A study on the impact of RBI monetary policies on the Indian Stock market

Introduction
Early in the 1990s, India began the process of liberalizing its markets, albeit some of
the prevalent quantitative restraints had already begun to be gradually eliminated
by then. It made modest headway toward the privatization of the publicly owned
loss-making enterprises, significantly loosened restrictions on capital flow, and
liberalized trade in goods.
India had a mostly internalized strategy for industrialization planning after gaining
independence from Britain in 1947. In contrast to many other emerging nations with
comparable levels of development, India had a well-developed financial sector and a
diverse production structure. Due to British ownership of a sizable portion of the
industrial sector, it also received huge amounts of FDI. Additionally, some plantations
and mines were (mostly) held by foreigners.
Several development finance institutions were established because industrialization
needed money. In 1955, the Imperial Bank has established as a national bank. Fourteen
further commercial banks were nationalized in 1969. A period of populism and financial
restriction followed. Because of populist forces, financial repression did not grow as a
structural aspect of development. It was necessary to raise money to subsidize
politically favored lobbies and cover the losses of poorly managed public-sector
manufacturing units. Being a permanent borrower, the government was interested in
ensuring that borrowing costs remained low, which is why state-owned banks and
financial repression were established. The asset side of the banks' balance sheets
deteriorated after nationalization, even though the state-owned banks were effective in
attracting savings. In addition to holding government assets as required by the Statutory
Liquidity Ratio, banks were required to maintain a high cash reserve ratio (CRR) (SLR).
When the CRR and SLR (together with other regulations) were taken into consideration,
there were frequently less than half of the banking system's assets left over for
commercial lending. The volume and cost of new issues were determined by the
Controller of Issues, who also oversaw the stock market. But when viewed in aggregate,
statistics like the ratio of M3 to GDP or the number of bank branches per person create
a positive picture.
Slowly but surely, things started to shift in the 1980s. In 1985, the Sukhomoy
Chakravarty Committee suggested freeing up the banking sector. Real exchange rate
targeting was explored to boost the nation's export performance.
Between 1985–1986 and 1989–1990, there was a nominal depreciation of roughly 45
percent, which resulted in a real devaluation of 30 percent. Such was the centralization
of decision-making in the nation (and the insignificance of the Reserve Bank of India)
that the Union Cabinet decided on the real devaluation! During this time, both imports
(which were also liberalized) and exports increased at a five percent yearly rate. In
1990–1991 the budget deficit was 8.4% of GDP and the current account deficit was 3.1%
of GDP. By sparking a severe balance of payments crisis in 1990, the Gulf War—a
temporary shock that at most represented one percent of GDP—illustrated the fragility
of India's macroeconomic balance.
A period of liberalization followed this macroeconomic disaster. India significantly
expanded its foreign trade and capital account despite maintaining significant budget
deficits. Different chapters will cover other facets of macroeconomic policy; in
particular, Buiter and Patel, Kletzer, and Acharya's chapters will cover the topics of
capital flows and monetary policy.
The monetary policy is a tool with which the Reserve Bank of India (RBI) controls the
money supply by controlling the interest rates. They do this by tweaking the
interest rates. RBI is India’s central bank. Every country’s central bank is responsible
for setting interest rates worldwide.

While setting the interest rates, the RBI has to strike a balance between growth and
inflation. In a nutshell – if the interest rates are high, that means the borrowing
rates are high (particularly for corporations). If corporate can’t borrow easily, they
cannot grow. If a corporate doesn’t grow, the economy will slow down.

On the other hand, borrowing becomes easier when the interest rates are low. This
translates to more money in the hands of corporations and consumers. With more
money, there is increased spending which means the sellers tend to increase prices
leading to inflation.

To strike a balance, the RBI has to consider all the factors and carefully set a few key
rates. Any imbalance in these rates can lead to economic chaos. The key RBI rates
that you need to track are as follows:

Repo Rate – Banks can borrow from the RBI whenever they want to borrow money.
The rate at which RBI lends money to other banks is called the repo rate. If the repo
rate is high, the cost of borrowing is high, leading to slow economic growth.
Currently, the repo rate in India is 8%. Markets don’t like the RBI increasing the repo
rates.

Reverse repo rate – Reverse Repo rate is the rate at which RBI borrows money from
banks. When banks lend money to RBI, they are certain that RBI will not default,
and hence they are happier to lend their money to RBI as opposed to a corporate.
However, when banks choose to lend money to the RBI instead of the corporate
entity, the banking system’s supply of money reduces. An increase in the reverse
repo rate is not great for the economy as it tightens the supply of money. The
reverse repo rate is currently at 7%.

Cash reserve ratio (CRR) –  Every bank is mandatorily required to maintain funds
with RBI. The amount that they maintain is dependent on the CRR. If CRR increases,
then more money is removed from the system, which is not good for the economy.

o RBI can also change the CRR rate to control the liquidity flow. To overcome
liquidity hurdles, the central bank can lower the CRR or cash reserve ratio for
commercial banks.
o This increases the liquidity in the market. Thus, investors become interested in
putting money in the stock market and the market goes up.
o More liquidity is always favorable for short-term and mid-term investors.
Oppositely, shrinks in the CRR rate can demotivate traders and investors. In such
a case, they are eager to pull out their money from the market, and the price
moves downtrend.

Monetary policy is concerned with changes in the supply of money. India's

monetary policy is about financing economic growth. In the 1980s the Indian
economy was suffering from a big economic crisis, and to meet the crisis India
approached World Bank and International Monetary Fund (IMF) for a loan and
World Bank granted the loan. Afterward, India introduced a new economic policy in
July 1991. The policy was introduced to slow down monetary expansions and
control inflation.
Monetary policy is formulated by the central bank (RBI) to facilitate economic
growth and control the supply of money. The RBI meets every quarter to review the
cash reserve ratio (CRR), statutory liquidity ratio (SLR), repo rate, and reverse repo
rate to control the money supply of the country. This is a key event that the market
watches out for. The first to react to rate decisions would be interest-rate-sensitive
stocks across various sectors such as – banks, automobiles, housing finance, real
estate, metals, etc. This analysis is aim to discuss the impact of monetary policy on
the Indian stock market. Stock prices are closely monitored as asset prices in the
economy and it is regarded as highly sensitive to economic conditions. The stock
prices depend on the key interest rates of RBI. If RBI increases CRR the interest rates
of the bank will increase. Hence all firms may not borrow money from banks which
results in a reduction in the production of goods and services. Due to these imports
will increase and exports will decrease, which causes a reduction in the Gross
Domestic Product of the country.
 In the stock market, a cut in interest rates will cause a positive impact. If CRR rates
will decrease the bank savings will be unattractive. Thus, depositors may move to
the stock market, which results in a boost in the security prices.
The liquidity in the stock market is generated by the central bank with monetary
policy. Stock market volatility is depending on the monetary policy rates. Hence
NIFTY volatility is influenced by the CRR of RBI. Recently India has experienced high
inflation because the RBI revised the Cash reserve ratio and policy rate (Repo rate).
So, any fluctuation in the monetary policy will directly impact stock market returns
and the nation's overall economy.

Functions of Reserve Bank of India

1. Credit Controller
To control the rate of inflation and deflation in the economy, RBI monitors the
supply of money. Because of this, the RBI is referred to as our nation's credit
controller. It also functions as a monetary controller, setting monetary policy for
our nation. RBI supports economic expansion and price stability. Under the
umbrella of monetary policy, the central bank has several different types of credit
control instruments that we will cover in more detail in the following section.

2. Currency Issuer
Indian currency notes may only be issued by the Reserve Bank of India. Along with
generating the new currency note, it is also accountable for exchanging worn-out
or damaged notes for fresh ones. The question is, can RBI print fresh notes as they
please? Not. The printing of currency notes is governed by a minimum reserve
mechanism. Since 1957, it has maintained a minimum reserve of Rs. 200 crores, of
which Rs. 115 crores is made up of gold as collateral for the issued currency. And
the foreign exchange reserve is the amount that is left over.

3. Regulator of Banks
To protect public deposit funds, the central bank controls every other Indian bank.
Banks are required to keep a specific amount of cash on hand with the RBI.
Additionally, it functions as all other banks' bankers. Indian banks may borrow and
deposit money from the central bank under exceptional circumstances. RBI keeps
an eye on interbank activity to ensure a quick and efficient clearing procedure.

4. Government’s Banker
The RBI handles all of the government's banking requirements, including providing
short-term credits, investing excess funds, floating loans, and other banking
activities. It serves the national and state governments. In addition, it serves as the
 government of India's principal financial advisor. The RBI is crucial to the nation's
financial system, playing a part in everything from monetary policy formulation to
the management of public debt.

5. Foreign Exchange Manager

The RBI controls the stability of the foreign exchange rate to control the flow of
foreign currency. Additionally, RBI checks foreign transactions to ensure they are
conducted by the Foreign Exchange Management Act. Thus, RBI's job in foreign
exchange management is more significant. It guarantees that merchants can
transact in foreign exchange clearly and simply.
o Ease in the foreign exchange rate can massively drive the stock market. Foreign
investment plays a vital role in moving the stock market towards an uptrend or
downtrend.
o Thus, ease in the foreign exchange rate and regulations can make foreign
investors interested to invest more money in the Indian stock market.

RBI Policy Timing

Under the RBI Act, the Monetary Policy Committee (MPC) has to meet at least 4
times a year. As per the urgency, MPC can meet more than 4times but not less
than that. MPC must publish its decision after the completion of every meeting.

Types of Monetary Policy by RBI

Monetary policy can be of different types. RBI brings different types of policies as
per the market requirement. Two common types are Contractionary monetary
policy and Expansionary monetary policy.
1. Contractionary Monetary Policy
As the name implies, this monetary strategy reduces or contracts the money
supply to combat inflation in an economy. By hiking bank reserve rates, selling
government bonds, and limiting money flow, the contraction is brought on. To
combat inflation, RBI essentially tightens monetary policy and slows the
economy.

2. Expansionary Monetary Policy

The monetary policy has a purpose that is completely opposed to a
contractionary monetary policy. Here, RBI implements a strategy to accelerate
the economy by expanding the money supply. The policy includes a decrease in
interest rates, an increase in cash flow, and a reduction in bank reserves. In
 essence, it stimulates global economic expansion. This monetary policy
increases market liquidity.

Instruments for Monetary Policy by RBI

Here, is the list of important direct and indirect instruments of monetary policy.

1. Liquidity Adjustment Facility (LAF)

The LAF is a crucial tool for monetary policy. With the help of repurchase
agreements and at a fixed interest rate, the instrument enables banks to borrow
money from RBI. Buy agreements allow banks to borrow money from the RBI in
exchange for the promise to later repurchase the same. Repo rate and Reserve
repo rate make up LAF.

2. Marginal Standing Facility (MSF)

Commercial banks can borrow money from RBI overnight by utilizing the MSF
option as well. The key distinction between MSF and LAF is that MSF is available
for a longer period and that only scheduled commercial banks are eligible to
apply. Banks may borrow money by drawing down on their SLR (Statutory
Liquidity Ratio) up to a predetermined amount and at a predetermined interest
rate.

3. Statutory Liquidity Ratio (SLR)

Commercial banks are required to hold specific levels of NDTL (Net Demand and
Time Liabilities) with themselves in the form of gold, cash, or government
securities. To limit the amount of money in the economy, the RBI might raise the
SLR rate, and vice versa.

