Central Communication in India and its Impact on the

Financial Markets

Ishita Gupta

7th May 2018

1 Introduction

Communication comes from the latin word communicare which means to share and cen-
tral bank communication means to share their monetary policy stance with their audience.
For certain central banks, the audience may include the general masses in addition to the
market. Since 1990s, the narrative around central bank communication has changed. It
has now become an essential monetary policy tool used by central bankers. Before, cen-
tral banks used to be secretive of their policy stance and argued against communication.
The change in narrative could be attributed to the impact communication has had on the
financial markets and the evolving definition of monetary policy. For example, Kohn and
Sack (2003) found that Fed’s chairman’s speeches moved the market in the United States
of America. Additionally, Ehrmann and Fratzscher (2007b), argue that speeches made by
members of the ECB have had a significant impact on the financial markets in Europe. Ad-
ditionally, during the financial crisis, several central banks used communication as a method
to make monetary policy more effective. Further, post-crisis central banks gained more au-
thority, hence, they became more credible and transparent, hence, after the financial crisis

1
that central bankers started adopting more transparent methods and communicating even
more. Simultaneously, the definition of monetary policy evolved; it went from just man-
aging interest rates to also managing expectations. As expectations became an important
part of developing efficient monetary policy. Hence, several economists started advocating
communication as an effective tool to “manage expectations” (Blinder, 2008). Therefore, it
can be argued that communication gained importance because of some of these factors and
has become an important aspect of monetary policy.

It is imperative to understand the meaning of communication, it’s different methods

and the reasons provided in support of monetary policy communication. It would also be
interesting to understand the short-term or a long-term impact of communication. Bernanke
and Kuttner (2005) try to understand why Fed’s monetary policy has an impact on the
financial market. Additionally, Blinder (2008) too tried to understand communication and
its implication in Europe and United States. However, most of the research is available on
developed countries and little is known in the context of developing countries. It could be
because of several reasons: underdeveloped financial markets, the structure of the central
banks and the mandate of the central bank. Irrespective, it is crucial to understand whether
communication has the same impact in developing nations as it does in developed countries.
If it does then the how can communication central banks located of the developing countries?

This question motivated me to understand central bank communication in India.

Hence, in this paper, I will try to analyze the impact of central bank communication on
the financial markets in India. This paper is divided into two sections: literature review
and an empirical study. The literature review tries to bring together different narratives
around communication. It contains an analysis of monetary policy in India as it provides
information on the Reserve Bank of India’s (RBI) history. In the empirical analysis, I
showcase the impact of RBI’s communication on the stock market and the bond market in
India. I have used SENSEX data from 2001-2018 to understand the impact on the Stock

2
market. Further, I have used three different types of government bonds: 1 year, 5 year
and 10 years, to analyze the bond market in India and calculate the risk free rate. The
empirical and theoretical model used in this paper is taken from Savor and Wilson (2013)
and Bernanke and Kuttner (2005). Savor and Wilson (2013) try to understand the impact of
macroeconomic announcements (FOMC announcements, employment rate and inflation) on
the stock and bond prices in United States. However, I only look at the impact of monetary
policy announcements on bonds and stock prices. In my regression models, I have controlled
for budget announcements, year fixed effects and Fed’s announcement because India has a
different institutional structure.

I find that on an average excess returns from the Sensex are not higher on the day
of the announcement compared to non-announcement days. Further, I find that the stock
market does not react to Fed announcement but risk-free rates calculated using 1-year gov-
ernment bond do react to budget announcements. This again contradicts the results obtained
by Bruce, Savor and Wilson (2015); they find that Fed announcement has an impact on the
financial markets of 36 countries. Additionally, I control for three days before and three days
after monetary policy announcement (Table 2). While three days before has not significant
impact, three days after the monetary policy announcement has a significant impact. There-
fore, it can be argued that the impact of communication does not flatten out right after the
announcement day.

Moreover, I find that year has an impact on stock prices (Table 3). It can be argued
that in India, year is important as the governor present might have an important effect on
the stock market. Further, I checked this hypothesis by controlling for governor fixed effects
in each year (Table 4) and I find that the presence of governor Raghuram Rajan seems to
have a significant impact on the excess returns from the financial markets (Table 5). Hence,
it can be argued that the governor present has an important impact on the financial markets
in India. Additionally, in 2016, the RBI moved to an inflation targeting regime and the

3
monetary policy committee was formed to make communication by the central bank more
effective. Therefore, it is important to control for year-fixed effects in India.

