Wednesday, December 14, 2011

Impact of Interest Rate on GDP

The Reserve Bank of India (RBI) has hiked repo rates by 375 bps since March, 2010 to curb inflation primarily by reducing demand in the system. Consequently inflation has got moderated, but such a massive increase in rates over short span of time has affected the economic growth significantly.

There is an interesting co-relation between GDP growth and repo rate hikes. Repo is the rate at which banks borrow from the RBI to meet their liquidity requirement. Currently, it is at 8.25%.

GDP growth is inversely proportional to repo rates, as can be seen from the chart below. When we compare the repo rate with the GDP growth in the period between Q4FY10 and Q2FY12, whenever there was a policy rate hike, GDP growth dropped. 

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