A RBI working paper has found that equity markets are affected more by the changes in the market’s expectations of future monetary policy than the policy rate surprise. File
| Photo Credit: Reuters

Equity markets are impacted more by the expectations of future monetary policy than the policy rate surprises on the day of announcement of the policy by the Reserve Bank, said an analysis.

According to a working paper prepared by RBI officials, the regulatory and development measures that are announced along with the monetary policy also impact the stock markets.

“Equity markets are affected more by the changes in the market’s expectations of future monetary policy (path factor) than the policy rate surprise (target factor) which is in agreement with the conventional thinking that equity markets are forward-looking,” the paper said.

The volatility in equity markets on the day of the policy announcement, it said, “is affected by both target and path factors, as markets digest the policy announcements and traders adjust their portfolios throughout the day”.

RBI Working Paper on ‘Equity Markets and Monetary Policy Surprises’ is prepared by Mayank Gupta, Amit Pawar, Satyam Kumar, Abhinandan Borad and Subrat Kumar Seet from the Department of Economic and Policy Research, Reserve Bank of India.

Understanding the impact of monetary policy announcements on the returns

The paper analyses the impact of monetary policy announcements on the returns and volatility in the BSE Sensex by decomposing changes in Overnight Indexed Swap (OIS) rates on policy announcement days into target and path factors. The target factor captures the surprise component in central bank policy rate action, while the path factor captures the impact of the central bank’s communication on market expectations regarding the future path of monetary policy.

While the short duration windows are aimed at controlling for other potential drivers of equity prices, it may be noted that the monetary policy announcements are accompanied by regulatory and developmental measures which can also impact markets, the paper said.

The sparse trading on occasions in the OIS markets and other domestic and global developments during the narrow window can also impact the analysis, it added.

The analysis covers the period starting with the implicit adoption of a flexible inflation targeting regime in India (January 2014) and ends in July 2022.

The Reserve Bank of India (RBI) introduced the RBI Working Papers series in March 2011. The central bank said the views expressed in the paper are those of the authors and not necessarily those of the institution(s) to which they belong.

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The Reserve Bank of India (RBI) has decided to facilitate wider non-resident participation in the Sovereign Green Bonds by permitting eligible foreign investors in the International Financial Services Centre (IFSC) to invest in such bonds.

“A scheme for investment and trading in SGrBs by eligible foreign investors in IFSC is being notified separately in consultation with the Government and the IFSC Authority,” Governor Shaktikanta Das announced as additional measures soon after the bi-monthly monetary policy committee meeting on April 5, 2024.

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Based on an announcement in the Union Budget for FY 2022-23, the Government of India had issued Sovereign Green Bonds in January 2023. The SGrBs were also issued as part of the Government borrowing calendar in FY 2023-24.

At present, foreign portfolio investors (FPIs) registered with SEBI are permitted to invest in SGrBs under the different routes available for investment by FPIs in government securities.

The Monetary Policy Committee (MPC) on April 5 decided to keep the policy repo rate under the liquidity adjustment facility (LAF) unchanged at 6.50%. This is the 7th time that the rates have been kept on hold.

The MPC also decided to remain focused on withdrawal of accommodation to ensure that inflation progressively aligns to the target, while supporting growth.

Also read: RBI Monetary Policy live updates – April 5

 “These decisions are in consonance with the objective of achieving the medium-term target for consumer price index (CPI) inflation of 4% within a band of +/- 2%, while supporting growth,” RBI governor Shaktikanta Das announced after the MPC meeting. 

Stating that the domestic economy was experiencing strong momentum, he said as per the second advance estimates (SAE), real gross domestic product (GDP) expanded at 7.6% in 2023-24 on the back of buoyant domestic demand. 

“Real GDP increased by 8.4% in Q3, with strong investment activity and a lower drag from net external demand. On the supply side, gross value added recorded a growth of 6.9 per cent in 2023-24, driven by manufacturing and construction activity,” he said.

Looking ahead, Mr. Das said, an expected normal south-west monsoon should support agricultural activity. “Manufacturing is expected to maintain its momentum on the back of sustained profitability. Services activity is likely to grow above the pre-pandemic trend,” he said.

“Private consumption should gain steam with further pick-up in rural activity and steady urban demand. A rise in discretionary spending expected by urban households, as per the Reserve Bank’s consumer survey, and improving income levels augur well for the strengthening of private consumption,” he added. 

“The prospects of fixed investment remain bright with business optimism, healthy corporate and bank balance sheets, robust government capital expenditure and signs of upturn in the private capex cycle,” he further said. The Governor said headwinds from geopolitical tensions, volatility in international financial markets, geo-economic fragmentation, rising Red Sea disruptions, and extreme weather events, however, pose risks to the outlook. 

“Taking all these factors into consideration, real GDP growth for 2024-25 is projected at 7.0% with Q1 at 7.1%; Q2 at 6.9%; Q3 at 7.0%; and Q4 at 7.0%. The risks are evenly balanced.”

On inflation the Governor said “Two years ago, around this time, when CPI inflation had peaked at 7.8% in April 2022, the elephant in the room was inflation. The elephant has now gone out for a walk and appears to be returning to the forest. We would like the elephant to return to the forest and remain there on a durable basis.”

“In other words, it is essential, in the best interest of the economy, that CPI inflation continues to moderate and aligns to the target on a durable basis. Till this is achieved, our task remains unfinished,” he added

He said the headline softened to 5.1% during January-February 2024, from 5.7% in December. After correcting in January, food inflation edged up to 7.8% in February primarily driven by vegetables, eggs, meat and fish. 

