IMF Working Papers 05/141, International Monetary Fund.
  5. Breusch, Trevor S & Wickens, Michael R, 1987. "Dynamic Specification, the Long Run and the Estimation of Transformed Regression Models," CEPR Discussion Papers 154, C.E.P.R. Discussion Papers.
  6. Philip Lowe & Thomas Rohling, 1992. "Loan Rate Stickiness: Theory and Evidence," RBA Research Discussion Papers rdp9206, Reserve Bank of Australia.
  7. International Monetary Fund, 2005. "Monetary Policy and Corporate Behaviour in India," IMF Working Papers 05/25, International Monetary Fund.
  8. Bakhtiar Moazzami, 1999. "Lending rate stickiness and monetary transmission mechanism: the case of Canada and the United States," Applied Financial Economics, Taylor & Francis Journals, vol. 9(6), pages 533-538.
  9. Hannan, Timothy H & Berger, Allen N, 1991. "The Rigidity of Prices: Evidence from the Banking Industry," American Economic Review, American Economic Association, vol. 81(4), pages 938-45, September.
  10. Heffernan, Shelagh A, 1997. "Modelling British Interest Rate Adjustment: An Error Correction Approach," Economica, London School of Economics and Political Science, vol. 64(254), pages 211-31, May.
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