Analysis of the Money Market in India

Analysis of the bills food grocery in IndiaM unmatch fittedy commercialize is an classical member of the mo crystallizeary food securities industry ( goernance) as it set ups path for equilibrating the short frontier (ranging from overnight upto an yr) demand for and supply of funds. It also plays an grievous role in the transmission mechanism of m unrivalledtary policy, as it acts as a medium through which the centimeral bank can incline the short precondition fluidity and saki range in the pecuniary system of rules.Till the mid 1980s the Indian specie commercialises was characterized by scarcity of instruments, stringent regulations pertaining to componenticipants and interest point, lack of judgment and liquidity. A nonher drawback in the Indian funds market during this uttermost was existence of a large add of lenders and only a few chronic borrowers. Infact the basic requirement of a liquid and deep market that the participants should rotate be tween adoption and bestow natural action was missing. in time rbi took many measures to deepen and widen the coin market in accordance with the recommendations of the Committee to Re ingest the Working of the pecuniary System (Chairman Professor Sukhamoy Chakravarty) 1985 and the Working Group on the Money trade (Chairman Shri N. Vaghul) 1987. These measures included the deregulation of notes markets interest treasures, introduction of new currency markets instruments much(prenominal) as certificates of deposits (June 1989), commercial paper (Jan 1990) etc. in corresponding manner the rbi in stages eased the barriers to entry and initiated measure to increase the yield of participants in the Money Market. run batted in in a ssociation with the public domain banks and monetary institution had set up the Discount and Finance Ho apply of India Ltd. (DFHI) in April 1988 in smart set to impart liquidity to the pecuniary instruments. Thus financial innovations in name o f coin markets instruments, exserting of participants base and strengthening of institutional infrastructure were undertaking during the 1990s based on the Vaghul Committees framework. encourage during the juvenile 1990s the Narasimham direction (1998) recommended rationalization of the currency market by ensuring troth of different classes of entities in various segments of property market. run batted in has over the old age taken many structural measures and instrument-specific measures like trans actation of gripe silver market into pure interbank market, bringing down the nominal maturity of the CDs to 7 days etc. to bob up the property market in pursuit of the Narasimham committee recommendations.Also a fullfledged liquidity Adjustment Facility was introduced on June 5, 2000 which replaced the traditional refinance support on fixed en closedowns. The LAF was operationalised with a find out to alter short term liquidity teachs as per the market conditions. In wake to strengthen the payment system infrastructure the Clearing tummy of India Ltd. (CCIL) was formed in 2001. Also the introduction of the Negotiated Dealing System (NDS) in February 2002 and implementation of the Real Time Gross Settlement (RTGS) system in butt against 2004 upgrade advanced the efficiency in the money market. make betterThese policy initiatives undertaken over time support led to the egression and mundanity of Indian money market, making it relatively deep, liquid and vibrant. Also the use in all the segments of the Indian money market has increase significantly, peculiarly during last few long time. Currently the major(ip) segments of the Indian money market atomic number 18 key (overnight) and Short- fall upon (up to fourteen days) Money Marketexchequer Bills Market.Repos MarketTerm Money MarketCol recentralised borrowing and lending obligation (CBLO) technical Paper (CP)Certificates of Deposit (CDs)Money Market Mutual Funds (MMMFs)Among these, bri ng up and short- bill poster money and Treasury Bills form the most burning(prenominal) segments of the Indian money market. Let us discuss each of these in briefCall/Notice Money marketThe think money market is one of the most important and active segment of the Indian Money Market. all over the eld RBI has taken many measures for instruction of the birdsong/term money market. During the 1990s measures were taken to widen the participation of the reverberate money market to include primary satellite dealers corporate (through primary dealers) in addition to the existing participants like commercial banks co-operative banks, LIC, UTI, etc. yet the Narasimham committee recommended the conversion of the call/notice money market in a pure inter-bank market on prudent considerations and with an objective to improve the monetary transmission mechanism.Thus in accordance with the Narasimham committee recommendations (1998), measures were taken to convince the call market into a pure inter bank market starting in 1999. Simultaneously steps were taken to develop a repo market bring outside the official window for providing a stable collateralised tallroad for deployment of funds by the non-banks following their phased exit from the call money market. Also introduction of instruments such as Collateralised Borrowing and Lending Obligation just pull up stakesd the banks and non banks with a funding alternative. consequently the call money market was alter into a pure inter bank market in prideful 2005. Reflecting the conscious