Impact of Real Interest Rates on Investment and Economic Growth in India: An Empirical Analysis, 2000-2020

Abstract

Interest rates are an important part of the transmission process of monetary policy. Interest rates influence the cost of loans, personal savings, corporate capital spending, the availability of credit, and the level of economic activity. This paper examines the relationship between real interest rates, capital accumulation and output growth in India using annual macroeconomic data over a period of two decades (2000-2020). The main explanatory variable is the effective interest rate, investment is proxied by gross fixed capital formation (GFCF) as a percentage of gross domestic product (GDP), and economic success is represented by the annual real GDP growth. The data are taken from the World Bank’s World Development Indicators and several international financial databases. The empirical approach is based on descriptive statistics, Pearson correlation analysis and ordinary least square (OLS) regression. The results suggest a strong and statistically significant negative relationship between real interest rates and investment activity. The estimated correlation coefficient is approximately -0.618, and the bivariate regression shows that a one percentage point increase in the real interest rate is associated with a decrease of around 0.69 percentage points in GFCF as a share of GDP. Real interest rates have a small and statistically indistinguishable from zero direct linear effect on annual GDP growth. The investment coefficient is expected to be positive in a multivariate growth model. However, its statistical significance is limited by degrees of freedom and macroeconomic fluctuations. Our results suggest that the impact of monetary policy on the economy is mainly through capital accumulation and financial intermediation, rather than through a direct channel. The research suggests that policymakers need to consider the objective of maintaining inflation under control and the goal of providing attractive financing conditions for productive investment.