An empirical examination of the term structure of interest rates in the Indian economy suggests cointegration (or long run stable relationship) among interest rates but existence of multiple common trends. The absence of a unique common trend implies that long run movements of any one interest rate are not dominated by the movements of the other interest rates. The presence of cointegration, however, suggests a long run interlocking of interest rates across markets and a possibility of their common response to changes in expectations about future monetary policy and/or economic fundamentals. The interrelationship between transitory (cyclical) components of interest rates reveals that yields, especially, of dated government of India (GOI) securities became closely aligned to money market conditions beginning from the second half of the calendar year 1996. Since short-term transitory components often stem from policy impulses, the closer synchronisation of the said yields with call money rates observed during this period could, perhaps, be attributed to the Reserve Bank of India (RBI) decisions to integrate the two markets by allowing primary dealers to participate in the interbank call money market.