4. Bank Rate
The RBI grants collateral-free loans to other banks at this bank rate. Additionally,
at this price, the RBI purchases or discounts government commercial papers,
including exchange bills. The bank rate and MSF rate are also closely related.
Every time the MSF changes, the bank rate also does.

5. Open Market Operation (OMO)

The RBI purchases and sells both short-term and long-term govt securities on the
open market using this OMO instrument. RBI purchases assets to add liquidity to
the market and sells them to remove liquidity. This is how the open market
works.
o Whenever RBI injects money into the open market by buying Govt securities, the
stock market moves up for injecting liquidity.
o Reversely, when RBI sells securities to absorb excess liquidity from the market,
generally share price goes down.
To maintain price stability and promote rapid economic growth, a central bank,
which in most cases is the monetary authority of a nation, uses monetary policy
to exert control over the amount of money available in the economy. The
Reserve Bank of India (RBI), which oversees all monetary policy in India, was
established to preserve the nation's economy's price stability.
1) Price Stability
Price stability is fostering economic growth while placing a strong emphasis on
price stability. The major goal is to create an environment that supports the
architecture needed for development projects to move forward quickly while
retaining fair price stability.
2) Controlled Expansion of Bank Credit
The controlled growth of bank credit and the money supply, paying particular
attention to seasonal credit needs without impacting output, is one of the RBI's
key responsibilities.
3) Promotion of Fixed Investment
By limiting non-essential fixed investment, it is hoped that investment
productivity will increase.
4) Restriction of Inventories
A sick unit is frequently the result of overstocking and products going out of
date as a result of the surplus of stock. The central monetary authority
performs this crucial task of limiting inventories to avoid this issue. This
policy's primary goal is to prevent excess inventory and idle funds within the
firm.
5) Promotion of Exports and Food Procurement Operations
To increase exports and ease trade, the monetary policy pays special
attention. It is a separate goal of monetary policy.
6) Ideally Distributed Credit
Decisions regarding the distribution of credit to priority sectors and small
borrowers are under the control of the monetary authorities. This policy
determines the specific proportion of credit that will be given to small and
priority sector borrowers.
7) lowering rigidity
The RBI works to create operational flexibility that offers a high degree of
autonomy. It promotes diversification and a more competitive environment.
To keep the financial system operating with restraint and caution, it maintains
control over it whenever and wherever it is required.
 8) To Increase Effectiveness
It is yet another crucial factor to which the central banks give significant
attention. By deregulating interest rates, easing operating restrictions in the
credit distribution system, introducing new money market instruments, and
other structural reforms, it seeks to improve the efficiency of the financial
system.

During the pandemic, the interest rate was low for a long time

When the pandemic started, companies had to halt their production and many
consumers were deprived of income. To run the economy smoothly, central banks
decided to reduce the interest rates so that companies and people could borrow
money at cheaper rates. Demand for goods and services surged due to the
availability of cheap money. This is one of the primary reasons for the surge in
share prices across the world.
Given that the economic impact of COVID-19 is subsiding and the economy is
returning to normalcy, inflation has also risen. High inflation is universally
considered harmful to the economy and the surest way of reducing the rate of
inflation is by raising policy rates. The lower rates have resulted in a situation that
economists call ‘too much money chasing too few goods. Consequently, inflation
has reached historic levels, leaving central banks with no other choice but to raise
interest rates.
Between March 2020 and May 2020, the RBI reduced the repo rate from 5.15
percent to 4 percent. This was done to mitigate the impact of the pandemic and to
support the economy that had come to a standstill. Over the same period, the
reverse repo rate was brought down from 4.9 percent to 3.35 percent. These two
rates are now at their lowest in a decade.
Inflation averaged 4.8 percent in FY20. It was 6.2 percent in FY21. The increase was
largely on account of pandemic-induced supply-chain disruptions and lockdowns.
During FY21, the food and beverage category was the major driver of inflation.
However, so far in FY22, the major contributors to inflation have been fuel and
transport. Crude-oil prices, petroleum product prices, and higher taxes are the
main reason for this. At the start of the pandemic, crude oil prices dropped sharply
as demand was benign. However, unprecedented cuts in supply by major oil-
producing countries and rising demand led to an equally sharp rise in prices. On
top of it, the government did not cut the central excise duty on petrol and diesel
till late 2021. There was moderation in crude oil prices towards the end of 2021
but the recent geopolitical tensions in Eastern Europe and the Middle East caused
crude oil prices to rise above $90 per barrel.

Higher rates in developed countries impact India

Higher rates in developed countries lead to an outflow of capital from emerging
markets like India. With a higher opportunity cost, the relative attractiveness of
investing in developing countries like India would decrease for foreign investors.
This would lead to higher outflows and reduced inflows in the Indian market.
Further, a higher interest rate in developed countries (for example, the US) would
strengthen their currency (US dollar) against the rupee. This would, in turn,
translate into a higher cost of imports. Crude oil and other petroleum products
would become more expensive and this would contribute to inflation. This would
further increase the cost of raw materials for many companies and, in turn, lower
their margins. However, for export-driven companies, the stronger dollar is
beneficial. As foreign investors move money out of India, it could lead to high
volatility in share prices. The past few weeks are an example of that.

Sectors that are more vulnerable and are relatively more immune to
interest rate hikes
As a rule of thumb, sectors, where debt plays an important role, tend to get
negatively affected when interest rates go up as the interest outgo of the
companies in such sectors rises, which reduces their margins and consequently
profits. Here are some sectors that may have to bear the brunt of rising rates:
Banks: At first glance, it might seem like banks should benefit from interest-rate
hikes. This is because banks would be able to charge a higher rate from borrowers
while keeping interested paid to depositors at the same level. However, that’s not
the entire picture. Individuals can choose to defer taking out loans and corporates
can choose to raise equity if the debt is not attractive. They might even seek to
borrow from abroad where rates are far lower. Moreover, an interest-rate hike
pushes the bond prices down, leading to losses in banks’ treasury portfolios as
they own a chunk of government bonds. So, in sum, higher interest rates do not
end up benefitting banks.
NBFCs: A similar conclusion can be drawn for non-banking financial companies
(NBFCs), with the major difference being that since most NBFCs don’t have a
depositor base to tap into, their cost of funds tends to increase more than that of
banks. Furthermore, given the lower credit quality of their loan book (assets), they
might start seeing some losses.
Real estate and Infra: The real estate and infrastructure sector are also vulnerable
to high-interest rates. When projects take a long time to complete, debt becomes
a necessity and consequently higher interest rates increase the company’s interest
burden. For real-estate developers, the impact is two-fold. First, demand gets
affected due to the higher cost of borrowing for a homebuyer, and second,
depending on the company, the cost of construction increases due to a higher
interest-rate burden. In the infrastructure-construction space, not all companies
are paid upfront. While there are different revenue models (e.g., build-operate-
transfer; engineering, procurement, and construction; hybrid annuity model)
wherein revenue is received at varying times and in varying amounts, debt plays a
very important role in all scenarios, given a large amount of capital invested and
the long payback period.
Automobiles: As a majority of automobile purchases (both passenger and
commercial) are financed via loans, a higher interest rate can put a dent in the
demand. And on top of that, a few manufacturers are highly indebted. Their
interest cost would also rise and hurt margins.
Others: There are many more sectors where debt plays an important role, such as
aviation, power, energy, metals, mining, etc. Since these sectors are capital-
intensive, the companies operating in these sectors need debt to fund their capital
expenditures. But the flip side is that the interest rate trajectory has a significant
influence on their performance. In contrast, sectors that are less affected due to
an increase in interest rates include FMCG, IT, and capital-light businesses like
asset management, exchanges, depositories, etc. But investors must keep in mind
that there is no hard-and-fast rule regarding the use of debt. There can be
companies in capital-intensive sectors with lower debt levels and companies in
capital-light sectors with high debt levels.

The decision to buy and sell a company should not be solely based on its sensitivity
to interest rates. Also, just because the interest rates are going to rise, it does not
guarantee that the operations of a company are going to be affected. The impact
of an interest rate hike would depend on a variety of factors such as the condition
of the current economy, how low-interest rates were in the first place, the ability
to absorb a rise in interest rates, the quantum of the rate hike, liquidity levels in
the system, etc. Simply stating that an interest-rate hike is bad is an incorrect
conclusion. While companies with high amounts of debt may get affected,
investors must still avoid painting all companies with the same brush. As an
example of a company in the interest-rate sensitive sector but still capable of
performing well, consider Bajaj Finance. The company is an NBFC with a strong
retail depositor base. Over the last two quarters, the company has raised nearly
`9,500 crores in non-convertible debentures of tenor ranging from two years and
above. In fact, about `4,444 crores are for over 10 years. This move not only
increases its liquidity buffer but also enhances the company’s ability to shield itself
from adverse interest-rate movements. Further, the company usually has more
loans than borrowings in the short term and therefore may not need to worry
about any mismatch in its cash flows.

Companies with high debt and low interest-coverage ratios

Company name Debt to equity Interest-coverage ratio

NXTDigital 44.60 0.1
Sun Pharma Advanced 31.80 -11.5
MMTC 24.20 -0.2
Jaiprakash Associates 19.30 0.5
OMDC 18.20 0.4
Shoppers Stop 17.10 0.5
Prime Focus 14.70 0.9
Future Lifestyle Fashions 10.30 -1.2
Swan Energy 4.50 0.0
DB Realty 3.50 -0.2
Ashok Leyland 3.30 1.0
Tata Motors 3.20 0.9
Jain Irrigation Systems 2.30 0.7
Dilip Buildcon 2.10 0.7
Bajaj Hindusthan Sugar 2.10 0.1

Whenever there are talks about interest-rate hikes, some companies will have a
high probability of getting affected. Why so? Because of their precarious financial
position. Certain companies would have not only accumulated a high level of debt
to finance their business but may also be in a difficult position to meet their
interest obligations. So, we have prepared a list of these companies (see table
‘Companies with high debt and low interest-coverage ratios) using the following
two criteria:
Debt to equity of more than two (this ratio measures the amount of debt in a
company compared to the amount of shareholders’ equity. The lower it is, the
better.)
 Interest coverage of less than one (this ratio measures the company’s ability to
meet its yearly interest obligations. The higher it is, the better.) As an investor, you
should avoid investing in these companies generally and more so in current times.

The Impact of RBI Interest Rate Hikes

When inflation runs too hot or asset bubbles get out of hand, the RBI raises interest
rates to cool things off.
Higher rates ripple throughout the entire economy. Mortgages, car loans, and
business loans become more expensive, slowing down cash flows. This can lead
businesses to amend or pause growth plans.
In the stock market, higher rates can incentivize investors to sell assets and to take
profits, especially in times like now when there have been a few years of double-
digit percentage returns on stocks. As you might guess, investor decisions like this
can lower stock prices—individually, at least, if not across major market sectors.
What’s more, if interest rates rise high enough, boring savings instruments like
savings accounts or fixed deposits might start looking more attractive to some
conservative investors.