Further, I find that Bond market does not react on the announcement day. While
the average returns from the 1 year and 5 year bonds are significantly higher on the day
of the announcement as compared to non-announcement days (Table 6). This result is
contradictory to the results obtained regression (Table 7) as on announcement days, the
regression Therefore, it can be argued that investors do not speculate in the bond market for
bond with longer maturity periods, therefore, the 10-year and 5-year bonds are not reacting.
Additionally, the year does not have significant impact on returns from the bonds. Blinder
(2008) argues that if communications steer expectation successfully, then asset prices should
react appropriately and policy decisions should become more predictable. However, the asset
prices in India are not reacting to communication. Hence, it leads us to another question:
is the monetary policy in India affecting expectations successfully or not? Lastly, the paper
will try to analyse the results and raise some questions that can be used for future research.

2 Literature Review

According to Woodford, monetary policy is the art of managing expectations (Blinder, 2008).
Therefore, communication can be an important tool for monetary policy as you can manage
expectations using monetary policy. It is interesting to note that not long before, central
banks did not believe in communication and kept a long “purdah” period before the policy
announcements. In 1980, J.C. Stein, argues the mechanism of communication by the central
banks impact’s expectations. Nonetheless, he was still skeptical of whether central banks
should communicate; he argued that secrecy and surprises would make monetary policy more
effective (Stein, 1989). In 1977, Kydland and Prescott pushed for greater communication
by the central banks and argued it would help increase efficiency (Hutchison et. al, 2012).

4
Since 1990’s some central banks started moving towards a more open communication policy.
Alan Blinder in 1996, in a conference, argued that increasing openness might increase the
efficiency of monetary policy. Additionally, Woodford (2001), proposed that in addition to
effective control of overnight interest rate, a successful monetary policy is the also “affecting
... the evolution of market expectations.” In recent times, communication is recognized as a
new monetary policy tool at the disposal of central bankers. This change in views through
time came about as financial markets developed and central banks gained more power and
authority. Consequently, these institutions became more accountable to the people, hence,
became more transparent and open.

Furthermore, it is critical to find out why should central banks communicate now.
Blinder provides two arguments: greater accountability and effective monetary policy. He ar-
gues that communication is essential as central banks become independent institutions they
become more accountable to the people. Further, clearer communication increases the “effec-
tiveness” of monetary policy. Additionally, a central bank’s objective should be to raise the
signal-to-noise ratio of monetary policy, in order to increase the “effectiveness” of monetary
policy. Clearer communication can help in increasing the signal-to-noise ratio. Moreover,
communication helps to conduct monetary policy by “anchoring inflation expectations and
reducing private sector uncertainty over monetary policy.” Additionally, central banks used
communication as a tool to effectively use unconventional monetary policies during the fi-
nancial crisis. In addition, there has been vast literature and empirical work that proposes
that communication has a long-term impact on interest rates. Further, markets become
more volatile around the day of the announcement, hence, this shows that announcement
days are important days for investors.

Therefore, the question arises, how does communication works? J.C Stein (1989),
puts forward the basic theoretical model for communication by Central Banks. He argues
that communication is a form of cheap talk game and one way to make policy effective is

5
providing imprecise or vague statements. He argues that the public knows that the Fed has
an incentive to lie in order to change beliefs of the public, therefore, they would never trust
the Fed. Hence, one way out of the problem is by making imprecise or vague statements.
Further, he argues that communication also depends on how strongly the central bank is
dedicated to their policy target. However, Blinder (2008), proposes that communication
would not work in a world where “expectations are rational, economic environment is sta-
tionary and the central bank is credibly committed to an unchanging policy rule” because all
the information would be predicted using the bank’s behavior. Therefore, in a world where
monetary policy communication will work should be changing, the central banks should not
be fully committed to one policy rule and the citizens should have a poor understanding of
the central bank’s policy and they should have non-rational expectations.

Lately, almost all central banks across the world have moved towards a more open
communication policy. Yet, the methods adopted by all central banks to communicate differ
greatly. Some of the means of communication are speeches, memos, press releases and press
conferences. While some prefer communicating through press conferences, i.e., ECB, others
prefer to release minutes of the monetary committee meeting with the voting strategy, i.e.,
Fed and Bank of England. The ECB believes that communication through press-conference
is more effective as the media can ask questions and clarify. Simultaneously, there is also
an ongoing debate on who should communicate: an individual or different individuals or
a committee as a single unit. Blinder (2008), has distinguished between three types of
committees: “individualistic, genuinely collegial and autocratically collegial”. He argues
that different views coming out of the same committee might confuse the market, therefore,
creating problems for the central banks by reducing the signal-to-noise ratio. Therefore, it
can be argued that the rationale behind the method adopted varies and it depends on the
financial markets of the country or area.

Another area of research is whether to adopt a forward-looking communication ap-

6
proach, i.e, communicate about the projected output growth, etc. Some central banks, i.e.,
New Zealand, Norway, Sweden and Hungary, publishes estimates of the output gap. How-
ever, some academics, i.e., Goodhart (2001) and Mishkin (2004), argue that announcing
the projected path for policy rate may complicate the committee’s decision-making process.
Further, a deviation from the projected path might impact the credibility of the central
bank which in the future might have negative consequences. Moreover, scholars argue that if
central banks provide forward-looking communication then the market might confuse it for
commitment. If communication is confused with the commitment of the central bank then
it might reduce the effectiveness of future monetary policy (Blinder, 2008).

