1. Monetary Policy and
Financial Markets
Tulasi Gopinath
Department of Economic and Policy Research
Reserve Bank of India
New Delhi

2. Structure of Presentation
• Introduction to Monetary Policy in India
• RBI Act
• Objectives
• Overview
• Latest Developments wrt Monetary Policy in India
• Urjit Patel Committee
• Recent Global Developments in Monetary Policy
• Monetary Policy and Financial Markets in India
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3. Introduction: RBI Act
• The preamble to the RBI Act, 1934 delineates the basic
functions of the Bank as
“to regulate the issue of Bank notes and keeping of reserves with
a view to securing monetary stability in India and generally to
operate the currency and credit system of the country to its
advantage”
• Maintain price stability
• Adequate flow of credit to productive sectors
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4. Introduction: Objectives
• In India, multiple objectives of
• price stability,
• financial stability (orderly conditions in financial markets) and
• growth.
• Not inherently contradictory, rather mutually
reinforcing
• Price and financial stability are important for growth
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5. Introduction: Overview
• Prior to 1980s
• Closed economy
• Trade and financial flows
• Administered regime
• Arbitrarily determined interest rates
• Selective credit controls
• Direct/Quantitative approach
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6. Introduction: Overview (2)
• Post 1980s
• Gradual opening
• Trade and financial flows increased
• Financial market reforms
• MM (instruments, institutions, and participants)
• Govt Sec market (market borrowing, market infra, risk
Mag)
• Credit markets ( interest rate deregulation, CRR, SLR,
CIBIL)
• Indirect approach
• Market-based (interest rate, LAF, OMO)
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7. Recent Developments in MP
• Efforts are underway to develop term money markets
by specifying
• How much can be borrowed under overnight, 7-day, 14-
day, etc
• overnight repos at 0.25% of bank-wise NDTL
• under 7-day and 14-day term repos of up to 0.75 per cent
of NDTL of the banking system
• More frequent term repo actions
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8. Latest Developments (Urjit Patel Committee)
• One of five Pillar (Reforming MP framework)
• Broad recommendations
• CPI nominal anchor
• Target of 4% (+/-2%)
• Inflation to be brought down to 8% first and to 6%, then
adopt target
• Monetary Policy Committee
• RBI and GoI working
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9. Recent Global Developments in MP
• Global financial crisis in 2008 prompted unprecedented
policy activism
• Ultra-loose MPs in AEs
• Zero-bound interest rates
• unconventional MP measures
• Asset purchases (QEs)
• Forward guidance
• Asset market signals are distorted
• Once, unconventional policies are withdrawn, …..
• India is equally vulnerable because of cross-border flows
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10. Monetary Policy & Financial Markets
• For traders/investors, implications of MP for financial
markets important
• Earlier, FMs were underdeveloped
• Administered interest and exchange rate
• No scope for trading
• Now FMs are developing
• Interest and ex - rates are market determined
• Increasing scope for traders/investors
• MP impacts FMs through the tools of
• interest rate
• liquidity and
• expectations
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11. Monetary Policy & Financial Markets (2)
• MP’s impact on FMs manifest in prices, arbitrage and
yield curve
• MP influences price-discovery in FMs
• MP helps in developing benchmarks for pricing across
maturities and markets
• Add risk premium
• Add term premium
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12. Monetary Policy & Financial Markets (3)
• Transmission mechanism
• Passing on policy impulses to the markets
• Market integration critical
• Through changes in policy rates, shorter-end of interest rate
spectrum is influenced, which transmits across terms structure
• Measures to promote integration
• Free pricing (ex rate determination, auction, etc)
• Widening participation (participation in call money, FII in debt
& eq)
• New instruments (repo, LAF, CP, CDS, CBLO)
• New institutions (CCIL, DFHI)
• Technology (trading and payment settlement)
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13. Monetary Policy & Financial Markets (4)
• Over time, FM integration improved
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14. Monetary Policy & Financial Markets (5)
• If transmission of policy impulses across markets and
across term structure not optimal, arbitrage
opportunities arise
• Across term structure
• Across markets
• Scope for trading
• Ex: buying in call and selling in forex
• Buy in shorter-end selling in longer-end
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15. Monetary Policy & Financial Markets (6)
• MP impacts yield curve
• MP influences expectations of future rate of interest
• Loose MP rises longer-term interest rate expectations and
hence steepens yield curve
• Tight MP lowers longer-term interest rate expectations
and hence flats yield curve
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16. Thank you
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