The Dynamics Behind Rate Hikes and Stock Performance

When trying to divine which way the market may move, it’s important to keep in
mind that rate hikes don’t hurt everyone equally. They can help certain sectors,
like financial stocks. If you are in the business of lending money, higher rates mean
higher margins.
On the other hand, rising rates tend to hurt growth stocks, like tech start-ups. In
uncertain markets, investors tend to look for stable companies, like commodities,
indices and established tech firms.
These companies tend to pay dividends, which ensure some growth even if the
share price drops. High-growth companies usually put their cash into expanding the
business and tend to churn through cash, so high borrowing costs can clip their
wings.
That’s why difficult markets favor selective investors—sometimes called “stock
pickers”—who guess the right companies and industries to invest in as market
conditions change.
But it’s pretty tricky to get the timing right, even for professionals, because not only
are you contending with any actions the RBI makes but also those of other investors
as well, many of whom have already priced rate hikes into their trading calculations.
But take heart, investors. While the RBI overnight lending rate matters, it is hardly
the only thing that impacts stock market returns.
That’s a large part of why experts recommend most people hold diversified
portfolios of large index funds. This way, you already have exposure to short-term
winners (even if it means you also hold some losers), come what may. And that
helps position you to be a winner long-term.
Literature Review: Theory and Evidence
The literature generally acknowledges that, at least in the near run, monetary policy
has an impact on the actual economy. Numerous research has been done in the
developed markets to evaluate the effectiveness of the capital markets regarding
the announcements of monetary policy. There have only been a relatively small
number of studies done in India. There isn't an agreement on the channel, though
how output and pricing behaviour is affected by monetary policy. A theoretical Over
time, monetary policy transmission explanations have undergone significant
changes. Revaluations of past principles are frequently prompted by moments of
crisis.
The role of the interest rate channel in the transmission of monetary policy was
discussed by Keynes in his general theory of production and employment. Friedman
and Schwartz [1963] highlighted the role of the money supply in addition to other
assets in their monetarist characterization of the transmission mechanism. The
wealth impact was emphasized by Ando and Modigliani in their life cycle hypothesis
(1963), while Tobin (1969) emphasized the significance of the cost of capital and
portfolio choice in the transmission of monetary policy.
Since Bernanke's key article in 1986, which offered alternate explanations of real
and nominal sources of prices for explaining the relationship between money and
income, monetary policy transmission has become a topic of intense investigation in
recent years. The effectiveness of various transmission channels has been found to
vary, but this is still an open question. The importance of the credit channel for
monetary policy transmission in the US was highlighted by Bernanke and Blinder
[1988]. The credit channel of monetary transmission, according to Romer and
Romer [1990], was not supported.
There is conflicting evidence in the literature regarding whether there are trade-offs
or synergies between monetary policy and price stability and financial stability.
According to Schwartz (1995), price stability results in a low probability of interest
rate mismatches and a low inflation risk premium. The correct interest rate
projection as a result of the prices being maintained honestly was the cause of this
risk minimization. Financial soundness is influenced by adequate risk pricing.
According to this viewpoint, price stability can be used to provide both required and
sufficient circumstances for financial stability. However, other authors adopt a
cautious position in this matter and contend that achieving price stability can be a
necessary but not sufficient prerequisite for achieving financial stability (Issing,
2008; Padoa-Schioppa, 2002). A high-interest rate strategy to curb inflation,
according to Mishkin (1996), could hurt the balance sheets of both banks and
businesses.
Herrero et.al., (2003) have suggested that inflation volatility might be caused by an
overly loose monetary policy.
Positive inflation surprises can transfer real wealth from lenders to borrowers, but
negative inflation surprises can have the opposite effect.
Unstable financial conditions could result from a highly tight monetary policy that
causes disintermediation. It is believed that extremely low inflation levels brought
on by a highly strict monetary policy may result in extremely low-interest rates,
which would make cash holdings more alluring than interest-bearing bank deposits
and, as a result, lead to disintermediation. Furthermore, a large rise in real interest
rates hurts banks' balance sheets and may cause a credit crunch, which has negative
repercussions for the real estate and banking sectors.
The theoretical justification for this claim was offered by Driffill et al. in 2005. They
claimed that the central bank's interest rate smoothing technique would cause a
moral hazard issue and encourage financial firms to maintain riskier portfolios. The
phenomena of interest rate smoothing can occasionally cause the equilibrium of
rational expectations in the economy to be uncertain, which prevents active
monetary policy. Therefore, smoothing could be both unnecessary and undesired.
The argument in a Symposium on "The Monetary Policy Transmission" published in
the Journal of Economic Perspectives in 1995 shows how there is no general
agreement on the mechanisms of monetary transmission. Using a framework of
financial market pricing, Taylor [1995] examined the effects of monetary policy
transmission on real GDP and prices and discovered that the conventional interest
rate channel was significant. The conduct of monetary policy has global
repercussions, according to Obstfeld and Rogoff's 1995 analysis, which stressed the
significance of the exchange rate channel. Beyond interest rates, exchange rates,
and equity prices, Meltzer [1995] reemphasized transmission through various asset
prices.
Bernanke and Gertler disputed the effectiveness of the interest rate channel in
1995. They stated that monetary policy only has a small impact on long-term
interest rates, which can only have significant effects on the acquisition of durable
assets. This suggests that monetary policy is ineffectual. They proposed that the
credit channel of transmission may be used to solve the puzzle. However, Edwards
and Mishkin [1995] questioned the efficiency of the bank lending channel,
contending that banks were losing significance in the credit markets as a result of
financial innovations.
In his book, Mankiw (2001), discusses the many implications of fiscal policy,
including the crowding-out effect caused by an increase in government spending.
Additionally, he emphasized how trade surpluses are caused by fiscal expansion
because it raises interest rates. He concluded that short-term fiscal policies were
necessary because persistently low saving reduces the capital stock and the level of
output. In their study Economic Cycles in India from 2006, Padma Dua and Anirvan
Banerji explored business cycles and recession in India. The study has talked about
the timing of these cycles in the Indian economy. The coincident index, which
combines several economic variables including output, income, employment, etc.,
has been considered. This indicator provides insight into India's business cycles.
Fiscal stimulus was emphasized in the 2008 World Economic Outlook report on
global financial stability since failing to do so will have a greater negative impact on
the actual economy. It should be timely, well-targeted, transitory, and fourthly, it
should put money in the hands of those who are likely to spend it quickly, according
to Elmendorf and Furman's (2008) four canons for a successful fiscal stimulus. The
Indian economy's recovery from the recession and the different expansionary fiscal
measures that the government has implemented are discussed in the Economic
Survey of India 2008–2009. India saw a V-shaped growth curve in 2008–09 as a
result of the decline in the economy, and then again after the monetary and fiscal
actions were executed. The numerous justifications for providing the fiscal stimulus
package have also been covered.
The benefits of fiscal stimulus on consumption, IIP, GDP, and the exchange rate are
detailed in Asian Development India's (2009) report on the Indian Economic Review.
The vast market borrowing program of the Central Government is cited as a reason
why RBI needs to practice better monetary control. In his piece, Keynesian Fiscal
Stimulus Policies Stimulate Debt—Not the Economy, J. D. Foster (2009) attacked the
federal government for placing too much emphasis on the stimulus package and its
size. He advises the US government to rebuild the foundation of the system rather
than offering such huge rewards. In his column for The Hindu in 2009, C.R.L.
Narasimhan analyzed the numerous stimulus plans announced around the world as
well as their benefits and drawbacks. In her 2009 article, "Global Recession and Its
Impact on Indian Financial Markets," Nidhi Choudhari explored the numerous
negative repercussions of the global financial crisis on the Indian economy,
particularly on the Indian stock market, Indian money market, and Indian forex
market. The impact on the GDP, exports, and unemployment rate was also covered
by her. She also covers the various fiscal and monetary responses implemented by
the RBI and the Government of India to address this economic downturn. She
concluded that the Indian economy had been largely immune from the contagious
effects of the global collapse because of a strong and resilient banking sector,
functional financial markets, strong liquidity management and payment and
settlement systems, and buoyant foreign exchange reserves.
It is a challenging task for central banks to maintain monetary and financial stability
simultaneously. The monetary stability in terms of low Inequality could be
exacerbated by inflation, which would increase the volatility of asset prices, which is
having detrimental macroeconomic effects (Borio et.al., 2003; Borio and Lowe,
2002). According to Borio (2006), policymakers' actions to manage liquidity could
lead to a failed monetary policy on the one hand, and cutting interest rates to
promote liquidity could increase inflation on the other. Successful inflation
targeting, according to Poloz (2006), may increase financial volatility; as a result,
central banks may be better concentrating on strengthening financial institutions
rather than trying to come up with more complex policies that would lessen
financial volatility.
Smets and Wouters [2002] discovered that monetary policy shock via the interest
rate channel had an impact on real production, consumption, and investment
demand in the euro area nations. The interest rate channel was also discovered by
Angeloni et al. to be the only channel of transmission in a few countries in the euro
area, despite being a significant channel in practically all of them. Any other
financial transmission channel or the bank lending channel was present when the
interest rate channel was not dominating.
Loyaza and Schmidt-Hebbel [2002] reviewed empirical studies on the transmission
of monetary policy at the time and concluded that the traditional interest rate
channel was still the most important channel for influencing output and prices,
while the exchange rate channel became significant in open economies.
Neoclassical channels, such as direct interest rate effects on investment spending,
wealth and intertemporal substitution effects on consumption, and trade effects
through the exchange rate, continued to be the main channels in macroeconomic
modelling, according to a recent survey by Boivin et al. [2010], with little evidence
supporting the effectiveness of bank-based non-neoclassical channels of
transmission.
According to Asogu (1991), inflation is typically utilized to address situations in
which an economy experiences swift, ongoing, and unacceptably high increases in
the overall level of prices, which lead to a general decline in the purchasing power
of the currency. He claims that inflation severely annoys consumers, investors,
manufacturers, and the government.
The long-term trend of rising price levels can be ascribed to variations in the rates of
growth and productivity in the industrial and service sectors, according to research
on various nations by Maynard and Van Ryckeghem (1975), as referenced in Masha
(2003). Other contributing factors to price increases include disparities in price and
salary elasticity across the two sectors, consistent nominal wage growth across the
board, and rigidities in both price and wage structures. The character of inflation
