ABSTRACT. Indian debt market is still in its incipient stage and evolving steadfastly as big-ticket financial sector reforms initiated by Government of India alongside the regulatory reforms initiated by the RBI and the SEBI. After the IPO boom in 2003, there has been a considerable decline in the value of debt securities traded on WDM of NSE. This declining trend is reversing slowly since last two years. Against this backdrop, the paper, first analyzes the structure of the debt market in India. Notwithstanding the thinness of the corporate bond market, it has grown and widened in terms of market participation, change in nature of instruments and convergence towards a market determined interest rates. Secondly, given these developments, the paper looks at the transmission mechanism of monetary policy using VAR analysis in order to ascertain the impact of monetary policy on the debt market. Following Alaverz and Atkenson (1996), the paper uses a heterogeneous agents variant of the limited participation framework of segmented markets model to explore the relationship of repo rate with one year government securities (G-secs) rate and the private final con- sumption expenditure. Following Mizarch and Occhino (2008), the paper examines the contribution of monetary policy to the dynamics of bond real returns. With the standard assumption of monetary authority controling the interest rate, the joint dynamics of the aggregate endowment and the monetary policy variable has been exogenously modeled whereas bond real returns are endogenously determined. The results indicate that the shocks in reverse repo rate are transmitted to call rate and one year G-secs rate substantially. Further, the analysis of the impact of repo rate on net market borrowings shows a reverse relationship as with the positive shocks in repo rate, the net market borrowings declines and vice-versa. In the end, the analysis of the relationship of repo rate with one year G-secs rate and the private final consumption expenditure show that the shocks in repo rate are transmitted to bond yields and after four to five quarters, the impulse response of repo rate converges with bond yields. pp. 359–388
JEL: E52, C32

Keywords: debt market, monetary policy impulses, interest rates 

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Indian Institute of Management Lucknow
Junior Associate, McKinsey

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