Moreover, there is a vast literature putting forward the implications of communica-

tion. Monetary policy communication, like everything, has a positive and negative impact.
Firstly, communication can influence the market expectations and move asset prices. Fur-
thermore, it increases the predictability of monetary policy and reduces the volatility by
reducing noise in the market. There have been various studies showcasing how the central
bank statements impact the financial market prices. Kohn and Sack (2003), found that
FOMC statements and Greenspan’s testimonies moved the market prices, while Greenspan’s
speeches did not. Ehrmann and Fratzscher (2007b), find a significant impact of speeches
of the ECB on the financial markets. They also show that markets react equally to the
statements made by all members of the Governing Council of the ECB. Brusa, Savor Wil-
son (2015), find that macroeconomic announcements around the world have an impact on
their local stock markets, in addition, Fed’s announcements to affect the stock market of 36
countries. They find that Fed announcements have a unique impact on global equity prices.
They also find that the average stock market returns and the Sharpe ratio is around 20-40
times greater on the days of the scheduled FOMC announcement days compared to non-
announcement days. They also find that global average market excess return is 2.7 bps on
non-announcement days, while on FOMC announcement days it is 27.6 bps. Further, they
find that average return from the US equity market on the day of the FOMC announcements

7
are under 40 bps higher while for the UK and Germany equity market it is over 40 bps and
for Japan, it is 60 bps. Therefore, they argue that FOMC announcement are “important
drivers” of the stock market returns (Brusa, Savor Wilson, 2015).

Additionally, Savor and Wilson (2014), find significantly higher average returns from
the stock market on the day of the announcement, two days before and two days after
the announcement. Further, they also find that on announcement days the stock market
betas are strongly related to the average returns. They also find that on announcement day
average excess returns are highly significant, hence, 60% of the equity risk premium is earned
on announcement days. One of the possible arguments they give is that on announcement
days due to reduced noise there is a clearer signal of the risk and the expected future returns
from the market. Secondly, it is possible that investors expect higher returns on riskier
assets on scheduled macroeconomic news days. They argue that risk-averse investors will
anticipate that they will be exposed to higher risk, therefore, they will demand and receive
higher expected excess return during those times. Therefore, they see a significant difference
between the average excess return from the stock market on announcement days and non-
announcement days. Further, they also find a significant difference in the returns on T-bills
on announcement days and non-announcement days (Savor Wilson, 2013).

However, if there is too much noise coming from the central bank then it can increase
volatility and affect the market negatively (Blinder, 2008). This some economist argue is
”miscommunication” by the central banks. Further, if the central bank communicates on
a topic which can create more noise then it could lead to problems for the central bank.
Additionally, the central banks can coordinate beliefs of the market in a particular direction,
however, if it fails to do it in the right direction then it might create problems. Therefore,
the central bank needs to be careful while communicating.

This leads us to a set of questions: How much should the central bank communicate?
Is there a right or wrong method to communicate? How much information should be provided

8
to the audience? Some scholars, i.e, Grosselin et al. (2007), propose that if the public is not
aware of the central bank’s preferences at all and “only unanticipated money matters” then
even a full transparent bank won’t be able to move interest rate. Hence, it is important to
have a bit of surprise element in monetary policy to make it more effective. Additionally, a
study in New Zealand finds that no method of communication is the best one; the efficient
method depends on the circumstances and the country of the central bank.

Till now, I have discussed the literature on central bank communication in the West,
mostly in the developed countries because of a lack of literature on central bank communi-
cation in India and developing countries.As discussed earlier, the lack of literature could be
because of several reasons: institutional problem, communication policy of the RBI and the
structure of the financial markets in India.

Firstly, the RBI recently adopted a more open communication policy in 2013. Before
2013, the RBI had a quarterly monetary policy and two mid-quarter reviews and after 2013
started announcing their policies every two months.

Secondly, as discussed earlier, transparency is an important variable for an open

communication policy. The Reserve Bank of India has throughout history struggled to
establish its independence. Therefore, RBI possibly could not establish a free communication
policy. In addition, the RBI also has a social role where it supervises which sectors are
allocated funds, however, the Fed and ECB, only have a set objective which is inflation,
growth and unemployment.

Thirdly, the structure of the financial market in India is different as it has a bank-
based financial system unlike in the USA, UK, etc. where communication is seen as a major
tool. Lastly, Hutchison et al. (2012), argues that RBI’s communication strategy is impacted
by its efforts to keep the exchange rate stabilized. Further, he argues that the most vocal
opinions against communication are RBI governors, i.e, Reddy. Therefore, all these factors
possibly hindered RBI’s communication policy and its impact on the financial markets.

