Credit Channel of Monetary Transmission in India - How Effective and Long is the Lag?

This paper examined the operation of credit channel of monetary policy transmission in India during the post-LAF period of 2001:3 to 2011:3. Drawing on the literature, two reduced form equations, one representing nominal bank credit and the other real bank credit was estimated following an approach similar to Hendry’s general-to-specific method. It finds that, besides the positive influence of economic activity on bank credit, policy induced expansion or contraction in deposit or money supply makes banks to adjust their credit portfolio correspondingly. Importantly, the credit channel of monetary transmission is found to be significant and robust. Specifically, the transmission of policy rate to nominal or real bank credit growth takes about seven months over the full sample period as well as across various sub-sample periods. Over the full sample period, 100 basis points increase in policy rate was found to reduce the annualised growth in nominal and real bank credit by 2.78 per cent and 2.17 per cent, respectively. However, a decline in the magnitude of the impact of policy interest rate on bank credit has been observed during the post global financial crisis period