Words that Move Markets- Quantifying the Impact of RBI's Monetary Policy Communications on Indian Financial Market

TL;DR

This paper investigates how the Reserve Bank of India's monetary policy communications influence Indian financial markets by analyzing sentiment and topics using advanced NLP techniques, revealing nuanced market reactions to different policy messages.

Contribution

It introduces a novel application of BERTopic and fine-tuned RoBERTa to analyze the impact of RBI's communications on markets, emphasizing topic-specific effects.

Findings

Dovish sentiment on interest rate policy leads to market declines.

Dovish sentiment on forex reserves management positively impacts markets.

Market reactions vary significantly across different economic topics.

Abstract

We analyze the impact of the Reserve Bank of India's (RBI) monetary policy communications on Indian financial market from April 2014 to June 2024 using advanced natural language processing techniques. Employing BERTopic for topic modeling and a fine-tuned RoBERTa model for sentiment analysis, we assess how variations in sentiment across different economic topics affect the stock market. Our findings indicate that dovish sentiment generally leads to declines in equity markets, particularly in topics related to the interest rate policy framework and economic growth, suggesting that market participants interpret dovish language as signaling economic weakness rather than policy easing. Conversely, dovish sentiment regarding foreign exchange reserves management has a positive impact on equity market. These results highlight the importance of topic-specific communication strategies for central banks in emerging markets.