9
2.1 Communication Policy of RBI

The Reserve Bank of India has a nuanced and detailed policy on communication. The policy
states essential details on how the communication is supposed to take place. For example,
it states who is allowed to say what and the guidelines or “principles” that should be fol-
lowed while making a statement. Additionally, the RBI reviews the policy every July and
makes the required changes. According to Reserve Bank of India’s “principle-based” com-
munication policy, “clear and structured communication is critical for effective functioning
as well as enlarging the spheres of traditional monetary policy instruments” (Reserve Bank
of India, 2017). Further, the main aims of the policy are: ensure transparency to strengthen
accountability and credibility, spread awareness about RBI’s responsibility and role, man-
aging expectations and encouraging “two-way flow of information” and giving information,
statistics and research.

According to their policy, RBI’s audience is researchers, academics, media, analysts,

institutions, market participants, government agencies and the common person which in-
cludes an urban and rural population of all genders and ages including school children.
Therefore, they argue that different forms of communications are used by the RBI to tar-
get different audiences. The medium of communication used by them is press releases,
notifications, publications, media (print and electronic), posters, speeches, press and video
conferences, quarterly and annual reports on the macroeconomic conditions. Therefore, the
RBI also has an active twitter account and Youtube channel to reach to the audience faster.
In order to reach to a wider audience, the RBI releases the reports in 11 regional languages
excluding English and Hindi.

Moreover, there are several principles that are guiding communication by the RBI.
The policy argues that the Reserve Bank’s communication should include rational, logic
and analysis, however, they would restrain from providing explicit forward guidance and
leave it to the interpretation of the analysts. Further, the RBI believes that some surprise

10
element can help to increase the efficiency of monetary policy, therefore, some parts of
the monetary policy would not be revealed. Additionally, they argue that communication
should be coherent and clear through formal structured and clear articulation of speeches,
“periodic statements” and report. Moreover, communication of the policy is to improve the
effectiveness of the policy, hence, sometimes the element of surprise can help to increase the
effectiveness of the policy. Further to make communication more effective, the RBI has a
department of communication whose head is the general spokesperson of the Reserve. Besides
the head of the communication department, only the governor and the deputy governor are
allowed to make statements about monetary policy and exchange rates. Additionally, the
deputy governors can only make announcements about their departments. Therefore, this
would help to streamline the process and not too many voices will confuse the market.

This idea of periodic communication is a recent change in the policy as in the past
18 years there have been 84 announcements. As before 2005, the monetary policy was
announced only twice a year and later the RBI started announcing their policy every quar-
ter. Further, they added two mid-quarter assessments every year. However, in 2013, after
Raghuram Rajan became the governor, the policy was announced bi-monthly. Additionally,
if there were some changes in the interest rates, the central bank would publish memos on
the change, however, during Rajan’s era any change in monetary policy was communicated
to the market by Rajan himself.

Furthermore, the extent to which is the communication policy is followed is question-

able as the results from Table 1 show that announcement is not regular. According to the
communication policy, the monetary policy should be announced after a periodic interval.
However, from Table 1 we can see that the policy is not announced on random days, mostly
Tuesdays. Therefore, it can confuse the market as they do not know which day to expect
the announcement.

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 Table 1

Day No. Of Announcements

Monday 6

Tuesday 53

Wednesday 10

Thursday 9

Friday 6

Secondly, the policy mentions that their audience includes the general public including
people belonging all ages and backgrounds. However, the RBI’s website or even the speeches
are not audience friendly. Central banks like Bank of England have a friendly website
which contains animations and sections explaining economic terms. Additionally, it contains
graphics which makes the website interesting and attractive. Further, the Guardian reported
that all members of Bank of England were asked to read Dr Seus as he communicates
coherently in simple language. Therefore, central banks around the world are making an
effort to make their communication more regular and coherent.

Thirdly, the credibility of the governor is also important in determining how market
perceives monetary policy communication. However, in India, most of the governors have
been retired bureaucrats which may not have been perceived to be credible by markets in
India. Hence, the communication policy of the RBI needs to be followed more by the members
of the RBI especially the governors and deputy governors. Additionally, The policy should
be more regular and audience friendly.

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3 Empirical Study

Generally, investors are believed to update their own views in response to the information
conveyed by the central bank. Therefore, various studies have found that financial markets
react to information that is provided by the central banks (Blinder, 2009). There have been
several studies to understand this impact in the USA, England, Eurozone and Japan. For
example, Ben Bernanke and Kuttner (2005), try to understand the impact of the Fed’s an-
nouncements on the stock prices in the United States. Additionally, Savor and Wilson (2013)
try to understand how macroeconomic announcements impact the asset pricing. They look
into how the prices change around important macroeconomic announcement days. Further,
in 2015, they try to understand how Fed’s announcement impacts the stock markets in 37
countries. They also look into how communication by Bank of England, Bank of Japan and
ECB influence the market and find that their has a statistically significant impact on the
market. Hence, it can be argued that communication is an important tool used by central
banks to influence the market. Therefore, In this section, I try to understand the impact
of central bank’s communication on the assets, i.e., stock market and bond market in the
Indian context.

