Big Data Analytics Solutions | Financial Services in India |Decimal Point Analysis

Decimal Digest
07 Jan 2013

Does the RBI have leverage in influencing investment decisions of Indian Corporates?

The traditional rationale for existence of a central bank and its monetary policy is the leverage that it has on investment decisions of the domestic corporate sector, as a direct outcome of changing interest rates. The rough thinking goes something like – when the central bank observes high inflation, it increases interest rates, as a result domestic corporates reduce investment demand, leading to a reduction in overall demand, which then leads to reduction in demand pull inflation and vice a versa.

This relationship between central bank action and direction of inflation can become weak if domestic corporates can fund their investments through foreign sources. The table below shows the sources of funding for India’s domestic corporates for 2009-10, the latest year for which data is available.

Table 1: Sources of Funding for Indian Corporate Sector

Source:Decimal Point Analytics Estimates

From the above table, we can see that Indian corporates funded nearly three-fifth of their requirements from foreign sources in FY10. It would be hard to imagine that foreign sources of funds would be influenced by RBI’s interest rate decisions. In other words, Indian corporates are more sensitive to actions by US FED than those by the RBI.

On the other hand, Indian households – without having unfettered access to foreign capital markets due to structural and regulatory issues - have no choice than to accept RBI’s negative real rates. As we have discussed in this publication in the past, this negative real rate regime is leading to increased speculative activities by Indians – in terms by hoarding of gold and real estate.

It would be desirable if the RBI appreciates that its monetary policy has very low leverage on Indian corporate sector, and adjusts its monetary, regulatory and structural stance accordingly, with a view to increase the effectiveness its actions.


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