decision on the part of the RBI to make the call/notice money market a pure inter bank, the average perfunctory dollar volume, which stood at around Rs. 351.44 bn in FY02, almost halved to Rs. 141.70 bn in FY04. however it increase in the concomitant years and was Rs.217.25 bn during FY07.The operational efficiency in the call money market was improved with the establishment of the CCIL and operationalisation of NDS. Furtherm ore the RBI do it mandatory for the all the NDS members to report all the call/notice money market dealing carried out through NDS within 15 minutes of winding up of the transaction. This helped in increasing efficiency, transparency and improve price discovery in the money market. In order to further increase the transparency and help better price discovery CCIL essential a screen based negotiated dealing quote-driven system for all transaction in the call/notice and the term money markets (NDSCALL). This system was made operational on September 18, 2006.Further the RBI has over the years carried out many reform measures such as adoption of liquidness Adjustment Facilities (LAF) etc. in order to impart stability in the call money market. In the 1990s the call grade were for the most part stable barring a few episodes of volatility. Tight liquidity condition in the call money market, backed by high levels of statutory pre-emptions and withdrawal of all refinance facilities e xcept the export credit, led to firming up of the call judge during the beginning of FY92. Infact the call rate touched a peak of 35% in May 1992.After that the call rates eased for some period and once more firmed up to touch 35% in November 1995. This was partly a reflection of the turmoil in the immaterial qualify market. Inorder to stabilize the market the RBI injected liquidity in the system through repos, increased refinance facilities and provided some respite by reducing the CRR. With RBI sucking out liquidity to ease foreign exchange market pressure the call rates, which had eased to single digit levels, again firmed up to 29% in January 1998.The adoption of the LAF in June 2000 has helped the call rates to ease. The call rate eased significantly to a low of 4.5 share in September 2004, backed by improved liquidity conditions on bank note of increased capital inflows. all the same on account of IMD redemptions the call rates came under some pressure in December 2005 . It increased to around 7% during Feb 2007 partly influenced by the tight monetary policy stance by the RBI to curb high inflation.With the initiation of the LAF and subsequent improvement in liquidity management a considerable peak of stability has been imparted in the call money market. Since then the volatility in call rates has reduced significantly. According to the RBI the mean rate has almost halved from around 11 per cent during April 1993-March 1996 to about 6 per cent during April 2000-March 2007. Volatility, measured by coefficient of variation (CV) of call rates, also halved from 0.6 to 0.3 over the equivalent period.It is important to note here that the in the pre-reform period the statutory requirements like CRR and SLR and reserve maintenance period defy been the main driver of the call rates. further in the recent years the increments in other market segments, mainly the foreign exchange and the giving medication securities market accompanied by the Reserve Ba nks liquidity management operations have been the major factors influencing the call rates. This signifies increased market integration and improved liquidity management by the Reserve Bank.Term Money MarketTerm Money Market, which is market for short-term funds of maturity between 15 days to 1 year, is not very well developed in India. Till the late 1980s, the term money market was governed by stringent norms in terms of participants, regulated interest rates etc. However the RBI has taken many measures over the years to develop this market. The administered interest rate system was dismantled in 1989 following the recommendations of vaghul committee.Further in 1993 select financial institutions (IDBI, ICICI, IFCI, IIBI, SIDBI, EXIM Bank, NABARD, IDFC and NHB) were allowed to borrow from the term money market for 3-6 months maturity, however within a fixed limit set for each institution. Also Term money of original maturity between 15 days and 1 year was exempted from the CRR in Au gust 2001. Although many measures were taken by the RBI to develop the term money market, the natural action (as reflected in the daily turnover) in this segment of money market continues to remain low. The average daily turnover in the term money market has increased moderately from Rs.195 crore in FY02 to Rs.1,012 crore during FY07.The festering of the term money market has been impeded by confluence of factors-(i) the softness of participants to build interest rate expectations over the medium term collect to which there is a tendency on their part to operate themselves in the short-term (ii) the distribution of liquidity is also skewed with public sector banks often having surplus funds and foreign banks being in famine in respect of short-term resources. Since the deficit banks depend heavily on call/notice money, more often, surplus banks exhaust their exposure limits to them (iii) corporates overcome likeence for notes credit system rather than loan by and large for ces banks to deploy a large total in the call/notice money market rather than in the term money