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Correlation Between Policy Rate and Yields

This document discusses the correlation between the Reserve Bank of India's (RBI) policy repo rate and government security (G-Sec) yields of different maturities in India. It finds that short-term G-Sec yields, such as the 3-month yield, are more highly correlated with and reactive to changes in the repo rate compared to long-term yields like the 10-year yield. While policy actions influence all maturity yields, the effects tend to decrease with increasing maturity. The repo rate is the main policy instrument that RBI uses to steer short-term interest rates and overall monetary policy.

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114 views3 pages

Correlation Between Policy Rate and Yields

This document discusses the correlation between the Reserve Bank of India's (RBI) policy repo rate and government security (G-Sec) yields of different maturities in India. It finds that short-term G-Sec yields, such as the 3-month yield, are more highly correlated with and reactive to changes in the repo rate compared to long-term yields like the 10-year yield. While policy actions influence all maturity yields, the effects tend to decrease with increasing maturity. The repo rate is the main policy instrument that RBI uses to steer short-term interest rates and overall monetary policy.

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Dhaval224
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Correlation Between Policy Rate and Yields

• There are several instruments that are used by Reserve Bank of India to implement the monetary
policy, to regulate magnitudes such as interest rate, money supply and availability of credit to
achieve the economic objective. The same are listed below:

• Repo & Reverse Repo rate which impact interest rates.


• Liquidity Adjustment Facility (LAF)
• Marginal Standing Facility (MSF)
• Bank Rate
• Cash reserve ratio (CRR).
• Statutory liquidity ratio (SLR) which impacts liquidity conditions in the market.
• Open Market Operations (OMOs)
• Others

• Interest rates are nudged by RBI through its monetary policy by increasing or decreasing the
Repo rates.
• RBI by changing CRR, impacts the liquidity condition in the market which will impact bond yields
too.
• The policy actions by RBI affect short term yields and long-term yields differently.
• While short term rates are directly influenced by RBI via its policy actions and are therefore more
correlated with the policy actions.
• On the other hand, the long-term rates are not only depended on RBI's policy actions but also
takes into consideration market expectations of what impact current short-term rates will have
on inflation and economy.
Correlation between Repo Rate and Yields

Source: RBI. Bloomberg. Data from April 2001 to August 2019.

• The chart above shows the movement of 3 month & 10-year G-Sec yield and Repo rate during
different RBI policies.
• From the above chart, we can see 3-month G-Sec yield moves more in line with policy action
than 10-year G-Sec yield.
• Policy changes do have an effect on yields of all maturities; however, the effects may reduce with
increase in maturities.
• Table below shows the correlation between policy action and G-Sec yields having different
maturities. We can see that change in short term rates have higher correlation than long term
rates with policy action.

Correlation 3M 1 yr 3 yr 10 yr
Repo Rate 0.52 0.43 0.37 0.29
Repo Rate Trend

• The chart above shows yield curve changes at various dates when the repo rate was cut and hiked.
From the chart, we can see that when repo rate changes, short term yields reflect the change more
than long term yields.

As of today, RBI's repo rate stands at 4.40 percent. The Reserve Bank in its last monetary policy
reduced the repo rates by 75 bps to 4.40 percent from earlier 5.15 percent

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