Monetary and Fiscal Policy Impacts on the Indian Sovereign Bond Market: A VAR Approach

Abstract

This study analyses the dynamic relationship between yield curve behaviour and the macroeconomy in India, with a focus on both monetary and fiscal policy impacts. Using the monthly data on yields of Treasury bills and government securities from April 2000 to March 2020, we employ principal component analysis to extract the three yield curve factors—level, slope and curvature. We then use an unrestricted vector autoregressive model to analyse the relationship between these three yield curve factors and macroeconomic variables: inflation, GDP growth, exchange rate and monetary and fiscal policy indicators. Our findings reveal a bidirectional causality between yield curve factors and macroeconomic variables. Monetary policy plays an important role in shaping the yield curve, with short-term rates having more pronounced effects than long-term rates. Notably, this study is among the first to incorporate fiscal policy indicator in the Indian context, providing a more comprehensive understanding of policy impacts on the sovereign bond market. Our results offer valuable insights for policymakers and investors, showing the interrelationship of fiscal and monetary policies with bond market dynamics in emerging economies. This research contributes to the growing macrofinance literature and enhances our understanding of financial market dynamics in a developing economy. JEL Classification: E430, C32, G120, E44