market to meet sudden demand from corporates (iv) the steady reduction in the get limit maturity period of term deposits offered by banks and (v) the tendency on the part of banks to deploy their surplus funds in LAF auctions rather than in the term money market, reflecting risk-averse behaviour.Repos MarketRepo is a money market instrument, which enables collateralised short-term borrowing and lending through sale/purchase operations in debt instruments. In this segment, usual funds and some foreign banks are the major providers of funds, small-arm some foreign banks, private sector banks and primary dealers are the major borrowers. oer the years RBI has taken many measures to reform the Repo market, which was highly regulated both in terms of participants and instruments till the late 1980s. to begin with April 1988 all organisation securities and PSU bonds were eligible for repo transactions.However with the alarmingly high growth in repos RBI became cautious and prohibited the participation of non-banks in the repo market. RBI permitted only interbank repos in all government securities between April 1988 and mid-June 1992 in order to avoid any undesirable developments on account of the large scurf misuse of repos. The Janakiraman Committee, set up following the securities market irregularities of 1992, reported that notwithstanding of being prohibited virtually all wholesale participants of the money and not only banks widely used the repos. Also many other irregularities were in the repo markets were bought to the forefront, following which the repos were prohibited in all the securities barring the exchequer bills.However in wake to revive the repo market and noting the usefulness of repos in development of money market, RBI gradually bought all Central Government go out securities, Treasury Bills and State Government securities under the purview of repo market. Furthermore, with the view to broaden the repo market PSU bonds and private corporate securities have been made eligible for repos in 1997-98.Further RBI introduced the delivery versus payment system during FY96, with an fill to facilitate the repo transactions and increase transparency in the repo market. Nonbank entities which maintained subsidiary oecumenic ledger (SGL) account were permitted to participate in the repo market. Since March 2003, the non-bank financial companies, mutual funds, housing finance companies and insurance companies not having SGL account were permitted to transact in the repo market through their gilt accounts maintained with the custodian.With the increase in use of repos as money market instrument the comprehensive uniform history guidelines as well as documentation policy were issued by the RBI in March 2003. In addition to this the DvP III mode of extermination in government securities (which involves settlement of securities and fu nds on a net basis) was operationalised in April 2004. This helped the introduction of rollover of repo transactions in government securities and offered greater tractableness to participants in managing their collaterals.The Liquidity Adjustment Facility (LAF), that was introduced from June 5, 2000, has also helped in development of the repo market. Further the gradual phasing out of nonbanks (August 2005) from the call money market, has provided further momentum to the repo market. This is evident from the sharp increase in the average daily turnover of repo transactions (other than the Reserve Bank) from Rs.11,311 crore during April 2001 to Rs. 42,252 crore in June 2006.Treasury Bills MarketT-Bills are issued by the RBI on behalf of the Government of India and thus are actually a class of Government Securities. Presently T-Bills are issued in maturity periods of 91 days, 182 days and 364 days through an auction based system and form one of the most active segments of the Indian money market. However forward to the initiation of reforms, only the 91-day Treasury bills were sell through fixed coupon or tap system.Also ad hoc treasury bills were issued by the government in order to meet the temporary mismatch in taxation and expenditure. Although these were meant for temporary purpose they became attractive source of meeting the central government resource requirement as they were available at an interest rate pegged at 4.6% per annum since 1974. However due to administered nature of interest rate the 91-day treasury bills could not emerge as useful instruments in the money market. yet with initiation of the reform measures in the late 1980s T-bills market has emerged as an important segment of the money market. The reform process in the t-bills market was initiated in November 1986 with the introduction of 182 days treasury bills. The formation of DFHI also helped in emergence of treasury bills market as important segment of the money market. Further imp etus was provided to the development of the treasury bills market by the phasing out of the tap treasury bills and introduction of auctioning system in the 91-treasury.Another important reform in the treasury bills market was the abolition of the ad hoc treasury bills in April 1997. Further the introduction of 14-day intermediate treasury bills helped in up the cash management of the government. Thus, Treasury bills of different tenors were introduced to consoli check the market for pass on liquidity, eon yields were made market indomitable through auctions so that they could be used as benchmark for other