[Determinants of Yields on Government Securities in India]

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ACKNOWLEDGEMENT

I would take this opportunity to thank my research supervisor, family and friends for their support and guidance without which this research would not have been possible.

DECLARATION

I, [type your full first names and surname here], declare that the contents of this dissertation/thesis represent my own unaided work, and that the dissertation/thesis has not previously been submitted for academic examination towards any qualification. Furthermore, it represents my own opinions and not necessarily those of the University.

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ABSTRACT

This paper examines the determinants of the Government yields in India using weekly data from April 2001 through March 2009. The analysis covers Treasury Bills with residual maturity of 15-91 days and Government securities of residual maturity one, five and ten years respectively. The empirical estimates show that a long-run relationship exists between each of these interest rates and the policy rate, rate of growth of money supply, inflation, interest rate spread, foreign interest rate and forward premium. At the same time, the empirical results also show that the relative importance of the determinants varies across the maturity spectrum. The normalized generalized variance decompositions suggest that the policy rate and the rate of growth of high powered money are less important in explaining the proportion of variation in longer term interest rates. The weight of the forward premium also diminishes as we move towards higher maturity interest rates. The inflation rate is also relatively less important in explaining variations in the 10-year rate. The yield spread, on the other hand, is more important in explaining the longer term rates. The results also show that a large proportion of the variation in the rates on the 5-year and 10-year government securities is attributed to the interest rate itself suggesting that the unexplained variation may be a result of cyclical factors that are relatively more important for longer term rates but are not captured by the yield spread and are omitted from the estimations due to the high frequency of data employed.

TABLE OF CONTENTS

ACKNOWLEDGEMENT2

DECLARATION3

ABSTRACT4

CHAPTER 1: INTRODUCTION6

CHAPTER 2: LITERATURE REVIEW8

Interest Rates and Monetary Policy in India: Some Stylized Facts8

Determinants of Interest Rates15

CHAPTER 3: DATA AND EMPIRICAL MODEL21

Econometric Methodology23

Tests for Nonstationarity24

Cointegration and Granger Causality26

Granger Causality27

Variance Decomposition Analysis28

CHAPTER 4: EMPIRICAL RESULTS29

Generalized Variance Decompositions30

CHAPTER 5: CONCLUSIONS32

RERFERENCES33

APPENDIX36

CHAPTER 1: INTRODUCTION

Tracking interest rates and understanding their determinants is crucial for both financial market participants and policymakers. This is especially true in the case of an economy such as India with an evolving financial sector and increasing integration with the global economy. After almost two decades of financial liberalisation, the financial markets in India are now fairly developed and its monetary policy is also comparable to some extent to that of developed countries. In this scenario, the objective of the study is to examine the impact of domestic market forces and external factors on interest rate determination in India across the maturity spectrum.

The importance of such a study can hardly be over-emphasized given the fact that prior to economic reforms in India, not only was the ...