has been the subject of some studies.
Empirical research into the causes of inflation was conducted by Asogu (1991) using
10 distinct specifications that addressed the monetary, structural, and open
economy components of inflation. Money supply, along with associated lag values,
is one of the variables used. Real GDP (real gross domestic product) and its lagged
values, total domestic credit to the economy and its lagged values, and government
spending and its lagged values. In all, the models were calculated, and the nature of
inflation seems to be well reflected by the industrial output index, the import price
index, and an official exchange rate.
When there is inflation, most prices increase, however, certain prices grow quicker
than others, according to Jhingan’s (1997). from their research that there is a
connection between inflation and price increases. a favorable correlation with price
movements Consequently, if there is a relationship between inflation and the
performance of stock prices of stated companies, one should anticipate a positive
correlation.
According to economic theory, the nominal return is calculated by adding the real
return and anticipated inflation. Therefore, on the assumption that inflation and
real return are unrelated, the stock return should be positively correlated with
inflation. In his 1930 prediction, Fisher assumed that the nominal return on stocks
would be equal to projected inflation plus the actual rate of return. A positive
correlation between stock return and inflation is also predicted under Fisher's
theory. The stock market ought to serve as a buffer against inflation, according to
the Fisher Hypothesis.
The stock market is not impacted by inflation, according to another school of
thinking (Fama Proxy Hypothesis, 1981). But empirical research has shown that
shifts in inflation expectations have a detrimental impact on stock performance.
Several studies, including Nelson (1976), Jaffe and Mandelker (1976), Bodie (1976),
Fama and William Schwert (1977), Modiglian and Cohn (1979), Geske and Roll
(1983), and Kaul (1987), backed the claim that there is a negative correlation
between stock return and inflation. There have been several explanations offered
for this unfavorable correlation, including the taxation connection, dividend price
ratios, price-earnings ratios, the inverse relationship between inflation and real
economic activity, etc.
The impact of inflation announcements on stock prices in different industries over
the near term was examined by Dáz and Jareo (2009). The relationship between
unexpected inflation statements and stock returns was examined using an event
research methodology. There was no proof of a meaningful connection between an
exceptional return and an inflation declaration. When the economy is robust and
the news is bad, the news response is substantial, according to research by Adams,
McQueen, and Wood (2004) on the intraday stock return for PPI and CPI. Around
the time of the CPI announcement, Schwert (1981) looked at Standard & Poor's
daily returns and saw a negative market response to the CPI's unexpected inflation
component. Using hourly data for the CPI announcement, Jain (1988) also
discovered a detrimental impact on stock prices and trade activity.
Knif, Kolari, and Pynnönen (2008) claim that the stock market's response to inflation
shocks, both positive and negative, might vary depending on the economic
situation. In other words, how investors view inflation will affect stock returns in
various economic conditions. Wei (2009) provided more evidence in support of the
study and discovered that equities return react negatively to unexpected inflation
during contraction rather than expansion.
For the sample period from 1970 to 1997, Khil and Lee (2000) examined the link
between real stock return and inflation for the United States and 10 Pacific Rim
nations. For nine nations in the Pacific Rim and the US, they discovered a negative
link between actual stock returns and inflation. The link between actual stock return
and inflation was found to be favorable in Malaysia. The U.S. and Pacific were
checked because of the inflation rate. For instance, whereas inflation is moderate in
the United States, it is extremely high in Asian nations. Pimentel and Choudhry
(2014) give empirical evidence of the positive association between composite stock
returns and inflation for Brazil during periods of high inflation.
Stock returns and inflation were found to be positively correlated with CPI and
independent of PPI by Tiwari, Dar, Bhanja, Arouri, and Teulon (2015). (Producers
Price Index). Overall, they discovered that equities might be utilized as a long-term
hedge against Pakistani inflation using both of the criteria. The dynamic conditional
association of stock prices and inflation in the United States from 1791 to 2015 was
explored in one of the more recent research projects by Antonakakis et al. (2017).
They saw how the relationship between stock prices and inflation changed in a
variety of ways over time. The association, for instance, is highly favorable in the
1840s, 1860s, 1930s, and 2011 and significantly negative in other periods.
The results of a study titled "Estimating Monitory Policy Reaction Function (2011): A
Factor Augmented Vector Auto-Regressive (FAVAR) Approach." Banking and money
management journal. The discovery of monetary policy reaction functions was
made by Taylor (1993) in his important study. According to this, central bankers
raise the nominal interest rate when inflation exceeds the objective (the inflation
gap) or when output exceeds the potential (the output gap), and vice versa. The
information used in this study was gathered from several sources. The augmented
Dickey-Fuller test is used to determine whether any variables have a unit root.
Stefano (2004) used the structural VARs methodology to assess the impact of
monetary policy on stock market indices in Spain and the G-7 nations. For each
nation's monetary policy shocks and their impacts, a model is estimated. The RBI's
policy decisions affected the majority of the Indian financial market's segments, but
had little effect on the stock market, according to Rudra and Indranil's (2006)
research. The authors use an SVAR model to determine if the growing emphasis on
indirect tools has made it easier to communicate the stance of monetary policy.
They also give evidence of the asymmetric reaction of financial markets to
monetary policy shocks.
Agrawal (2007) discovered that the random walk hypothesis suggests price
movements that are essentially independent of historical price movement, as future
prices are independent of such factors as the volume of sales, short interest, odd-lot
sales, and stock gains and drops. The investigation gave evidence that the random-
walk hypothesis might be false or, at the very least, incomplete.
The literature analyzing how stock markets react to changes in monetary policy was
influenced by Martin et al. (2007). The study examined how the European stock
market responded to the ECB's unexpected interest rate choices. The identification
by heteroskedasticity approach takes into consideration the endogeneity between
interest rate movements and stock returns. Using a variety of techniques to isolate
monetary policy shocks, the study discovered a negative and significant relationship
between unexpected ECB actions and the performance of European stock markets.
Ernst (2009) discovered the effect of monetary policy surprises by the FED or
Bundesbank/ECB on the return volatility of German equities and bonds. In the US,
stock return volatility is sensitive to changes in monetary policy, but changes in
monetary policy in the Eurozone affect bond return volatility. Although not
significant for other Eurozone bond markets, these conclusions are solid for other
Eurozone stock markets.
According to Selim's (2011) analysis of the influence of currency rates on monetary
policy decisions, countries that aim for inflation consider exchange rates when they
formulate their monetary policies.
In their article, Ray & Prabhu (2013) answer two questions: (a) what is the nature of
integration among various Indian financial market categories, and (b) how has
monetary policy affected various market segments? The findings show that the call
money rate effectively transmits a monetary policy. Other financial markets than
the stock market have also shown evidence of transmission of monetary policy
shocks. According to the report, the money market sector is fairly integrated.
There is some integration between the markets for corporate bonds and
government securities. Less integration exists between the money market and the
stock market, and the same finding is true between the money market and the
currency market.
Bhattacharya et al., (2009) investigate how the monetary policy framework and the
microstructure of the money market interact. The interbank call market, the 91,
182, and 364-day T-bill markets are the four money market segments that the
authors take into consideration. The empirical study focuses on the relationship
between monetary policy announcements, turnover in each market group, and bid-
ask spreads.
According to the findings, the call market, turnover, CRR announcement impacts,
and lagged bid-ask spreads all exhibit the predicted statistically significant patterns.
Except for the 364-day T-bill market, policy rates are important in the market for T-
bills, although the CRR announcement effect is important in all segments except for
the 91- and 182-day ones. Finally, the considerable lagged impacts confirm the
persistence of volatility across all markets.
The effects of policy rate shocks on financial indicators are examined in the RBI
(2011) study. When the repo rate is the relevant policy variable, the liquidity deficit
period is taken into account, and when the reverse repo rate is taken into account,
the liquidity surplus period. According to the findings, the financial market's
numerous segments are all affected differently by changes in policy rates. The money
market reacts to changes in the policy rate the fastest. In situations where there is a
liquidity deficit as opposed to a surplus, the transmission mechanism is more
efficient.
Carrera (2011) explored whether the availability of bank loans is affected by tight
monetary policy. Because banks refrain from entering into new loan agreements
when the existing ones mature, Bernanke and Blinder (1992) also discovered a
negative association between these two.
According to Singh (2011), there may be an asymmetry in how the monetary policy
is communicated among the various financial market segments. As opposed to the
long-term financial market, the short-term money market exhibits more rapid
transmission of monetary policy changes, according to the research. In a liquidity
deficit as opposed to a surplus, there is a stronger pass-through from policy rates to
money market rates. Due to the significance of additional explanatory factors
including the fiscal position of the government, inflationary expectations, etc., there
is greater persistence of policy rate shocks on deposit rates compared to lending
rates.
In a time of significant capital inflows, Jain and Bhanumurthy (2005) analyze the
problem of Indian financial markets' integration with global markets. The findings
indicate a long-term link between the London interbank offer market and the call
money market (CMR) (LIBOR). Despite being there, the correlation between the
rupee/dollar exchange rate (ER) and LIBOR is not very strong. The authors conclude
that while the domestic foreign currency market and the international financial
market do not have a substantial integration, the short-term money market is
interconnected with the latter.
The relative effectiveness and reliability of alternative monetary policy instruments
in conveying policy signals in financial markets are examined by Bhattacharya and
Sensarma (2007). They take into account both the time before and after the LAF.
Hussain (2011) explicitly examined the effects of monetary policy announcements on
stock market returns and volatility by examining the reactions of US and European
equity indexes, which demonstrated that they were significant and immediate: a press
conference of the European Central Bank exerted a major effect on the same day. The
effect of macroeconomic announcements on trading volume and stock prices in the
futures market was investigated by Vortelinos, Koulakiotis, and Tsagkanos (2017) with
a single-country focus on the US. They discovered that the response was of a high
magnitude and relevance. Jiang (2017) also provided evidence to support the notion
that information-based trading improved the efficiency of the stock market and had a
favorable impact on stock prices. Furthermore, Smales (2012) looked into how the
Australian futures market responded to macroeconomic announcements, stock
returns, and order imbalances.
Statement of the problem
This study tells us about how new investors, as well as seasoned investors, lose their
money in the stock market just because they don’t track the RBI’s monetary policy.
When RBI cuts or increases the rates it affects the stock market.
Objectives

