The impact of demonetisation on interest rates
A year after demonetisation, one of its effects has been a substantial decline in lending and deposit rates. The chart, taken from the Reserve Bank of India’s (RBI’s) monetary policy report, has the details.
The chart shows that in the pre-demonetisation period—December 2014 to October 2016—while RBI lowered the repo rate by 1.75 percentage points, the weighted average lending rate (WALR) on outstanding loans went down by 0.75 percentage points.
But in the year after demonetisation, even though the repo rate has been lowered by a mere 0.25 percentage points, the fall in WALR on outstanding loans has been 0.50 percentage points.
The big change has been in fresh loans, where the fall in interest rates in the year after demonetisation has been equal to the fall pre-demonetisation, despite the much lower reduction in the policy rate.
The chart also shows how term deposit rates for banks also came down after demonetisation.
The upshot: Demonetisation and the resultant surge of deposits into banks did what RBI couldn’t—it ensured banks passed on reductions in the policy rate, helping borrowers. On the flip side, the very low rates of interest on bank deposits have led to a flow of funds to the capital markets.
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