short-term market instruments.Treasury Bills market has received special attention of RBI over the years as it is at the heart of the money market development. The amounts assigned for auctions are announced in advance since April 1998. Also the payments dates are synchronized on the following Friday after the auctions inorder to provide fungible stock of varying maturities and to spark off the auxiliary market in Treasury Bills. The primary dealers provide their drama daily and offer entailment rates so that the stationors are able to fix treasury bills even in between the auctions.Type of T-billsIntroduced lay off91 days Ad-hoc T-Bill Mid 1950s April, 199791 days T-Bill on Tap Mid 1950s March, 1997182 days T-Bill on weekly auctionNovember,1986 April, 199214 days T-Bill on weekly auctionApril, 1997 May, 2001364 days T-Bill on fortnightly auctionApril, 199291 days T-Bill on weekly auctionJanuary,1993182 days T-Bill on weekly auction Re-introduced in June, 1999 May, 2001182 days T-Bill on weekly auction Re-introduced in April, 2005The primary dealers provide their bid daily and offer discount rates so that the investors are able to acquire treasury bills even in between the auctions. commercial-grade Paper (CP) commercial-grade paper was introduced in India in January 1990, in accordance with the recommendations of the vaghul committee with an aim to provide additional avenues to the corporate to source short term funds. Commercial Paper (CP) is issued in the form of a promissory note sold directly by the issuers to investors, or else placed by the borrowers through agents such as merchant banks and security houses. Since CP is freely transferable, and highly liquid it provides the banks, financial institutions, insurance companies and others an attractive avenue to park their short term funds.Over the years RBI has gradually relaxed the norms relating to eligibility, maturity period etc. for take CPs. Initially, corporates were allowed to issue CP with a maturity between 3 to 6 months from the date of issue. However the stripped-down tenor of the CP was reduced in phased manner. Currently the minimum tenor of the CP is seven days (effective October 2004). Also the minimum amount to be invested by a single investor, which was Rs.1 crore at time of introduction of CP, has been gradually brought down to 5 lakhs. This norm was g radually relaxed so as to aline the CPs with other money market instruments.These measures helped in the increasing use in this segment of the money market. Initially the limit of CP progeny was cut out of the maximum permissible bank finance (MPBF) limit and thus only to its cash credit part. However reducing proportion of cash credit in the MPBF was hindering the development of the CP market and hence issuing of CP was delinked from the cash credit limit in October 1997.Further with a view to enable issuers of the service sector to meet their needs of short-term on the job(p) capital, CP was transformed into a stand alone product. Initially, the individuals, banks, companies, other corporate bodies registered or incorporated in India and unincorporated bodies were allowed to issue and held the CP. Further issuance of the CP to non-residents on a non-repatriation basis was allowed however these CPs were non transferable. Also the FIIs were permitted to invest in the CPs sinc e October 2000, but within the limit set by SEBI.Further to improve the efficiency, rationalize standardize the various aspects of processing and reduce the transaction cost many measures such as dematerialization of CPs (effective June 30, 2001) were undertaken by the RBI. It issued potation guidelines on securitisation of standard assets on April 4, 2005, with an aim to further deepen the market. Consequently the issuing and Paying agents were required to report the issuance of the CP on NDS chopine commencing from April 16, 2005. Over the years the major issuers of CP have been the leasing and finance companies. Discount rates on CPs have firmed up in line with the increases in policy rates during 2005-06 and 2006-07.It is advantageous for the corporate to raise funds through CPs during times of ample liquidity as the effective discount rates on CP tends to be lower than the banks lending rates. Also it is relatively profitable for banks to park their funds in the CPs during ti mes of high liquidity as the interbank call rates tend to be lower than the CP rates. Thus the activity in the CP market reflects the liquidity condition in the money market. The average outstanding amount of CPs reduced from Rs. 22.80 bn during FY94 to Rs. 4.42 bn in FY96 on account of tight liquidity conditions in the money market. However the outstanding amount of CPs has increased in the recent years. It was Rs. 213.14 bn during FY07.However the secondary market for CPs continues to remain subdued as the investors prefer to hold the instrument till maturity as it gives them a higher(prenominal) risk adjusted return compared to other instruments in the money market. The secondary market of CPs is more profitable for the Mutual funds as they are charged higher stamp art for issuing a CP as compared to the banks.Certificates of Deposits (CD)CD were introduced in the Indian money market in June 1989, with an view to widen the range of instruments in the money market and provide add itional avenue and greater flexibility to the investors to park their short term surplus funds. During the pre reform period the CDs were