 To know how the monetary policy impacts our Indian market

 To identify how the CRR and Repo rate impact stock market volatility.

 To predict how the inflation data influences RBI to cut or increase the rates.

 To explain how RBI monetary policy was able to control inflation.

Period of study
The study is based on the closing values of Nifty 50 and sectoral indices for 5 years
from 1st April 2016 to 30th March 2021.
Data analysis
The data which have been collected in this study will be analyzed using Descriptive
statistics, Correlation, Chi-square, and Anova.
Sources of Data:
Information has been collected from Secondary Data.
Secondary sources- Secondary data are those which have already been collected by
someone else and which already had been passed through the statistical process.
The secondary data was collected through websites, books, and magazines.
Tools for data collection
RBI websites
National Stock Exchange
Articles
Macro trends
Trading Economics
Profile of the selected organization
A study on India would be crucial among studies on monetary policy frameworks in
particular nations. This is due to a few distinct characteristics that make India a
special case study among nations, not just because of the size of its population or
economy. Even though India has constantly maintained a democratic form of
government, its economic structure resembled a command-and-control economy
until the 1990s. The Indian economy has been moving toward market forces during
the last 20 years or more, with a good rate of GDP growth and a low rate of
inflation. Except for the balance of payments crisis that occurred in 1990–1991, this
transformation had been gradual and had only minor setbacks. The Indian
experience and the role played by the monetary framework in it can be a helpful
lesson in preventing financial crises, as well as in timing and sequencing economic
changes, given that this period is marked by repeated financial crises in significant
portions of the world.
The Reserve Bank Bill was first proposed in 1927, and it went through the entire
legislative process at that time. The discussion, among other things, was centered
on two interconnected issues: first, the interaction between the colonial
government and the domestic financial system; and second, whether the Bank
should be founded with private or government shareholding. In the meanwhile, the
country's capital was moved from Kolkata, then known as Calcutta, to New Delhi,
and legislation established the Bank's headquarters to be in Mumbai, the nation's
financial hub. The dispute was ultimately resolved in favor of private ownership
(known as Bombay then). The Bank was nationalized in 1949, becoming
government-owned as a result, and unexpectedly followed the United Kingdom's
lead. During the four decades from 1950 to 1990, the RBI played a variety of
developmental roles in addition to the usual central banking one. The Bank
redefined its position in the field of public policy, namely in the foreign and financial
sectors, with the start of reforms in 1991. The Bank's role in formulating monetary
policy has to be in line with the reform program before national and international
developments.
Since the 1990s, there has been some global convergence in how monetary policy is
conducted. Currently, the instruments used by monetary authorities to evaluate
macroeconomic changes and the creation of expectations show significant
similarities. In the choosing of tools as well as in the operational processes, there
are common aspects. The institutional architectures are starting to show certain
similarities. With the emphasis on central bank autonomy and the ongoing
globalization of the financial markets, communication tactics and, consequently,
public responsibility, are at the forefront in all central banks. The trade-offs that
influence monetary policy decisions are finally more well understood.
The mission assigned by the monetary authority is the first and most crucial
element of the monetary policy framework of a nation. This obligation is usually laid
out in the central bank legislation in a democracy. It is interesting to note that,
despite significant changes in India's financial sector, the Reserve Bank of India Act
of 1934's stipulations for the country's monetary authority has not changed.
Traditional monetary policy goals have included fostering economic development,
reaching full employment, averting financial crises, averaging out business cycles,
and stabilizing long-term interest rates and the real exchange rate. While some
goals are mutually supportive, others are not. For instance, the goal of price stability
frequently conflicts with the goals of stable interest rates and high short-term
employment. As opposed to objectives, monetary policy targets are immediate
goals that, if reached, will help policymakers achieve their longer-term aims. These
goals are not objectives in and of themselves. Operating targets and intermediate
targets are the two categories of monetary policy objectives.
In 1991, the Indian government launched a broad program of market-oriented
reforms. It is crucial to understand that the biggest difference between the pre-and
post-liberalization periods was that investments in the former were not driven by
the market while those in the latter were. The financial plans ensured that the
anticipated investment (in terms of sectoral targets) was realized and the industrial
licensing system ensured that investment was aligned with plan targets. To achieve
projected investment goals in diverse industries, the whole financial system,
including banks, collaborated. As the government-controlled a sizable portion of
bank lending at this time, banks' screening and monitoring roles were significantly
downplayed. In the post-liberalization era, the banking sector underwent significant
deregulation, and trade and industrial policy saw significant reforms. As a result,
investment is now entirely driven by the market.
Before the start of the reforms, 28 state-owned commercial banks in India
accounted for 90% of deposits and advances in the country's banking industry.
Private sector banks and foreign banks did exist, but the policy environment
severely constrained their operations, growth, and potential new entry. The banks
were subjected to significant limitations during this time regarding credit allocation
and pricing. Additionally, banks' sources of funding were heavily controlled and
constrained. Government-imposed limitations on the interest rates in this market
prevented banks from freely raising additional equity and from participating in the
money market. Certificates of Deposit (CDs) weren't established until 1989, but
even then, the market was heavily constrained. In reality, the government set all
interest rates in the financial system using a complex and in-depth administrative
framework.
Even the current account, let alone the capital account, was not convertible in
terms of the balance of payments. The low level of development of the government
securities market prevented the use of open market operations, forcing the RBI to
alter the monetary stance primarily through the Cash Reserve Ratio (CRR). In this
situation, any drawl of reserves triggers a nearly instantaneous reduction in bank
lending. However, this would not be related to the flaw in the stock market.
In January 1993, the RBI established comprehensive guidelines regulating the
admission of new banks as part of an ongoing reform initiative. The market
structure of the banking industry was impacted by the new criteria, which enabled
participation by both private sector banks and foreign institutions. In 2000, the
proportion of government-owned banks in total deposits and advances was under
80%. Banks now operate with a great deal more freedom in terms of assets and
liabilities thanks to financial deregulation. The interest rates on bank loans were
gradually deregulated between 1991 and 1994. Interest rates on loans worth more
than 0.2 million dollars were entirely deregulated in October 1994. Deposit rates
were also largely liberated from controls. Under the Company's Act of 1996, all new
banks were required to be corporations, and their shares had to be listed on stock
exchanges. This has made previously unavailable sources of funding for banks (in
the form of fresh equity issues) available. In reality, many government-owned banks
have also raised money. By removing the bank-specific restrictions on CD issuance
in 1993, the CD market has also improved. The primary market for CDs has seen a
lot of activity as a result, but the secondary market is still very small. A well-
regulated and substantial market for government securities has been created as a
result of the financial sector reform. Open market operations are now the primary
method used by the RBI to undertake monetary policy changes. A distinct oversight
agency called the "Board of Financial Supervision" (BIFS) was established in 1994 as
independent oversight and monitoring body. About all financial intermediaries,
including banks, development banks, and non-banking financial companies, this
body exercises its inspection and supervision functions.
Directly as a result of the reform process, banks began to compete for both loans
and deposits by 1994. In addition, the introduction of numerous new banks
significantly intensified the strains of competition. Banks have used these markets
to raise money more frequently as a result of the development of financial
instruments and the subsequent maturation of the money and equity markets.
Banks are consequently exposed to the negative effects of these marketplaces'
flaws. These flaws serve as the foundation for both the bank lending channel and
the credit channel of monetary transmission, respectively.
The Reserve Bank of India Act of 1934's preliminary provisions established the
required tasks as regulating the issuance of Bank Notes and maintaining reserves to
ensure monetary stability in India and generally running the currency and credit
system of the country to its advantage.
It should be emphasized that although comparable, the RBI's interpretations are
different. GDP growth is probably positively correlated with credit growth in an
economy, albeit the magnitude of this correlation may change over time. We'll talk
more about this element in Section 3 of the paper. The RBI has placed an additional
emphasis on credit creation, which provides Indian monetary policy objectives a
distinctive quality that isn't generally covered in textbooks. However, the goal is
typically followed by "for sustaining general economic growth" or just "to support
growth." As a result, supporting or facilitating GDP growth can be considered an
extra monetary policy objective in India beyond price stability.
Once more, there is room for judgment regarding the relative importance of price
stability vs growth. It is assumed that the goal would be influenced by the
underlying macroeconomic environment. Therefore, monetary policy in India aims
for a "judicious balance between price stability and growth," although it is noted
that because of the democratic system of governance in India, the "judicious
balance" is highly skewed towards price stability, which in some respects amounts
to an "informal mandate" to the central bank for maintaining an "acceptable" level
of inflation.
Here, it's interesting to wonder who sets these goals. In a democratic system,
elected officials are normally in charge of setting the goal. This aim is made public
through a clear contract between the government and the central bank in monetary
policy frameworks like IT. There is no such formal contract in the case of India.
Instead, Section 7 of the RBI Act of 1934 states that the central government may
occasionally give the Bank any instructions it deems essential in the interest of the
public after consulting with the Governor of the Bank. The RBI Act does not specify
that such directives must be in the public domain or require parliamentary
approval.
A crucial question is how monetary policy impacts inflation and output. A central
bank's monetary policy framework tries to achieve the desired goals of policy in
terms of inflation and growth. The monetary base and/or short-term interest rates
are typically under the supervision of central banks, which also determines the rate
at which reserves are provided to or withdrawn from the banking sector in an
economy. Depending on the underlying monetary transmission, these central bank
liquidity operations and interest rate actions will have a different effect on the end
goals.
The process by which policy changes are transformed into the ultimate goals of
inflation and growth is known as monetary transmission. The literature has
historically identified four major channels for the dissemination of monetary policy,
including the money supply and credit-related quantum channel; (ii) the interest
rate channel; (iii) the exchange rate channel; and (iv) the asset price channel. A fifth
channel, the expectations channel, has gained more relevance in recent years in the
conduct of forward-looking monetary policy.
Literature also distinguishes between two categories of channels for the
transmission of money: neoclassical channels and (ii) non-neoclassical channels. The
neoclassical channels concentrate on how changes in interest rates affecting
commerce, consumption, and investment have an impact on the final goals. The
non-neoclassical channels primarily affect banks' behavior and balance sheets by
altering the credit supply and changing how much credit is available. Depending on
the economy's stage of growth and the design of its financial system, these
channels operate differently in different economies.
According to market valuations of financial assets and liabilities, changes in interest
rates by the monetary authority could potentially cause price changes in assets.
Increased interest rates have the potential to cause a local currency appreciation,
which in turn could have an impact on net exports and, overall demand and output.
The degree of confidence in these expectations is also impacted by policy
pronouncements and actions, as well as assumptions about the direction the
economy will take in the future.
On the output side, these modifications have an impact on how individuals and
businesses in the economy behave in terms of spending, saving, and investing.
According to a basic theory, higher interest rates tend to favor saving rather than
consumption, all else being equal. Similar to this, a greater currency value on the
foreign exchange market increases spending by lowering the price of imported
items in comparison to domestically produced commodities. As a result, changes in
the interest rate and currency rate have an impact on the demand for the products
that are produced.
On the front of inflation, the labor market and other domestic supply capacities, as
well as the degree of demand for them, are major factors affecting the pressure for
domestic inflation. If there is a labor shortage, salaries will be under pressure to
rise, which some businesses may be able to pass on to customers in the form of
increased pricing. Additionally, changes in exchange rates have an impact on both
the domestic pricing of imported goods and services as well as the component of
total inflation by having an indirect impact on the prices of goods and services that
compete with imports or employ imported inputs.
Nevertheless, there are various ways to understand the functions assigned to the
RBI. Specifically, "monetary stability" can refer to both internal and external
stability. Price stability becomes a key goal if it is defined strictly in terms of internal
stability. If, however, the interpretation also takes into account external stability,
the mandated mission shifts to embrace all aspects of financial stability, including
price stability. Maintaining price stability and guaranteeing an appropriate flow of
credit to productive sectors is how the RBI describes its role as a monetary authority
on its website.
In 1935, the Reserve Bank of India was founded. The Reserve Bank has been acting
in both a regulatory and developmental capacity, like all central banks in developing
nations. The Reserve Bank concentrated on broadening and developing the financial
system as part of its role in development. It was crucial in creating the right financial
institutions to encourage saving and investing. The apex institutions that are
currently in operation in the areas of agricultural credit, term finance to industries,
and credit to export were virtually split off from the Reserve Bank. The process of
developing and strengthening institutions to satisfy the needs of the nation is
ongoing. The Reserve Bank had also entered the field of loan allocation through its
promotional role. Pre-emption of financing for specific industries, and that too at
low-interest rates, was incorporated into the overall strategy. Over time,
commercial banks have been mandated to give a specific proportion of their overall
credit to industries that were deemed "priority sectors."
After the 1950s, it was clear that the Reserve Bank of India was playing a proactive
role in controlling the expansion of credit and money. The wholesale price only
increased by 1.8 percent annually on average during the 1950s. The average yearly
growth, however, was 10.3 percent in the 1970s compared to 6.2 percent in the
1960s. The contribution of deficit financing to promoting economic growth received
a lot of attention during the early planning stages. Judicious credit creation, which is
done in part in anticipation of rising productivity and the availability of real savings,
also has a role to play, according to the First Plan. Consequently, deficit financing—
which in the case of India meant Reserve Bank lending to the government—was
given a position in the financing of the plan, though its scope was to be constrained
to the extent that it was not inflationary. There was very little monetary growth,
especially in the 1950s. The dependency on market borrowing and deficit finance,
however, grew as each subsequent plan was confronted with a resource shortage.
These developed into a noticeable state starting in 19705. The remarkable
expansion in reserve money, principally due to Reserve Bank lending to the
Government, was the single most significant factor influencing the conduct of
monetary policy after 1970.
The system had the following characteristics as of the end of the 1970s, to sum it
up. The Reserve Bank of India, the country's central bank, set all interest rates for
