Impact of monetary policy on stock market: India

Abstract

Financial markets play a crucial role in the foundation of a stable and efficient financial system of an economy. Numerous domestic and international factors directly or indirectly affect the performance of the stock market. The growing globalization of financial markets and adoption of more flexible monetary and exchange rates regimes resulted in increasing evidence of predictability of stock markets performance using monetary variables. The response of the financial markets towards monetary policy depends on market efficiency and the degree of development of both financial institutions and equity culture in the market. This explains the extensive research on the linkages between advanced/mature stock markets behaviour and monetary policy, while it remained relatively unexplored area for emerging markets. Post introduction of LAF in 2000, new indirect tools like Repo rate, Call money rate (CMR), reverse repo rate etc. have emerged for monetary policy signalling. This paper attempts to explore the impact of monetary policy (via CMR) on stock prices in India. The variables used in the study are NSE stock price Index and Call Money rate (CMR) which acts as a proxy for monetary policy. The paper intends to examine the robustness and efficacy of monetary policy instruments in transmitting the policy signals and its impact on financial market. In this study, Structural Vector Autoregression (SVAR) model has been employed to understand the response of Indian financial market to monetary policy shocks.