The annoncement impact of bank rate on commercial paper rate

Abstract

Central bank actions are designed to influence asset prices and yields, which in turn affect economic decisions. Following the reforms in the Indian financial sector, the Bank rate has emerged as an important indicator for signalling the stance of monetary policy for the market and guiding the interest rates to the desired trajectory. Commercial Paper (CP) has evolved as an important source of resource mobilization by the corporates during last few years. Like other money market rates, CP rates are also influenced by the changes in the Bank rate. This paper attempts to capture the extent and nature of influence of announcement of bank rate changes on Commercial Paper rates in India. It concludes that the time series data of CP rates and Bank rate are non-stationary at level. However, these data series are found to be cointegrated. The Error Correction Model reveals that the changes in Bank rate are not quickly reflected in the CP rates. The regression equations reveal that there is a statistically significant relationship between Bank rate and CP rates. The result obtained from using regression analysis for 30 days window period for each of the eight times when Bank rates have changed reveals that compared to 1999-2000, the CP rates have become more sensitive to Bank rate changes during 2001-2003. The bank rate has thus established itself as a potent signalling rate for CP rates in recent years.