India is believed to not have a fully developed financial system unlike countries like
United States, UK and Eurozone. In areas like USA, UK and Eurozone, the most direct way
through which monetary policy transmission takes place is change in asset prices. Therefore,
to analyse the impact of monetary policy on asset pricing is crucial for academics in the
countries which have this channel (Bernanke Kuttner, 2005). Irrespective of banking system
being India’s main channel for monetary policy it would be interesting to see if asset prices
react to monetary policy.

Irrespective of banking channel being the main transmission channel, announcement

about interest rates still concerns investors. Therefore, this could affect the market and
there would be a change in asset pricing around the day of the announcement.Hence, my

13
hypothesis is that the market would react around the day of the announcement. To test my
hypothesis, I will be using the same model as used by Savor Wilson (2013) which is also
used by Bernanke and Kuttner (2005). They argue that on the day of the announcement,
the return from the test asset can be decomposed into the surprise about the announcement
(zt+1 ), the conditional expectation from the test asset return and the residual term (ut+1 ).

rt+1 = Et[rt+1] + zt+1 + ut+1

They argue that as they are interested in analyzing the average long term return
from the market they will not look into the negative and positive direction of the news. In
addition, the significance of the Beta is more important the the magnitude and sign as they
want to see if the average excess return is significantly different between the two types of
days.

3.1 Data

I have used daily returns from the BSE Sensex as a proxy for market returns. This data on
the Sensex was collected from the official site of BSE from the year 2001 - 2018 for daily
returns. To calculate risk free rates, I have taken three different bond maturity periods- 1
year, 5 year and 10 year. This data has been used to analyze the bond market too. There
have been structural changes within the RBI post 1998, therefore I decided to use the data
available from 2001 on wards. Post 1998, the RBI adopted the multiple target approach
which lasted till 2016.

As discussed earlier, the data on monetary policy announcements is obtained from

the official website of the RBI. The data on 84 pre-scheduled announcements ranges from
2001 - 2018. As discussed in the earlier section, the number of announcements made by the
RBI was decided by the governor. Before 2005 the announcements were bi-yearly, 2005-2013
were quarterly with two policy reviews and post 2013 there were bi-monthly. This data was

14
used to create the independent variable, the RBI announcement dummy. RBI announcement
dummy is 1 on the day of the announcement and 0 on the day of the non-announcement.
Rate change is defined as if on that day RBI hiked or reduced the interest rate.

Table 2: Descriptive Stats

No. Of Announcements

Number of Announcements 84

No of rate changes 38

Further, I have calculated the excess returns using three different government bonds
term maturity: 1 year, 5 years and 10 years. I have defined excess returns as:

er = rm − rf t

Where rf is the risk free rate from bond of maturity period t and rm is the return from the
market. Additionally, the data regarding the announcements made by the Federal Reserve
have been obtained from the official website of the Federal Reserve. As there is no official
site containing data on budget announcements in India, I have taken the data regarding the
dates from several newspaper articles.

3.2 Methodology

I have analyzed the impact of communication of the RBI on stock prices and bond prices. In
order to make the results more rigorous, I have controlled for day fixed effects. In addition to
the controls used by Savor and Wilson, I am also controlling for the budget announcement
and Fed announcement as they might also have a significant impact on the stock market in
India. Hence, to preserve the orthogonality of my the error terms, I have controlled for the
above variables.

The OLS regression model for understanding the impact of communication of the RBI

15
on Stock prices is as follows:

Excess return = RBI announcement dummy + Fed announcement dummy + Budget

day + excessreturni,t−1 + excessreturn2i ,t−1 + day fixed effects + ui

Further, I have controlled for changes in the asset prices three days prior and later
the announcement by adding dummies.

Excess return = RBI announcement dummy + Fed announcement dummy + Budget

day + excessreturni,t−1 + excessreturn2i ,t−1 + day fixed effects + three days pre-monetary
policy+ three days post-monetary policy + ui

Next, I controlled for the impact of governor (Gi ) and year as it is possible that some
governors communication had a higher impact than the others. I added year fixed effects
as it is possible that in certain years the stock prices were impacted due to other issues, i.e,
financial crisis of 2007-08.

