Unconventional monetary policy and its impact on term premium in India

Abstract

As the economic growth of India declines in the past few years and especially during the Covid pandemic, dependence on monetary policy to stimulate growth has risen sharply. Recently, the serve Bank of India (RBI) resorted to a few unconventional measures of monetary policy like Long-Term Repo Operations (LTRO), Targeted LTRO (TLTRO), Operation Twist, G-Sec Acquisition Programme (G-SAP 1.0 and 2.0) along with the conventional measures like controlling policy (repo and reverse repo) rates. The usual monetary policy measures help in influencing the short-term interest rates. However, through a range of such unconventional policy measures, RBI is now trying to influence the long-term interest rates, which are usually governed by the bond markets. [1] The structure of interest rates in our economy is determined by the yield curve—a plot that depicts the yield for bonds offering equal credit quality at different dates of maturity. The gradient of the yield curve gives us an understanding of the expected interest rates in future, which further helps us figure out the expected future inflation. A simple measure of this gradient is the term premium. Hence an understanding of the factors determining term premium is crucial for an inflation targeting monetary policy that the RBI implements. In this report, we have tried to access the impact of these unconventional monetary policy measures on the term premium.