‘Rise in credit may not always result in higher investments’

An increase in credit may not always find its way towards investments as businesses may use credit lines to finance current liabilities, a Reserve Bank paper said.

The paper further says that banks respond to changes in money market spreads faster and better than changes in policy rates, which are announced by the RBI bi-monthly. “In addition to slow or lagged monetary policy transmission, an increase in credit may not always find its way towards increasing investments. Firms may use their credit lines to finance their current liabilities rather than undertaking capital formation,” said the paper written by Saurabh Ghosh and Abhinav Narayanan, both officials of the Reserve Bank of India (RBI).

Monetary policy transmission has remained a pivotal topic of interest across all central bankers. Empirically, however, it is hard to disentangle the effects of a policy change on firms’ investment demand, banks’ credit supply and their interactions.

The findings indicate monetary policy transmission works with a lag for bank lending.