Excess return = RBI announcement dummy + Fed announcement dummy + Budget

day + excessreturni,t−1 + excessreturn2i ,t−1 + day fixed effects + three days pre-monetary
policy+ three days post-monetary policy + year fixed effects + Gi + ui

The variables can be interpreted as following:

RBI announcement day = 1 if it was a scheduled monetary policy announcement by

the RBI on that day and 0 otherwise

Fed announcement day = 1 if Fed announced monetary policy on that day and 0
otherwise

Budget announcement day = 1 if budget was announcement on that day and 0 oth-
erwise

Governor dummy = 1 if governor i was in tenure on that day and 0 otherwise

16
3.3 Results

3.3.1 Stock Market

I first run a t-test to understand the difference between the average excess returns on an-
nouncement days and non-announcement days. The findings suggest that for excess returns
calculated using the 1-year government bonds, the difference between excess returns on
announcement days and non-announcement days is statistically significant and is 0.509453.
Similarly, the difference between excess returns calculated using the 5-year government bonds
is 0.3826843 and is statistically significant. However, the difference between excess returns on
announcement days and non-announcement days calculated using 10-year government bonds
is 0.2950794 and it is not statistically significant. This result differs from result obtained by
Savor and Wilson (2013) as they find that 10-year government bond also has significant im-
pacts. The results also contradicts their result that as the maturity of the bond increases, the
difference between excess return should also increase. However, I find that as the maturity
increases the difference reduces and it becomes statistical insignificant.

I further run a simple OLS regression to study the impact of RBI’s announcement
on the excess returns from the stock market. I find that excess returns calculated using
1-year and 5-year bonds are impacted by RBI’s communication. From Table 3, we can argue
that on the day of the announcement of monetary policy, the excess returns from the stock
market will be 0.300 percentage point higher than the excess returns on non-announcement
days.

Moreover, there are studies that showcase that the prices factor in the announcement
effect before the day of the announcement which aligns with the efficient market hypothesis.
Woodford (2002), argues that if investors are rational then they would anticipate the market
rate by studying bank behaviour and factor the change in the prices. Hence, I wanted
to see if it is applicable in the Indian Stock Market too. I observe that when I control

17
for three days before and three days after the monetary policy announcement day, excess
returns calculated using the 10-year bond becomes significant. Three days before and three
days after is a dummy variable which is equal to 1 if the day is one day, two days or three
days before and after the announcement day and 0 otherwise. The results (Refer to the
appendix) show that there is no impact of three days before on the excess returns on the
market calculated using any bond length.

Table 3: OLS Regression

(1) (2) (3)

VARIABLES Excess R- 10 YB Excess R- 5 YB Excess R- 1 YB

RBI announcement day 0.305 0.403 0.300*

(0.202) (0.687) (0.179)
Budget announcement day 0.818** 0.741 0.809**
(0.374) (0.959) (0.380)
Fed announcement day 0.0542 -0.0136 0.276
(0.189) (0.216) (0.190)
Three days before the announcement 0.150 -0.225 0.189*
(0.102) (0.162) (0.103)
Three Days after the announcement 0.176* 0.0541 0.219**
(0.101) (0.162) (0.103)
Observations 3,800 470 3,800
R-squared 0.323 0.162 0.303

Standard errors in parentheses

*** p<0.01, ** p<0.05, * p<0.1
However, this effect nullifies after the addition of year fixed effects. I find that RBI’s
announcements have no significant impact on the excess returns calculated using bond of any
term maturity. Savor and Wilson’s model does not control for different years, however, in

18
India communication strategy has changed over the years depending on the governor differs.
Moreover, there have been several institutional changes in the RBI over the course of time,
therefore, to preserve the orthogonality of the error terms, I added a variable to control for
the year effect. The results in Table 4 provides evidence that years have a significant impact
on the excess returns and the RBI announcement dummy becomes insignificant.

Table 4: OLS regression with year-fixed effects

(1)
Excess R - 1 YB

RBI announcement dummy 0.247

(1.42)
[1em] budget announcement day 0.781∗
(2.10)

Fed announcement day -0.0431

(-0.23)

year 0.0729∗∗∗
(12.51)

N 3802

t statistics in parentheses

∗ ∗∗ ∗∗∗
p < 0.05, p < 0.01, p < 0.001

Consequently, I checked for the years during which RBI’s communication had a sig-
nificant impact on excess return. I found that the following years had a notable effect - 2008,
2011 and 2016. One possible reasons for this could be the governors in these years. There-
fore, I run the regressions again controlling for the governor. The governor dummy is equal
to 1 if he was in tenure on that particular day and 0 otherwise. I add an interaction term
between governor and RBI announcement day dummy. This is to ensure that the impact is

19
due to the presence of the governor on the day of the monetary policy announcement.

The results obtained in Table 5 show that the governor effect was significant in 2016.
The observations highlight that Rajan’s presence had a highly significant impact on the
excess returns from the market. However, the interaction dummy is insignificant implying
that Governor Raghuram Rajan making the announcement does not influence the excess
returns. As the data for the number of days of announcement are few during one governors
term, therefore, the results can be problematic.

