Credit channel of monetary policy transmission: Evidence from India

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The present study explores the effectiveness of the credit channel of monetary policy transmission in India from the perspective of magnitude, timing, and composition puzzles. To validate, further investigation of the effectiveness of the balance sheet channel and bank lending channel using the corporate cash flows and interest rate spreads, respectively, has been done. The study employs the structural vector autoregression model using the long-time quarterly series sample period from June 1998 to June 2022. The findings show that the anomalies concerning magnitude, timing, and composition effect do not exhibit a strong presence in the Indian context. The analysis of the weighted average call money rate and coverage ratio suggests a weak presence of the balance sheet channel in India with a weak negative correlation of 0.2943 (p < 0.05). The overall behavior of spread analysis also shows a weak presence of the bank lending channel in India. Although some presence of the bank lending channel is seen on banks’ managed liability side, the effect of external finance premium is not reflected in the lending rates with a correlation of 0.0577 (p > 0.05) between prime lending rate spread and weighted average call money rate spread. From the evidence, the study concludes the weak presence of the credit channel in India. Therefore, the monetary authorities might have to rely on other channels or may devise other unconventional mechanisms like Operation Twist and Long-Term Repo Operations observed during the COVID-19 pandemic to steer the real economy.

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    • Figure 1a. Response of real GDP to a monetary policy shock
    • Figure 1b. Response of inflation to a monetary policy shock
    • Figure 1c. Response of WACR to a monetary policy shock
    • Figure 2a. Response of final demand to a monetary policy shock
    • Figure 2b. Response of change in stock to a monetary policy shock
    • Figure 3a. Response of private final consumption expenditure to a monetary policy shock
    • Figure 3b. Response of gross fixed capital formation to a monetary policy shock
    • Figure 4. WACR and coverage ratio
    • Figure 5a. Response of interest expenses to a monetary policy shock
    • Figure 5b. Response of net profit to a monetary policy shock
    • Figure 5c. Response of net sales to a monetary policy shock
    • Figure 5d. Response of salaries and wages to a monetary policy shock
    • Figure 6. Relationship between the interest rate spreads
    • Conceptualization
      Debaditya Mohanti, Souvik Banerjee
    • Data curation
      Debaditya Mohanti, Souvik Banerjee
    • Formal Analysis
      Debaditya Mohanti, Souvik Banerjee
    • Investigation
      Debaditya Mohanti, Souvik Banerjee
    • Methodology
      Debaditya Mohanti, Souvik Banerjee
    • Software
      Debaditya Mohanti, Souvik Banerjee
    • Validation
      Debaditya Mohanti, Souvik Banerjee
    • Writing – original draft
      Debaditya Mohanti, Souvik Banerjee
    • Writing – review & editing
      Debaditya Mohanti, Souvik Banerjee