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Until early 2016, India’s growth had been accelerating when growth in other countries was decelerating. But then the converse happened. The world economy embarked on a synchronous recovery, but India’s GDP growth—and indeed a number of other indicators such as industrial production, credit, and investment—decelerated. There are five reasons for this:

• First, India’s monetary conditions decoupled from the rest of the world. Until the middle of 2016, real policy interest rates were following the global trend downwards. Since then, the downward drift has continued in most other countries, with rates falling. But in India, for the same period, average real interest rates increased. This tightening of monetary conditions contributed to the divergence in economic activity in two ways. First, it depressed consumption and investment compared to that in other countries. Second, it attracted capital inflows especially into debt instruments, which caused the increase in demand for rupee and consequently rupee appreciates which causes dampening of exports.

Can anyone please explain what is written in bold in layman's terms?

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This means that interest rates rose in India at the same time that they stayed relatively low in other areas of the world. The fact that investors could get a higher yield in India led to an increase in demand for their currency (if I can get a 5% yield on Indian bonds, why would I get a 2% yield on US bonds?) This led to an increase in demand for their currency so that investors could buy Indian bonds/Invest in India at higher yields. The appreciation of the rupee (increase in value) led to India’s goods costing more (it took more dollars to buy Indian goods for example due to the currencies rise in value). This led to fewer goods being demanded (higher prices decrease demand). So Indias exports declined.

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  • $\begingroup$ So when interest rates increased in India, commodities and services got dearer (because the rate at which the corporate firms/industrial organizations had to borrow to run their businesses became higher) as a result of which consumption decreased. $\endgroup$ – Soumee Mar 15 '18 at 10:05
  • $\begingroup$ Can you please explain two more things: first: while interest rates were decreasing globally, what could be the possible reason that it increased in India. Second: How the increase in interest rates resulted(or generally results) in capital inflows, and how capital inflows result in appreciation of the rupee? $\endgroup$ – Soumee Mar 15 '18 at 10:13
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    $\begingroup$ The RBI (reserve bank of India) raised interest rates in order to reduce inflation, while other countries globally were experiencing deflation, or did not curb inflation. That explains "why" rates rose (to curb inflation). A rise in rates increases capital inflows because people want the higher yield (return) so long as inflation is decreasing. In order to invest in India (or any country) you have to buy the local currency, increasing demand for the currency, and increasing that currencies value. $\endgroup$ – Simeon Ikudabo Mar 15 '18 at 10:31

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