loans and savings. A specific portion of credit has to be given by the commercial
banks to the so-called "priority sector." Credit to parties exceeding a predetermined
sum required prior approval from the central bank. Nearly 85% of the total bank
assets were transferred to the public sector after major commercial banks were
nationalized in 1969. Foreign banks were permitted to operate with a limited
number of branches, except tiny private banks.
As the size of the government's borrowing increased, two things happened: (a) the
Statutory Liquidity Ratio (SLR) steadily increased, forcing banks to invest an
increasing percentage of their deposits in government securities that carried lower
interest rates than "market rates"; and (b) the Reserve Bank of India started to
subscribe to leftover Treasury Bills and securities, which allowed the deficit to be
monetized. To mitigate the expansionary effects of deficits as much as possible, the
Reserve Bank has to take on the challenging task. Rising reserve money levels
caused the banking system to become more liquid, which needed to be continually
cleaned up. Since the interest rates on government securities were much below the
"market rates," open market operations could not be used for this objective. The
major strategy used to absorb the excess liquidity in the system was to raise the
Cash Reserve Ratio (CRR). In actuality, the CRR on additional deposits was 25% in
the middle of 1999. The SLR was 38.5 percent as well. As a result, almost 63.5
percent of further deposits were pre-empted in some way.
Reserve Bank of India, 1985 addressed a wide area in the Committee's report. One
of its main recommendations was to control the money supply in a way that
accounted for inflation that was acceptable and the predicted growth rate of real
income. The Committee wanted an agreement between the Central Government
and the Reserve Bank on the level of monetary expansion and the extent of
monetizing the fiscal deficit because it was recognized that government borrowing
from the Reserve Bank had been a significant contributor to the increase in reserve
money and, consequently, money supply. The Committee believed that without
such coordination, the Reserve Bank's efforts to keep monetary growth within the
bounds defined by the anticipated increase in output may be rendered impossible.
Although the Committee's advice was in theory approved, it wasn't until the 1990s
that it could become a reality.
Following the 1991 economic crisis brought on by a problematic balance of
payments scenario, the government made significant modifications to India's
economic strategy. The balance of payments issue was quickly resolved by
employing monetary policy, which also quickly brought stability back. To fully
benefit from the announced devaluation of the rupee, an extraordinarily strict
monetary policy was implemented. However, it didn't end there. Reforms to the
financial sector were now an essential component of the new reform plan. The goal
of the banking sector and capital market reform was to support and hasten the
expansion of the real estate market. Reforms in the bailing sector took several
different shapes. The prescription of prudential requirements, especially the capital-
adequacy ratio, was the most significant reform. Furthermore, the monetary policy
environment saw several significant adjustments that provided commercial banks
more freedom in how they managed their assets and liabilities. Before everything
else, the administered structure of interest rates was gradually undermined. Except
for very small loans and export credit, banks in India are currently completely free
to set their deposit rates and loan interest rates. Second, the government started
taking out loans at standard interest rates. For both Treasury Bills and dated
securities, the auction method was established. Third, pre-emptions in the form of
CRR and SLR were steadily reduced as a result of the economic reforms' emphasis
on lowering the fiscal deficit. Fourthly, the scope of cross-subsidization in terms of
interest rates was significantly reduced as a result of the reform of the interest rate
structure, even though the allocation of credit for the priority sector continued.
In the 1990s, India's monetary policy had to cope with several difficulties, some of
which were conventional and others of which were novel and related to the
country's need to operate in an increasingly open economy. To reap the full
benefits of devaluation, monetary policy has to deal with the effects of devaluation
in the early years and the urgency of restoring price stability. The issue of
monetizing the deficit remained a problem, and a solution needed to be found even
while the fiscal deficit was being reduced. In the end, the Government and RBI came
to a new agreement on the funding deficit as a result of this. Ad-hoc Treasury Bills,
which allowed the Indian government to restock its cash reserves by issuing
Treasury Bills in the Reserve Bank's favor and had the effect of monetizing the
deficit, were phased away. It was replaced with a system of fixed-capacity Ways and
Means Advances. The Reserve Bank of India kept making discretionary purchases of
the dated securities. The monetary impact of capital inflows was initially addressed
by monetary policy in the years 1993 and 1994 as a result of a large increase in
foreign exchange reserves from $ 9.2 billion in March 1992 to $ 25.1 billion in
March 1995. Today, we are in a comparable scenario. The issue is more significant.
Because there were few government securities available at market rates or close to
them, our capacity to stabilize was constrained in those days. The RBI is currently in
a similar scenario, even though all of the government securities at its disposal have
market-related interest rates. The problem is one of sufficiency. The use of
monetary policy to stabilize the rupee came into play in 1995–1996 due to a shift in
perception of the exchange rate following a protracted period of nominal exchange
rate stability relative to the US dollar. This was a completely new experience for the
central bank. Later, during the East Asian crisis, similar circumstances again
developed.
The financial sector changes have altered the institutional environment in which
monetary policy now operates. A new facet of monetary policy has been added as a
result of this alteration in the institutional architecture. There are now more
transmission channels available. The significance of indirect monetary regulations
has grown over time. When the administered interest rate structure was gradually
eliminated and a system of market-determined interest rates on government assets
emerged. For the first time, open market transactions such as "repo" and "reverse
repo" procedures appeared as a tool for monetary management. To manage market
liquidity daily, the Liquidity Adjustment Facility, originally introduced in 1999 and
later improved, is developing as a key operational instrument. In the current setting,
the Bank Rate plays a new role. The repo and reverse repo rates are the same. The
development of monetary policy as a stand-alone tool of economic policy was made
possible by the 1990s.
The cost and accessibility of credit and money are two ways that monetary policy
has an impact. It has some benefits as a tool for economic policy. Fiscal policy has a
longer "Inside Lag" than monetary policy, which is the delay between the time when
action is required and the time when action is performed. Consequently, monetary
policy can react swiftly to short-term changes.
Traditional definitions of monetary policy include those that are directly related to
the provision of money, which includes both cash and demand deposits. The
provision of money in a specific sense has thus been described as the focus of
monetary policy.
However, in addition to the central bank's policies, the government's monetary
standard and statutory reserve regulations, as well as operations and policies
relating to exchange rates and international transactions, also play a significant role
in monetary policy. As a result, monetary policy is the term used to refer to the
rules that a nation's government and central bank follow to achieve the broad goals
of that nation's economic policy. According to this interpretation, monetary policy
has no independent goals and is, at best, a hybrid of general economic policy. This is
as it should be since all the different policies that are typically thought of, namely,
fiscal policy, commercial policy, and monetary policy, are distinct elements of the
same unique entity known as the economic policy.
At least one instance where the complaint of "too tight" monetary policy warrants
consideration may be seen in the history of the 1990s. The incident took place in
1995–1996 and was the first time the flexible exchange rate regime put into place in
the early 1990s was put to the test. The RBI constantly upheld its position on
battling volatility despite not being wedded to any particular exchange rate values.
After a protracted period of exceptional stability, the INR-USD rate underwent a
significant test when it sharply declined.
The rupee's value versus the US dollar varied slightly throughout the first half of
1993. However, the rupee held steady at 31.37 throughout the second half of 1993
and nearly the whole 1994–1995 period. The INR-USD market in India has been
highly volatile since September 1995. Up to February 1996, there were still
significant swings in the rupee's value versus the US dollar, which reached a low of
37.40. The RBI's market stabilization intervention, however, proved successful. The
rupee steadied at about 34.23 by April 1996.
Though there may be concerns about whether the RBI operated too carefully, it
should be recalled that uncalled-for volatility in the foreign exchange market could
have had disastrous effects on an economy that was only beginning to be driven by
the market. The Mexican crisis was still recent, and the RBI needed to work on
building its reputation. The successful control of the foreign exchange market's
volatility, it might be argued, served to establish the credibility of the RBI even
though GDP growth for a single year was negatively impacted. After the Southeast
Asian financial crisis was successfully managed, its confidence significantly
increased. Therefore, the RBI move showed a clear preference in favor of financial
stability even if monetary policy had been "too tight". Interestingly, following a
period of high inflation from 1990 to 1995, the rate of inflation in India started to
decline in 1995–96.
An additional crucial query is: Does the monetary policy have any role in bringing
India's inflation rate totally in line with that of developed countries by further
reducing it? The data on core inflation shows that monetary policy will only play a
small additional role in this process, beyond guaranteeing financial stability. Fiscal,
administrative, and competition policies should be oriented more and more
towards the micro level to further align the inflation rate.
Given the size of India, local price shocks may occur in a specific location.
Unfortunately, this feature cannot be investigated using the WPI data that are used
by the Indian monetary authorities for policy objectives. However, we can
determine the significance of this issue thanks to CPI data (for industrial workers)
that are accessible for 76 different Indian cities.
The study's surprising findings include the possibility that regional inflation rates can
vary by as much as 20.0 percentage points in a single year, like the year 1998, which
is quite a large range. It should be noted that the average CPI-based inflation rate
for the same year was 13.4%. The range of the inflation rate standard deviations
among regions was typically 2.0 to 2.5 percentage points. Furthermore, while the
spatial distribution was generally found to be near to the normal distribution, it
tended to tilt and exhibit leptokurtic behaviour during periods of strong inflation,
along with an increase in standard deviation. Despite having a similar monetary
policy, India has a significant amount of regional heterogeneity in inflation, which
emphasizes the significance of local supply shocks that monetary policy cannot
address. Instead, if India decides to adopt formal IT shortly, one element that would
also require more rigorous examination is the existence of large local price shocks.
Eliminating local monopolies and promoting interregional trade as much as feasible
is crucial.
India has been able to keep its inflation at a manageable level, unlike many
developing nations. In the past, India's inflation rates have infrequently reached
double digits, and when they have, it has been due to supply shocks from changes
in the price of agricultural commodities or world oil prices.
Monetary policy has been somewhat successful in reducing output volatility and
giving the economy an increasing sense of resilience. For roughly 25 years, the trend
rate of GDP growth has increased gradually to nearly 6.0%, and India's economy has
become one of the fastest-growing in the world.
Characterized during the past 15 years of periodic financial crises that severely
harmed growth and welfare in many emerging nations, monetary policy has been
successful in maintaining financial stability in India. Additionally, internal factors
including geopolitical unrest, a drought, and foreign sanctions characterized this
period. Even while we may have had a little luck, we think that using good
judgment and developing our talents on all levels also helped. It is important to
remember that the Reserve Bank has been working to create reliable and effective
financial markets and intermediaries to lay the groundwork for the efficient
transmission of monetary policy.
The foreign sector has been strengthened and turned around with success. Import
restrictions have been all but eliminated, and the convertibility of the current
account has been in place since 1994. For non-residents, the capital account is
essentially open. The most successful exchange rate policies over time have focused
on managing volatility without having a set rate goal and allowed the underlying
supply and demand circumstances to determine the exchange rate movements over
a period in an orderly despite sub-investment grade sovereign ratings, international
investor trust in India's handling of its external sector is rising. India currently has
the sixth-largest pool of reserves in the world, which is enough to pay off all of its
external debt. India has become a creditor since 2002.
Saying that the money supply influences the level of prices in the economy is a
given in a monetary economy, where every single transaction is valued in terms of
the national currency. When the output is set and the short-term price level is
analyzed, the excess demand condition in the economy—which is dependent on the
amount of demand for and supply of real money balances—is what mostly
determines the price level. Thus, it makes sense that as soon as the real money
balance rises above what the population demands, pressure will be put on the
market for products, services, and assets, which will increase the cost of those
goods and services.
There is no denying that changes in the price level can be brought on by several
other internal and external shocks, which have an impact on the cost structure of
enterprises, even though this explanation of the money and price link is well known
to all of us. However, inflation cannot be sustained if there is not a sufficient rise in
the money supply. Constant pressure on prices is what inflation is all about. In this
respect, inflation might be considered a monetary phenomenon. There are,
however, three significant caveats to this assertion. First, there may be a variable
delay between the start of a monetary adjustment and the period when its full
effects on prices and output are felt.
This lag's duration depends on the dynamics of the real economy as a whole and
how quickly economic actors respond to changes in the monetary situation. A
monetary shock may therefore take several months to manifest itself in prices and
output. Second, it's crucial to distinguish between a shift in relative prices and their
immediate effects on the overall pricing situation, on the one hand, and a steady
rise in prices, on the other. A firm's cost structure may be suddenly shocked, which
could increase the price of its product relative to competitors. This could lead to
some resource reallocation and an increase in the economy's general price level.
What are the aims of economic policy, and should the goals of monetary policy be
the same as these goals? are the first set of questions that need to be answered.
Should monetary policy's objectives include all of the objectives of economic policy?
The necessity to give monetary policymakers clear direction has made the question
of objectivity more crucial. This element has gained importance given the mounting
pressure on central banks' autonomy. While accountability must accompany
autonomy, accountability itself necessitates a clearly stated set of objectives.
The main goals of India's economic strategy have been to accelerate economic
growth, guarantee a certain level of price stability in the economy, and advance
distributive fairness since the beginning of development planning. The way
monetary policy has operated in India over the past few decades shows that it has
also placed a strong emphasis on these overarching goals of our economic strategy.
But what exactly is the economy? It is crucial to understand that no one aspect of
economic policy can effectively pursue all of the goals.
Economic policy practitioners are aware that if all goals are to be achieved, there
should be as many instruments as there are objectives. There is always the issue of
choosing the best target or objective to assign to each instrument when there are
several that are both relevant and desired.
The theoretical literature and empirical data make it abundantly evident that,
among the different policy goals, monetary policy is best adapted to attaining the
objective of price stability in the economy. Additionally, it has been acknowledged
that the long-term goals of growth and price stability do not necessarily contradict
one another. Instead, a low and stable price environment is increasingly seen as a
necessary prerequisite for enhancing the growth and productive potential of the
economy in today's changing economic situation.
Data Analysis and Interpretations
Date Repo rate Change Reverse Change
repo rate
05-04-2016 6.50 -0.25 6.00 -0.25

