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. 

Interest rate effect - Infrastructure growth falls to 5.2%

High interst rate has started showing its colors on the infrastructure and overall growth of the economy. As per the data released on 1st June the growth of the six core infrastructure industries in April had fallen to 5.2%. In March 2011 the infrastructure growth was 7.4%.

Yesterday the GDP growth numbers were reported as 7.8% way below the street estimates.

RBI has increased interest rates by 300 basis points in last 1 year and the market is expecting another round of 25 bps rate hike on 16th June by RBI.