dubbed as a “ black box ”. 2 hence, explaining monetary transmission is a constant challenge for every central bank. let me now turn to the issue of transmission of monetary policy in india. in the last few years, there have been several empirical studies, examining the interest rate channel of monetary transmission. the general conclusion from these studies is that increases in policy rate have bernanke, ben and alan blinder ( 1995 ), “ inside the black box : the credit channel of monetary transmission ”, journal of economic perspectives, 9, 27 – 48. bis central bankers ’ speeches a statistically significant negative impact on output and moderating impact on inflation. however, the negative effect of a policy rate increase is first felt on output before the moderating impact on inflation. the lags in policy rate changes on output are 2 – 3 quarters and on inflation 3 – 4 quarters. the total impact on policy change could, however, linger for 8 – 10 quarters. 3 a notable feature of monetary policy transmission in india is the asymmetry one observes during different phases of a monetary policy cycle. usually, during a phase of rising policy rate, banks may be quick in raising their lending rates while in a phase of falling policy rate, banks may be slow in reducing their lending rates as cost of deposits does not adjust commensurately given the fixed nature of deposit contracts. this pattern reflects that loans, being mostly at variable rates, can be re - priced at a quicker pace than the fixed rate bank deposits. the asymmetric transmission also needs to be seen in relation to overall liquidity conditions. for example, in a tight liquidity condition, even if the policy rate is reduced banks may not be in a position to reduce deposit rates and hence lending rates with the apprehension of losing deposits. there could be other considerations for not lowering deposit rates if rates of return in competing products such as small savings and mutual funds are more attractive. another consideration in a falling interest rate scenario could be that banks might want to protect their profit margin through a more sluggish adjustment of their lending rates. notwithstanding various complexities, the interest rate channel of monetary transmission has been evident over the monetary policy cycles in the recent years. the policy interest rate changes did impact the market interest rate in the same direction, though at varying intensity. the magnitude of changes in lending rates, however, more closely followed the changes in deposit rates ( table 2 ). please see, mohanty, deepak ( 2012 ),

deepak mohanty : interest rates and economic activity speech by mr deepak mohanty, executive director of the reserve bank of india, to the association of financial professionals of india ( afpi ), pune, 23 august 2013. * * * the assistance provided by sitikantha pattnaik and abhiman das in preparation of the speech is acknowledged. i thank ms. preeta misra, director & member secretary, association of financial professionals of india ( afpi ) for this opportunity to interact with distinguished professionals of corporate india. in the recent period, there has been an animated debate on the role of interest rates in influencing real economic activities. in particular, the discussion has been on how a change in policy interest rate impacts the lending rates, and thereby industrial performance and overall economic activity. in this context, the last decade through 2012 – 13 has been eventful with rapid changes in the monetary policy stance responding to the evolving growth - inflation dynamics. this is a period in which we recorded one of our highest output growth rate as also one of the lowest. inflation showed significant variation. we also experienced the global financial crisis, the adverse effects of which are still lingering. as you know, indian economy is currently passing through a very challenging phase : growth has slowed ; though wholesale price inflation has come down consumer price inflation remains close to double digits, and financial market volatility has increased. a major factor in the recent growth slowdown is a significant deceleration in private corporate investment. since you are the key professionals taking investment decisions, i thought it will be relevant to discuss how does monetary policy decisions, through interest rate changes, affect investment decisions and thus economic activity? another motivation for this subject is that colleagues in the reserve bank have done substantial research in this area and a paper entitled “ real interest rate impact on investment and growth : what the empirical evidence for india suggests? ” was placed in the public domain. 1 i will urge you to look at that paper so that it generates further research and discussion. against this background, my presentation will be as follows : i will briefly review the stance of monetary policy and economic outcome during the last decade through 2012 – 13 ; discuss monetary transmission with a focus on the interest rate channel ; and examine the impact of interest rate changes on economic activity both at the macro and micro levels. changes in monetary stance in the last 10 - year period from 2003 – 04 to 2012 – 13, monetary policy response can be broadly categorised