Rates (2016)

Before rate changes

Stocks/Index Mar 28, Mar 29, Mar 30, Mar 31,
2016 2016 2016 2016
HDFC Bank 500.47 503.48 508.81 511.77

Tata Motors 363.15 372.30 388.44 386.44

DLF 100.71 100.89 108.74 108.51

Banknifty 15604.90 15666.25 16134.85 16141.65

Nifty 7615.10 7597.00 7735.20 7738.40

After rate changes

Stocks/Index Apr 05, Apr 06, Apr 07, Apr 08,
2016 2016 2016 2016
HDFC Bank 505.23 507.16 504.29 506.13

Tata Motors 370.35 376.55 375.05 371.30

DLF 107.23 108.22 107.37 111.96

Banknifty 15695.00 15636.95 15530.75 15568.35

Nifty 7603.20 7614.35 7546.45 7555.20

HDFC Tata Motors DLF Banknifty Nifty

 Bank
Mean 506.1325 377.5825 104.7125 15886.9125 7671.425

Median 506.145 379.37 104.7 15900.55 7675.15

Standard
Deviation 5.100656 12.00753 4.519339 291.3115 75.86059
Variance 26.01669 144.1808 20.42443 84862.4 5754.829
Skewness -0.00935 -0.45393 0.000869 -0.0378 -0.04753
Kurtosis -2.96595 -3.20268 -5.97913 -5.7768 -5.7087
Range 11.3 25.29 8.03 536.75 141.4

Descriptive Statistics (Before rate changes)

The volatility of stocks or markets can be understood by analysing standard

deviation, variance, or the coefficient of variation.
Bank nifty standard deviation is 291.3115. Bank nifty was much more volatile
when the rates are to be disclosed.
The volatility in stock was more before the rate was decreased.
The stock with negative skewness generates small profits and few severe or
great losses in the term considered. On the alternative hand, a stock with
positive skewness generates small losses and few excessive profits.
Bank nifty and Nifty are negatively skewed by -0.0378 and -0.04753
If you see here the market already knew the RBI is going to reduce the rates
because of this Bank nifty and nifty fell by little points.
Descriptive Statistics (After rate changes)
HDFC Bank Tata DLF Banknifty Nifty
Motors
Mean 505.7025 373.3125 108.695 15607.763 7579.8
Median 505.68 373.175 107.795 15602.65 7579.2
Range 2.87 6.2 4.73 164.25 67.9
Standard
Deviation 1.2282067 2.9623681 2.2201877 72.907617 33.954111
Variance 1.5084917 8.775625 4.9292333 5315.5206 1152.881
Skewness 0.090194 0.128936 1.780489 0.293816 0.035352
Kurtosis -0.93662 -4.30646 3.152001 -2.14706 -5.15371

The volatility of stocks or markets can be understood by analysing standard

deviation, variance, or the coefficient of variation.
The volatile in the market was less when RBI declared monetary policy as both
nifty and Bank nifty standard deviation is less i.e., 1152.881 and 5315.5206
The stock with negative skewness generates small profits and few severe or
great losses in the term considered. On the alternative hand, a stock with
positive skewness generates small losses and few excessive profits.
Bank nifty and Nifty are negatively skewed by 0.293816 and 0.035352
The market didn’t get any effect when the RBI decreased the rates as it already
got discounted earlier.
Chi-square
Hₒ: There is no significant impact on the stock market when RBI declares the
monetary policy
H₁: There is a significant impact on the stock market when RBI declares the
monetary policy
p-value = 0.026488
Significance level = 0.05

As the p-value is less than the significance level hence rejects the null
hypothesis. That means there is a significant impact on the stock market when
RBI declares the monetary policy
 Date Repo rate Change Reverse Change
repo rate
02-08-2017 6.00 -0.25 5.75 -0.25

Rates (2017)

Before rate changes

Stocks/Index Jul 26, Jul 27, Jul 28, Jul 31,

2017 2017 2017 2017
HDFC Bank 847.39 867.80 862.40 865.26
Tata Motors 457.30 445.40 445.85 444.60
DLF 184.91 185.05 181.08 182.88
Banknifty 24670.70 24922.40 24811.30 25103.65

Nifty 10020.65 10020.55 10014.50 10077.10

After rate changes

Stocks/Index Aug 02, Aug 03, Aug 04, Aug 05,

2017 2017 2017 2017
HDFC Bank 871.46 868.77 863.10 868.09

Tata Motors 446.90 440.35 431.45 435.60

DLF 182.97 182.55 179.85 179.61
Banknifty 25122.80 25055.20 24675.05 24827.45

Nifty 10114.65 10081.50 10013.65 10066.40

 Descriptive Statistics (Before rate changes)
HDFC Tata Motors DLF Banknifty Nifty
Bank
Mean 860.7125 448.2875 183.48 24877.01 10033.2
Median 863.83 445.625 183.895 24866.85 10020.6
Standard
Deviation 9.15148 6.03053 1.8823567 182.85473 29.407624
Variance 83.74969 36.367292 3.5432667 33435.854 864.80833
Skewness -1.66114 1.955622 -0.72426 0.291054 1.941504
Kurtosis 2.877424 3.858092 -1.93344 -0.16324 3.823482

The volatility of stocks or markets can be understood by analysing standard

deviation, variance, or the coefficient of variation.
The volatility in bank nifty was more when compared to nifty. Bank nifty and
Nifty standard deviation is 182.85 and 29.407.
Here we could see the HDFC bank was more volatile before the rates were
changed.
The stock with negative skewness generates small profits and few severe or
great losses in the term considered. On the alternative hand, a stock with
positive skewness generates small losses and few excessive profits.
The market didn’t get impacted more before the rates were changed.
Descriptive Statistics (After rate changes)
HDFC Bank Tata DLF Banknifty Nifty
Motors
Mean 867.855 438.575 181.245 24920.13 10069.05
Median 868.43 437.975 181.2 24941.33 10073.95
Standard
Deviation 3.4880032 6.635071 1.7604829 206.53718 42.073527
Variance 12.166167 44.024167 3.0993 42657.608 1770.1817
Skewness -0.94073 0.443966 0.032986 -0.35759 -0.65614
Kurtosis 1.832029 -0.65482 -5.62694 -3.05599 1.145356

The volatility of stocks or markets can be understood by analysing standard

deviation, variance, or the coefficient of variation.
Bank nifty was in much volatility before and after the rates were changed but
nifty wasn’t much impacted to rate changes. Even the HDFC bank, Tata Motors,
and DLF didn’t get much impacted.
The stock with negative skewness generates small profits and few severe or
great losses in the term considered. On the alternative hand, a stock with
positive skewness generates small losses and few excessive profits.
The bank nifty and nifty is negatively skewed when the rates was been
declared for 4 days in the market.
Chi-square
Hₒ: There is no significant impact on the stock market when RBI declares the
monetary policy
H₁: There is a significant impact on the stock market when RBI declares the
monetary policy
p-value = 0.74019
Significance level = 0.05
As the p-value is more than the significance level hence rejects the null
hypothesis. That means there is no significant impact on the stock market when
RBI declares the monetary policy
Rates (2018)

Date Repo rate Change Reverse Change

repo rate
01-08-2018 6.50 +0.25 6.25 +0.25

Before rate changes

Stocks/Index Jul 26, Jul 27, Jul 30, Jul 31,

2018 2018 2018 2018
HDFC Bank 1,069.98 1,074.64 1,058.91 1,063.59
Tata Motors 258.25 268.15 267.50 264.10
DLF 182.77 183.06 181.52 188.64
Banknifty 27406.40 27634.40 27842.60 27764.15

Nifty 11167.30 11278.35 11319.55 11356.50

After rate changes

Stocks/Index Aug 01, Aug 02, Aug 03, Aug 06,

2018 2018 2018 2018
HDFC Bank 1,053.44 1,039.53 1,035.36 1,031.77
Tata Motors 265.05 260.85 258.45 254.05
DLF 185.80 180.42 181.52 181.96
Banknifty 27596.60 27355.95 27695.50 27898.50

Nifty 11346.20 11244.70 11360.80 11387.10

 HDFC Tata Motors DLF Banknifty Nifty
Bank
Mean 1,066.78 264.5 183.9975 27661.89 11280.43
Median 1,066.79 265.8 182.915 27699.28 11298.95
Standard
Deviation 35.452482 4.529348 3.1663057 190.73896 81.89371
Variance 1256.8785 20.515 10.02549 36381.351 6706.58
Skewness -0.0031 -1.20949 1.725871 -0.93443 -1.15014
Kurtosis -2.1475 0.632739 3.255843 0.192654 1.292886
Descriptive Statistics (Before rate changes)

The volatility of stocks or markets can be understood by analysing standard

deviation, variance, or the coefficient of variation.
Bank nifty and nifty had a normal variation in the market. Their standard
deviation is 190.738 and 81.893.
The stock with negative skewness generates small profits and few severe or
great losses in the term considered. On the alternative hand, a stock with
positive skewness generates small losses and few excessive profits.
Bank nifty and nifty were negatively skewed. If you had invested in DLF you
would have made a profit because of the market conditions.
Descriptive Statistics (After rate changes)

HDFC Bank Tata DLF Banknifty Nifty

Motors
Mean 1,040.03 259.6 182.425 27636.64 11334.7
Median 1,037.45 259.65 181.74 27646.05 11353.5
Standard
Deviation 21.76503 4.59673 2.34136 225.4072 62.34105
Variance 473.7165 21.13 5.48196 50808.41 3886.406
Skewness 1.365558 -0.05932 -1.534391 -0.23389 -1.55692
Kurtosis 1.920581 0.201515 2.763443 0.605316 2.749552

