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The signalling mechanism of monetary policy is of vital importance as it conveys the central bank's assessment of the economy and its future outlook. In the Indian context, changes in the policy environment since the later half of the 1990s have brought about shifts in the operating procedure of monetary policy. As a result, beside the traditional instruments, new indirect instruments have emerged as tools of monetary policy signalling. Against this backdrop, we examine the efficacy and robustness of alternative monetary policy instruments in transmitting policy signals and its impact on financial market behaviour. Employing a SVAR model, we ascertain whether the gradual emphasis on indirect instruments have facilitated the task of conveying the monetary policy stance and also provide evidence of asymmetric response of financial markets to monetary policy shocks.

Central banks emphasise on transparency of communication with the public in order to enhance the effectiveness of monetary policy. In this regard, the signalling of policy stance is of vital importance as it conveys the intent of the monetary authority and its future outlook on macro fundamentals. While the signalling mechanisms in developed countries are quite robust, they tend to be weak in the case of emerging market economies, particularly in the wake of market segmentation and absence of a well-defined transmission mechanism. In the Indian context, the changes in the framework and operating procedure of monetary policy since the later half of the 1990s has necessitated broadening the array of policy instruments for communicating shifts in monetary policy stance, whereby greater reliance is on price rather than quantity adjustments. Against this backdrop, the paper examines whether the shift in emphasis towards the price channel vis-à-vis the quantity channel is borne out by empirical evidence on Indian financial market data. In particular, we try to ascertain the relative efficacy and robustness of alternative monetary policy instruments in communicating policy signals and influencing financial market behaviour. More specifically, this paper has two objectives. First, to discuss briefly the empirical literature on the pass-through effect of policy signals on financial market behaviour. Second, in view of the above, to empirically analyse the impact of changes in policy instruments on various segments of the Indian financial market through a Structural Vector Auto Regression (SVAR) model and draw policy perspectives. While most studies have analysed the dynamic interaction between monetary policy and financial markets in developed countries (e.g. Faust & Rogers, 2003; Roley & Sellon, 1995), the present paper is different in three ways. First, we examine the case of an emerging economy, viz. India, where the transmission mechanism exhibit dynamics that are significantly different from more mature markets. Second, we study the impact of all monetary policy instruments, which are actively used by the central bank, on different segments of the financial market. 1 Third, we impose identifying conditions from theory and observed market behaviour instead of estimating an atheoretic model and discuss in detail the policy implications of the results obtained from the empirical exercise. The rest of the paper proceeds as follows. Section II briefly reviews the empirical literature on the pass-through effects of monetary policy announcements on financial markets. Section III provides a brief discussion of the changes in operating procedure in India brought about by changes in the policy environment. Section IV provides an empirical analysis of the signalling impact of monetary policy in India along with its policy implications. Section V concludes by summarising the key findings.

Our analysis suggests that even though the Bank Rate was identified by the RBI as the principal signalling instrument in the pre-LAF period, quantity adjustments through CRR had a dominant impact on financial markets vis-à-vis rate instruments. In the post-LAF period, however, the situation changed as the reverse repo rate became the most important signalling rate of the RBI. The impact of these signalling instruments, however, was confined to the money, forex and bond markets leaving the stock market largely unaffected. Thus, while the RBI's policy actions had an impact in most segments of the financial market in India, its impact on the stock market was negligible. For the remaining segments of the financial market, we are able to provide empirical evidence on the effectiveness of monetary policy signals, both in the pre and post-LAF periods and the asymmetric impact of monetary policy announcements on financial markets, albeit somewhat muted in the post-LAF period.