Fuel prices remained in deflation for the sixth consecutive month in February. CPI core (CPI excluding food and fuel) disinflation took it down to 3.4% in February — this was one of the lowest in the current CPI series, with both goods and services components registering a fall in inflation, he said. He said going ahead, food price uncertainties would continue to weigh on the inflation outlook. An expected record rabi wheat production in 2023-24, however, will help contain cereal prices. Early indications of a normal monsoon also augur well for the kharif season. 

“On the other hand, the increasing incidence of climate shocks remains a key upside risk to food prices. Low reservoir levels, especially in the southern states and outlook of above normal temperatures during April-June, also pose concern. Tight demand supply conditions in certain pulses and the prices of key vegetables need close monitoring,” he said. 

“Fuel price deflation is likely to deepen in the near term following the recent cut in LPG prices. After witnessing sustained moderation, cost push pressures faced by firms are showing upward bias. The recent firming up of international crude oil prices warrants close monitoring. Geo-political tensions and volatility in financial markets also pose risks to the inflation outlook,” he added. 

“Taking into account these factors and assuming a normal monsoon, CPI inflation for 2024-25 is projected at 4.5% with Q1 at 4.9%; Q2 at 3.8%; Q3 at 4.6%; and Q4 at 4.5%. The risks are evenly balanced. 

The MPC also noted that domestic economic activity remains resilient, backed by strong investment demand and upbeat business and consumer sentiments. Headline inflation has come off the December peak; however, food price pressures have been interrupting the ongoing disinflation process, posing challenges for the final descent of inflation to the target. Unpredictable supply side shocks from adverse climate events and their impact on agricultural production as also geo-political tensions and spillovers to trade and commodity markets add uncertainties to the outlook, Mr Das said. 

“As the path of disinflation needs to be sustained till inflation reaches the 4% target on a durable basis, the MPC decided to keep the policy repo rate unchanged at 6.50% in this meeting,” he added. 

Stating that monetary policy must continue to be actively disinflationary to ensure anchoring of inflation expectations and fuller transmission, he said the MPC would remain resolute in its commitment to aligning inflation to the target. 

“The MPC believes that durable price stability would set strong foundations for a period of high growth. The MPC also decided to remain focused on withdrawal of accommodation to ensure that inflation progressively aligns to the target, while supporting growth,” he said. 

RBI Governor Shaktikanta Das delivers the plenary address at the ‘Kautilya Economic Conclave’, in New Delhi, Friday, Oct. 20, 2023.
| Photo Credit: PTI

 

Interest rates will remain high, and any change will depend on the way the world evolves, Reserve Bank of India Governor Shaktikanta Das said on Friday, highlighting fresh uncertainties that have emerged in the global economy in the fortnight since the latest Monetary Policy review. 

Referring to the recent spurt in U.S. bond yields to a record high, combined with policy pronouncements from central banks with mixed data points from around the world, Mr. Das asserted that while central banks must remain agile to these developments, the first line of defence must be stock exchanges and financial institutions. Some uncertainties that already existed, have been exacerbated, he noted, like the rise in crude oil prices and the persistent volatility in financial markets.  

Asked about the ‘higher for longer’ interest rate prospects at the Kautilya Economic Conclave, the Governor said central banks will have to be extra vigilant about the growth-inflation dynamics while keeping a hawk’s eye on price rise.  

Editorial | Tightrope walk: On RBI holding rates

“How these economies are going to play out next year in terms of their growth, because if growth slows, that also creates other challenges for financial stability,” said Mr. Das. “So I would not venture to say how long these interest rates will be high, but I’m not giving a forward guidance,” he noted. 

Interest rate cuts in India, he emphasised, are not on the agenda at the moment. “Interest rates will remain high, how long they will remain high, I think only time and the way the world is evolving, will tell,” Mr. Das underlined. 

RBI governor Shaktikanta Das delivers the plenary address at the ‘Kautilya Economic Conclave’, in New Delhi, on October 20, 2023.
| Photo Credit: PTI

Reserve Bank of India (RBI) governor Shaktikanta Das on October 20 stressed that the monetary policy must remain actively disinflationary to ensure that the decline in inflation from its peak of 7.44% in July continues smoothly.

Addressing the Kautilya Economic Conclave 2023, he also said price stability and financial stability complement each other and it has been an endeavour at RBI to manage both efficiently.

Retail inflation declined to a three-month low of 5.02% annually in September on account of moderation in vegetables and fuel prices, and was back within the Reserve Bank’s comfort level.

The inflation based on Consumer Price Index (CPI) was 6.83% in August and 7.41% in September 2022. In July, inflation touched a peak of 7.44%.

The Reserve Bank has raised the key policy rate (repo) by 250 basis points since May 2022 to tame inflation. However, it pressed the pause button on rate hike in February this year.

“We have maintained a pause on policy rate. So far 250 basis points rate hike is still working through the financial system. We have also appropriately fine-tuned our communication to ensure a successful transmission of the interest rate hikes,” the governor said.

He also said expansion of digital payments have made monetary policy transmission more quick and effective.

Mr. Das also stressed that the monetary policy is always challenging and there is no room for complacency. In his speech, the governor also said the global economy is now facing a triad of challenges — inflation, slowing growth and risks to financial stability.

“First, no moderation in inflation which is getting interrupted by recurring and overlapping shocks. Second, slowing growth and that too with fresh and enhanced obstacles. And third, lurking risks of financial stability,” he said.

With regard to the domestic financial sector, he said Indian banks would be able to maintain minimum capital requirements even during stress situation.

India is poised to become the new engine of global growth, Mr. Das said, and added the country is expected to clock 6.5% GDP growth rate in the current fiscal ending March 2024.