Table 5: OLS regression with governor dummy

(1)
excess return 1

RBI announcement 0.423

(0.66)

Rajan 0.461∗∗∗
(3.57)

Rajan*mpc 0.403
(0.52)

cons 7.122∗∗∗
(4.53)

N 234

t statistics in parentheses

∗ ∗∗ ∗∗∗
p < 0.05, p < 0.01, p < 0.001

Further, I analyse whether the magnitude of change in repo rate has an impact on
the excess return (i.e, if the RBI cuts the repo rate by 0.5 basis point then it would have
a greater impact on the excess returns as compared to 0.25 basis point). Therefore, in the
regression model, I use change in interest rate as the independent variable instead of the

20
RBI announcement dummy. The variable is defined as the number of basis points by which
the RBI has cut or increased the repo rate, i.e., 0.25 or 0.5. The results stated in Table 6
show that the impact is insignificant. Thus, it can be proposed that the magnitude of rate
cut does not impact the excess return.

Table 6: OLS regression with change in interest rate as independent variable

(1)
excess return 1

δInterestRate -0.350
(-0.52)

budget day 0
(.)

Fed announcement 0.281

(0.30)

cons 0.0343
(0.01)

N 78

t statistics in parentheses

∗ ∗∗ ∗∗∗
p < 0.05, p < 0.01, p < 0.001

3.3.2 Bond Market

The bond market is an important area for the Reserve Bank of India as they can use open
market operations in order to control the interest rates. Further, government bonds are seen
as risk free and I have used the 1 year, 5 year and 10 year government bond in my analysis
for excess return. Therefore, it would be interesting to see the impact of communication on
the bond market.

21
 In order to test this, I first run a t-test to see if the average returns from the bond
market differ for government bonds on the day of the announcement and non-announcement
days. I find that for average returns from 1 year and 5 year bond on the day of the an-
nouncement are statistically different from non-announcement days. However, the returns
from the 10-year bonds do not differ on the announcement and non-announcement days.

Lastly, for the bond market, I ran did a t-test to see whether there was a significant
difference between 1 year and a 5 year government bond. I find that there was a statistical
difference between the returns from a one year and five year bond on the announcement as
compared to the a non-announcement day.

Table 7

(1) (2) (3)

ten year bond -0.153

(-1.36)

five year bond -0.240∗

(-2.07)

one year bond -0.367∗

(-2.46)

N 4171 4150 3895

t statistics in parentheses

∗ ∗∗ ∗∗∗
p < 0.05, p < 0.01, p < 0.001

I use Savor and Wilson’s model again, therefore, I regress the return from the bond
for maturity period t on the day of the announcement. I control for Fed announcement and
Monday-Thursday effect. In addition, I control for return from the bond on the previous day
and the square of the term. The results in Table 8 show there is a significant relationship

22
between returns from the 1-year government bonds and announcement days. The bond
market also seems to react to the Fed’s announcements and the Budget day

Table 8: OLS regression with Bond Market

(1)
i

RBI announcement -0.0176∗

(-2.00)

budget day -0.0395∗

(-1.97)

Fed announcement 0.0211∗

(2.27)

N 3873

t statistics in parentheses

∗ ∗∗ ∗∗∗
p < 0.05, p < 0.01, p < 0.001

3.4 Limitations

The model used in the paper was taken from Savor and Wilson (2013) and Bernanke and
Kuttner (2004) which was done in the analysis in the US context. The financial market in
the US is different from the financial market in India in terms of structure. Further, the
central banks of the two countries have very different structures, mandates and roles in their
economy. While, their core role remains the same, how the two central banks are perceived
by their own citizens and markets are different. Therefore, replicating the model in the
Indian context might have lead to some biases in the results.

Secondly, there is no control of the political system or elections in the model. Elections
or news about elections can influence the market. Hence, it can be important to take political

23
dummies into the model in order to preserve orthogonality of the error terms.

Lastly, in India, data is a constraint, hence, not all days are present in the data.
Additionally, there have only been 84 announcements in 18 years. Hence, the observations
for the independent variable are few. Further, for year wise analysis, there are only 6
announcements per year, hence, again the pool for treatment is small.

3.5 Conclusion

Communication is an important tool used by almost all central bankers around the world as
it increases the efficiency of monetary policy transmission. On the day of the announcement
of monetary policy, important information about the economy also is revealed. If investors
care about the announcement, there is will be a significant change in the prices or the volumes
of contract traded on the day of the announcement as compared to non-announcement
days. However, the content of the announcement and the credibility of the central bank are
important aspects which determine the reactions of the investors. Therefore, I hypothesize
that returns from the market on the day of the announcement will be greater as compared
to the non-announcement days. This is because investors look forward towards scheduled
announcements.