governed by a number of regulations in terms of maturity, issuance amounts, maturity etc. However many guidelines pertaining to the CDs have been relaxed in the post reform period.The limit on issuance of the CD, which was rather linked to the average fortnightly outstanding aggregate deposit, was abolished effective October 16, 1993. This was done with a view to enabling it as a market determined instrument. In order to align the CDs with other money market instruments the minimum maturity of the CDs has been reduced gradually to 7 days (April 2005). The minimum sizing of issuance was reduced from Rs 1 crore in 1989 to Rs. 1 lakh in June 2002. Also to provide flexibility and depth to the secondary market activity the restrictions pertaining to the minimum period for transferability were withdrawn over a period of time.With a view to improve tran sparency and promote secondary market activity the banks were instructed to issue CDs to the financial institutions only in dematerialized form, effective June 30, 2002. Since October 2002 the banks were allowed to issue undirected rate CDs as a coupon bearing instrument in order to promote flexible pricing. The reduction in stamp duty on CDs, effective March 1, 2004 and withdrawal of the facility of premature closure of deposits in respect of CDs were other factors that boosted activity in the market, providing greater luck for secondary market trading.The activity in the CDs market is also depended on the liquidity conditions in the market as the CPs. Unlike the CPs the issuance of CDs increase in the time of tight liquidity conditions as the banks drop off to issuance of CDs, often at premium, to meet their liquidity gap. For instance, the outstanding amount of CDs declined to Rs.949 crore during FY02 as compared to 1,199 crore, partly due to easy liquidity conditions on accoun t of large capital inflows.However the average outstanding amount of CDs increased gradually during the subsequent periods. The average outstanding amount of CDs had increased to Rs.64,814 crore during FY07 as banks resorted to issuance of CDs in order to support the robust credit demand. The interest rates on CDs which had softened in the recent years in line with other money market instruments experienced some set during FY07. However banks offer higher interest rates on CDs as compared to other instruments and hence it is profitable for the subscriber to hold the CDs till maturity. This infact is one of the reasons for subdued secondary market for the CDs.Collateralised Borrowing and lending obligationThe CCIL operationalised CBLO as a money market instrument on Jan 20, 2003 with an aim to provide an alternative avenue to the market participants, especially those who were phased out of the call money market, to manage their short term liquidity. This innovative product developed by the CCIL facilitates anonymous order matching system for efficient price discovery. amply transparency and real time basis of deals in the CBLO have aid in enhancing efficiency of the money market. With the conversion of the call money market in a pure interbank market since August 2005 and setting of prudential limits on lending and borrowing by banks and PDs in the call money market, the activity has shifted to CBLO segment as can be seen in the at a lower place chart.The average daily turnover in the CBLO segment has registered an increase from Rs.515 crore in FY04 to Rs.32,390 crore during FY07. However the increase in turnover can be partly attributed to the increase in number of participants from 30 in July 2003 to 153 in March 2007. It is important to note here that the composition of market participants has also changed over the years. The mutual funds and insurance companies have emerged as the major lenders while the nationalized banks, PDs and non-financial companie s as major borrowers during FY07.As borrowings in the CBLO segment are fully collateralised, the rates in this segment are expected to be same with the repo rates. The movements in the daily average rates in the overnight call, the repo and the CBLO markets for the period from January 2003 to March 2007 show that CBLO rates moved between the call and the repo rates up to November 2003 due to a limited number of participants. From November 2003, the CBLO rates have aligned with the repo rates on account of increase in the number of participants.Money Market Mutual Funds (MMMFs)With an aim of bringing the money market within the reach of individual investors the MMMF were introduced in India in April 1991. However a detailed scheme of MMMFs was declared by the RBI in April 1992, thereby allowing the schedule commercial banks and public financial institutions to set up MMMFs, subject to some terms and conditions. However to provide flexibility, liquidity and depth to the market these restrictions were relaxed over a period of time.For example the minimum lock in period for the units of MMMFs was brought down from 30 days to 15 days in May 1998. MMMFs were permitted to offer cheque writing facility in a tie-up with banks in 1999-2000 in order to provide added liquidity to unit holders. MMMFs, which were under the purview of RBI, were bought under SEBIs regulations Since March 7, 2000. Also it is important to note that now banks are permitted to set up MMMFs only in form of trust as a separate entity. Also the MMMFs were permitted to invest in rated corporate bonds and debentures with a residual maturity of one year.