The transmission of monetary policy impulses on the economy thus relies very much on well functioning money and capital markets. The first element in the transmission mechanism, the money market, came under significant stress in August 2007. Concerns about sudden liquidity needs and caused banks’ demand for funds to rise sharply, while doubts about counterparties’ solvency led supply to drop.
Understandably, there are certain rigidities in the overall interest rate structure in the economy that constrain banks from reducing their lending rates. These have been well documented in the earlier monetary and credit policy statements of the RBI. Subsequently, interest rates on small savings have also moved down and there is a commitment from the Government to link these rates with market related rates.