The volatility of stocks or markets can be understood by analysing standard

deviation, variance, or the coefficient of variation.
Bank nifty volatility will be more when the RBI comes up with the monetary
policy. The bank nifty standard deviation and the nifty standard deviation were
225.407 and 62.341.
The stock with negative skewness generates small profits and few severe or
great losses in the term considered. On the alternative hand, a stock with
positive skewness generates small losses and few excessive profits.
Bank nifty and nifty were negatively skewed when the RBI declared its
monetary policy.
Chi-square
Hₒ: There is no significant impact on the stock market when RBI declares the
monetary policy
H₁: There is a significant impact on the stock market when RBI declares the
monetary policy
p-value = 0.3619
Significance level = 0.05

As the p-value is more than the significance level hence rejects the null
hypothesis. That means there is no significant impact on the stock market when
RBI declares the monetary policy
Rates (2019)

Date Repo rate Change Reverse Change

repo rate
04-10-2019 5.15 -0.25 4.90 -0.25

Before rate changes

Stocks/Index Nov 28, Nov 29, Dec 02, Dec 03,

2019 2019 2019 2019
HDFC Bank 1,245.37 1,254.87 1,245.81 1,235.62
Tata Motors 164.80 161.50 161.05 158.20
DLF 212.65 214.36 212.79 213.57
Banknifty 32122.95 31946.10 31871.45 31613.35

Nifty 12151.15 12056.05 12048.20 11994.20

After rate changes

Stocks/Index Dec 04, Dec 05, Dec 06, Dec 09,

2019 2019 2019 2019
HDFC Bank 1,231.93 1,225.98 1,226.42 1,223.37

Tata Motors 169.40 166.10 161.50 160.50

DLF 214.89 215.72 213.09 211.87
Banknifty 31979.30 31712.95 31341.55 31316.65

Nifty 12043.20 12018.40 11921.50 11937.50

Descriptive Statistics (Before rate changes)
HDFC Tata DLF Banknifty Nifty
Bank Motors
Mean 1,245.42 161.3875 213.3425 31888.4625 12062.4
Median 1,245.59 161.275 213.18 31908.775 12052.125
Standard 130.7480 2.7038 0.7899 211.5677 65.2425
Deviation
Variance 17095.047 7.31062 0.623958 44760.92 4256.588
Skewness 0.131401 0.246765 0.76348 0.54507 0.90912
Kurtosis 1.4939 1.3969 1.5331 1.0790 1.9016

The volatility of stocks or markets can be understood by analysing standard

deviation, variance, or the coefficient of variation.
Bank nifty and nifty had a normal variation in the market. Their standard
deviation is 211.5677 and 65.2425.
The stock with negative skewness generates small profits and few severe or
great losses in the term considered. On the alternative hand, a stock with
positive skewness generates small losses and few excessive profits.
Both indexes were not much impacted by an upcoming monetary policy that’s
the reason why the market was trading sideways.
Descriptive Statistics (After rate changes)

HDFC Bank Tata DLF Bank nifty Nifty

Motors
Mean 1,226.93 164.375 213.8925 31587.61 11980.15
Median 1,226.20 163.8 213.99 31527.25 11977.95
Standard
Deviation 120.78496 4.143569 1.7387 317.8553 59.7137
Variance 14589.007 17.16916 3.02309 101032.01 3565.736
Skewness 1.137536 0.469187 -0.21485 -0.566091 0.085408
Kurtosis 2.17558 -2.86792 -2.81658 -2.77559 -4.82621

The volatility of stocks or markets can be understood by analyzing standard

deviation, variance, or the coefficient of variation.
Whenever RBI comes up with monetary policy the most impacted index is Bank
nifty. The volatility in Bank nifty was more when compared to nifty as their
standard deviation is 317.855 and 59.713
The stock with negative skewness generates small profits and few severe or
great losses in the term considered. On the alternative hand, a stock with
positive skewness generates small losses and few excessive profits.
DLF is negatively skewed by -0.2148. Even the Bank nifty is negatively skewed
by -0.5660. This tells us that the bank’s nifty was bearish after the rate
changes.
Chi-square
Hₒ: There is no significant impact on the stock market when RBI declares the
monetary policy
H₁: There is a significant impact on the stock market when RBI declares the
monetary policy
p-value = 0.0439
Significance level = 0.05
As the p-value is less than the significance level hence rejects the null
hypothesis. That means there is a significant impact on the stock market when
RBI declares the monetary policy
Rates (2020)

Date Repo rate Change Reverse Change

repo rate
27-03-2020 4.40 -0.75 4.00 -0.90

Before rate changes

Stocks/Index Mar 23, Mar 24, Mar 25, Mar 26,

2020 2020 2020 2020
HDFC Bank 759.40 755.61 843.25 886.90
Tata Motors 66.20 68.55 70.25 70.80
DLF 123.72 118.47 121.41 135.48
Banknifty 16917.65 17107.30 18481.05 19613.90

Nifty 7610.25 7801.05 8317.85 8641.45

After rate changes

Stocks/Index Mar 27, Mar 30, Mar 31, Apr 01,

2020 2020 2020 2020
HDFC Bank 890.20 818.55 848.32 816.58
Tata Motors 70.70 68.15 71.05 67.95
DLF 136.07 128.23 134.80 129.99
Banknifty 19969.00 18782.40 19144.00 18208.35

Nifty 8660.25 8281.10 8597.75 8253.80

Descriptive Statistics (Before rate changes)
HDFC Bank Tata DLF Banknifty Nifty
Motors
Mean 811.29 68.95 124.77 18029.98 8092.65
Median 801.325 69.4 122.565 17794.18 8059.45
Standard
Deviation 64.63009 2.068413 7.456232 1265.027 472.4534
Variance 4177.049 4.278333 55.595 1600294.4 223212.27
Skewness 0.376737 -0.92905 1.510688 0.626952 0.250688
Kurtosis -3.83542 -0.42707 2.52688 -2.31771 -3.15243

The volatility of stocks or markets can be understood by analysing standard

deviation, variance, or the coefficient of variation.
Bank nifty already knew that rates are going to be reduced so it reacted earlier.
It was much more volatile than nifty.
The stock with negative skewness generates small profits and few severe or
great losses in the term considered. On the alternative hand, a stock with
positive skewness generates small losses and few excessive profits.
All the indexes and stocks were positively skewed but tata motors were
negatively skewed this tells us that it had borrowed money because of the
upcoming monetary policy it got more impacted.
Descriptive Statistics (After rate changes)
HDFC Bank Tata DLF Banknifty Nifty
Motors
Mean 843.4125 69.4625 132.2725 19025.94 8448.225
Median 833.435 69.425 132.395 18963.2 8439.425
Standard
Deviation 34.40581 1.63929 3.757697 737.3523 210.58978
Variance 1183.76 2.68729 14.1202 543688.49 44348.058
Skewness 1.110642 0.026453 -0.08849 0.464656 0.061185
Kurtosis 0.042504 -5.7005 -4.42245 0.500021 -5.48367

The volatility of stocks or markets can be understood by analysing standard

deviation, variance, or the coefficient of variation.
Nifty was more volatile than bank nifty when the rates was been changed.
They had a standard deviation of 210.589 and 737.352
The stock with negative skewness generates small profits and few severe or
great losses in the term considered. On the alternative hand, a stock with
positive skewness generates small losses and few excessive profits.
The bank nifty and nifty did not get much impact when RBI declared monetary
policy.
Chi-square
Hₒ: There is no significant impact on the stock market when RBI declares the
monetary policy
H₁: There is a significant impact on the stock market when RBI declares the
monetary policy
p-value = 2.6049
Significance level = 0.05
As the p-value is more than the significance level hence rejects the null
hypothesis. That means there is no significant impact on the stock market when
RBI declares the monetary policy
Rates (2022)
Date Repo rate Change Reverse Change
repo rate
04-05-2022 4.40 -0.40 3.35 No change

Before rate changes

Stocks/Index Apr 28, Apr 29, Apr 30, May 03,

2022 2022 2022 2022
HDFC Bank 1,453.54 1,449.30 1,390.05 1,392.17
Tata Motors 305.90 301.90 293.85 293.00

DLF 247.33 245.75 243.78 244.32

Banknifty 33722.80 33714.50 32781.80 32465.75

Nifty 14864.55 14894.90 14631.10 14634.15

After rate changes

Stocks/Index May 04, May 05, May 06, May 07,

2022 2022 2022 2022
HDFC Bank 1,366.48 1,380.50 1,378.83 1,392.46
Tata Motors 289.45 291.50 301.25 302.75

DLF 242.40 244.91 246.94 254.28

Banknifty 32270.35 32783.70 32827.80 32904.50

Nifty 14496.50 14617.85 14724.8 14823.15

Descriptive Statistics (Before rate changes)
HDFC Bank Tata DLF Banknifty Nifty
Motors
Mean 1,421.27 298.6625 245.295 33171.21 14756.18
Median 1,420.74 297.875 245.035 33248.15 14749.35
Standard
Deviation 225.7982 6.27393 1.591 645.169 143.2057
Variance 50984.839 39.362 2.5313 416243.17 20507.87
Skewness 0.009586 0.324008 0.681563 -0.20348 0.038359
Kurtosis -5.90787 -3.99484 -1.34591 -4.83538 -5.77446

The volatility of stocks or markets can be understood by analysing standard

deviation, variance, or the coefficient of variation.
Bank nifty and nifty had discounted this news earlier itself as we could see
their volatility had increased before the rate has been changed. Their standard
deviation is 645.169 and 143.205
The stock with negative skewness generates small profits and few severe or
great losses in the term considered. On the alternative hand, a stock with
positive skewness generates small losses and few excessive profits.
Bank nifty was negatively skewed when compared to all other stocks and
indexes.
Descriptive Statistics (After rate changes)
HDFC Bank Tata DLF Banknifty Nifty
Motors
Mean 1,379.57 296.2375 247.1325 32696.59 14665.58
Median 1,366.48 296.375 245.925 32805.75 14671.33
Standard
Deviation 202.472 6.73428 5.114 288.508 140.4771
Variance 40995.08 45.3506 26.1532 83237.1 19733.837
Skewness -0.05458 -0.03684 1.236975 -1.81918 -0.19759
Kurtosis 1.37877 -5.30508 1.7821 3.449363 -1.0783

The volatility of stocks or markets can be understood by analysing standard

deviation, variance, or the coefficient of variation.
After rate changes made by RBI nifty and bank nifty did not get much
impacted.
The stock with negative skewness generates small profits and few severe or
great losses in the term considered. On the alternative hand, a stock with
positive skewness generates small losses and few excessive profits.
Bank nifty and nifty are negatively skewed by -1.8191 and -0.1975.
Chi-square
Hₒ: There is no significant impact on the stock market when RBI declares the
monetary policy
H₁: There is a significant impact on the stock market when RBI declares the
monetary policy
p-value = 0.000531
Significance level = 0.05
As the p-value is less than the significance level hence rejects the null
hypothesis. That means there is a significant impact on the stock market when
RBI declares the monetary policy
Inflation rate (2016-2021)

Inflation Rate
7.00%

6.00%

5.00%

4.00%

3.00%

2.00%

1.00%

0.00%
2015 2016 2017 2018 2019 2020 2021 2022

USD/INR