The results obtained show that the average excess return from the Sensex on the day
of the announcement is significantly greater compared to non-announcement days. How-
ever, the results obtained after controlling for the year fixed effects differ from Savor and
Wilson (2013, 2015) as the impact becomes insignificant. Firstly, the literature available on
asset prices and Fed announcements do not take into account the year fixed effects as they
assume that communication policy remains the same throughout the years. They, further,
assume that all governors will have the same influence on market and will adopt the same
communication policy. However, in India, the methods adopted by each governor are differ-
ent. Additionally, each governor has his own views about communication which they follow,

24
hence, making it important to control for governor in the regression. Over the course of
time, there have been changes in RBI’s communication policy and its mandate. For exam-
ple, the RBI has moved from a multiple approach to an inflation targeting regime in 2016.
As discussed earlier, RBI has also moved from announcing it’s policy twice a year to every
two months in 2012.

Secondly,transparency and credibility of the central bank are important aspects of

central bank communication. Central Banks, for example, Fed, ECB and Bank of England,
are seen as independent authorities separate from the government. The heads of these central
banks are also seen as independent and credible figures by its audience (the citizens and the
market). However, in the Indian context, RBI is sometimes not seen as an independent
body making it hard for the institution to be seen as a transparent body. In Dincer and
Eichengreen (2014) study, India is ranked last in terms of independence of central bank.
Therefore, adding the governor dummy or the year fixed effects is necessary for the Indian
context. This may be a plausible reasons for the differing results. Raghuram Rajan has
had a significant impact on the market,he has used different strategies to communicate with
the market like press-conferences, RBI YouTube channel, speeches in India and abroad,
and individual post-policy press-conferences. He has given more press-conferences and post-
policy conferences than any governor, and has made RBI more transparent and accessible to
the public. In his the first speech, he argued about the importance of communication. An
qualitative example which proves communication helped India is the stabilization of rupee
after Raghuram Rajan’s speech. The notion of perceiving the credibility of governor and
RBI to be the same as changed post the creation of the Monetary Policy Committee (MPC)
in 2016. Before the creation of the MPC, the governor was solely responsible for monetary
policy, however, after the formation of the committee, the decision has become collective.

Another important year for communication in India is 2008. This year, due to the
financial crisis is critical year for central banks around the globe. Post crisis, the institutional

25
role of central banks changed. This change was accompanied with an extensive focus on
communication by the Central Banks. There is a significant amount of literature highlighting
the importance of communication during the financial crisis.

Based on the results obtained, it can be said that the efficient market hypothesis does
hold in India as the markets do not react to the announcements by the RBI. Therefore,
there is no difference between announcement days and non-announcement days. It is argued
that important information about the economy is revealed on the day of the announcement.
Hence, if the market does not react on the announcement day, then the information revealed
is either not important or already anticipated by the market. This substantiates the claim
efficient market hypothesis would hold in India.

Correspondingly, the results also show that the change in magnitude does not have
an impact on the excess returns, i.e, a 0.25 basis point reduction or increase will have the
same impact as 1 basis point increase or reduction. This shows that the announcement day
is important rather than the amount of the rate cut or hike .

Moreover, Bruce, Savor and Wilson (2015), find that markets in around 37 countries
react to the announcements made by the Fed. However, the Indian market is not responding
to the Fed announcement. This is an interesting as announcement by the Fed affects the
investor’s decision to invest in a particular market. A possible explanation for the difference
in results is not fully developed financial markets in India. It would also be interesting to
analyse the change in investments on the day of the announcement. However, due to the
lack of data this analysis could not be done.

Further, I find that announcements continue to influence excess returns till three days
after the announcement day. This shows that the effect does not flatten out immediately post
announcement proving that three days post announcement are important to the investors.
It may be true because the RBI posts the notes from post conference meeting with analysts
and researchers one day after.

26
 In the Bond market, only the 1-year government bond is reacting significantly to
RBI’s announcement. This trend in the Indian market is not similar to the bond market in
the USA. Savor and Wilson (2013), find evidence that when the term length of the bond
increases, the magnitude of the beta of the announcement dummy also increases. They also
showcase that on the announcement day the returns from the bonds are significantly higher
than non-announcement day. This difference in results in the bond market in India could
be because investors do not speculate in the Indian bond market as investors in India are
interested in long-term investment, making the bond market in India less reactive. This also
ties up with the analysis regarding the excess returns calculated using 10 year government
bond.

Lastly, monetary policy, communication by the RBI, financial markets and their re-
lationships have ample scope for future research. Generally, academics would argue that
as there is more risk associated with announcement days investors should be rewarded for
holding assets on the day of the announcement. Therefore, making these assets more volatile
around the day of the announcement. However, as seen in the paper, in India the markets
are not as wavering as expected. This raises interesting questions regarding the relationship
between the monetary policy and the financial markets in India. For example, How does
monetary policy affect financial markets in India? How fast is the transmission of monetary
policy in asset prices in India?

27
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