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Need to Rethink Fiscal Strategy

The dispute between the finance ministry and the Planning Commission on the fiscal deficit for 2006-07 is indicative of the dilemmas that the government now finds itself in, after the passage of the Fiscal Responsibility and Budget Management Act. The focus on reduction in deficit numbers is counter-productive and needlessly ties the hands of the government. The ban on government borrowing from the RBI from April 2006 onwards, except for ways and means advances, is yet another new constraint on resources. There is therefore a need to rethink the government's fiscal reform strategy. Apart from more dynamic measures of resource mobilisation, the focus of attention should shift from the size of the gross fiscal deficit to the productive purposes for which deficits are incurred. Increasing social expenditures will also create some pressure on the revenue deficit of the government, which will have to be tolerated. Fiscal discipline and prudence are better achieved by concerted reforms on the administrative front, including effective decentralisation, rather than by controlling single measures like government deficits.

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Need to Rethink Fiscal Strategy

The dispute between the finance ministry and the Planning Commission on the fiscal deficit for 2006-07 is indicative of the dilemmas that the government now finds itself in, after the passage of the Fiscal Responsibility and Budget Management Act. The focus on reduction in deficit numbers is counter-productive and needlessly ties the hands of the government. The ban on government borrowing from the RBI from April 2006 onwards, except for ways and means advances, is yet another new constraint on resources. There is therefore a need to rethink the government’s fiscal reform strategy. Apart from more dynamic measures of resource mobilisation, the focus of attention should shift from the size of the gross fiscal deficit to the productive purposes for which deficits are incurred. Increasing social expenditures will also create some pressure on the revenue deficit of the government, which will have to be tolerated. Fiscal discipline and prudence are better achieved by concerted reforms on the administrative front, including effective decentralisation, rather than by controlling single measures like government deficits.

EPW RESEARCH FOUNDATION

I Fiscal Impudence!

That the reform processes are increasingly coming into conflict with developmental goals and programmes is evident from the reported differences between the union finance ministry and the Planning Commission on fulfilling the obligations of the government under the Fiscal Responsibility and Budget Management (FRBM) Act, 2003 and the statutory rules framed thereunder. These differences are not a hearsay articulated only by the media. The Planning Commission’s Mid-Term Appraisal of 10th Five-Year Plan (200207) had sharply exposed the fiscal dilemma faced by the central government. The government’s medium-term fiscal milestones consistent with the FRBM Act targets expect the centre’s gross tax revenue to grow, over the four-year period 2004-05 to 2008-09, at over 22 per cent per annum; this implies a tax buoyancy of 1.7 which is significantly higher than the buoyancy of 1.2 achieved during the first three years of the Tenth Plan. The Kelkar Task Force on FRBM had in fact proposed much higher buoyancy levels.

To an extent, the fiscal deficit constraints of the centre have been passed on to the states with the decision to move state borrowings as plan loans from the central budget to the market as recommended by the Twelfth Finance Commission (TFC). The Planning Commission has doubted, given the market conditions, that the states would succeed in exercising the above option without central borrowing support. In such an eventuality which is writ large on the fiscal scene, deficit targets and other objectives set in FRBM Act may be in jeopardy. In addition, there are a series of substantial additional programmes – Bharat Nirman, Sarva Shiksha Abhiyan, National Employment Guarantee Act, etc, which are crying for much larger government expenditures.

Even as these developmental programmes are envisaged, both the prime minister and the finance minister put forth narrow perspectives on the subject of tax resource mobilisation. While the former has just pronounced that his government is committed to a “moderate and broadbased taxation” system and that higher revenues are possible only with higher growth, the latter has gone a step further and has said that “enhanced taxation” would mean “literally killing the proverbial goose. The need of the hour is to increase disposable income, spur demand and generally give a boost to the economy” [Chidambaram 2005:47].

If the government was serious about a broad-based taxation system, it would have to concede that non-farm incomes today have ceased to be any reasonable measure of taxable capacity of the rich and the upper middle classes. In this respect, we have telling examples in the returns of incomes and assets filed by candidates contesting in parliamentary and state assembly elections. Three main sources which escape the clutches of their income taxes are: wealth, capital gains and personal estate earned on inheritance. What is called for is an integrated tax return a la Nicholas Kaldor combining income, wealth, capital gains, inherited personal estate and gifts.

Against the above background, the Planning Commission’s dispute with the finance ministry on fixing the fiscal deficit target at 4 per cent of GDP in the ensuing budget for 2006-07 instead of limiting it, as the latter insists, at 3.8 per cent of GDP for satisfying the 0.3 percentage point reduction per year as per the FRBM rules, appears bizarre. In the budget 2005-06, the government had failed to fulfil both the 0.3 percentage point reduction in the gross fiscal deficit and the 0.5 percentage point reduction in the revenue deficit.

The whole development process now calls for a rethink on the government’s fiscal reform strategy. Apart from more dynamic measures of resource mobilisation, the focus deserves to shift in favour of not the size of gross fiscal deficit but the productive purposes for which government deficits are incurred. Likewise, increasing social expenditures will call for some pressure on the revenue deficit of the government which will have to be tolerated. And there is the ban imposed on government borrowing from the RBI from April 2006 onwards, except for ways and means advances (WMAs); the government has eschewed even the WMAs despite there being serious constraints on resources. The parliamentary standing committee on the FRBM bill had cautioned in 2000 against such rigidities obviously on the ground that they invariably serve as a binding constraint on capital expenditures and developmental programmes and not on revenue expenditures. Fiscal discipline and prudence are better achieved by concerted reforms on the administrative front, including effective decentralisation rather than by controlling single measures like the fiscal and revenue deficits.

II Money and Forex Markets

The resilience of the Indian financial system is reflected in the smooth way the markets have absorbed the liquidity shock following the redemption of India Millennium Deposits (IMDs) worth $ 7.3 billion (about Rs 33,000 crore) towards the end of December 2005. No doubt, in January, the operations in money and government securities market remained constrained as the precariously balanced liquidity situation was disturbed, even though RBI tried to mitigate it by injecting funds through repo under liquidity adjustment facility (LAF) and suspending market stabilisation scheme (MSS) borrowings through treasury bills. In the initial part of the month, with the smooth redemption of IMD and reduction in the centre’s surplus balances, the sentiments in the money and government securities market improved temporarily, but the liquidity strain re-emerged with the outflow on account of central loan floatation. Apart from the acute shortage of short-term liquidity, there has arisen a shortage of long-term funds also, given the sharp surge in credit offtake and the yearon-year incremental credit-deposit ratio reaching 114 per cent, the IMD redemption leaving a huge hole in the bank deposit base and government spending remaining subdued. In addition, the international crude oil prices have been ruling firm, even though the domestic inflation rate has remained stable. Added to all these, towards last week, the unexpected hike in the reverse repo rate by 25 basis points to

5.50 per cent and at the same time retaining the spread between reverse repo and repo rate at 100 basis points with effect from January 24, effected in the third quarter review of monetary policy, further unsettled market sentiments somewhat. However, the finance minister assured the market that these hikes would be reversed as soon as the situation improves. Overall, the short-term rates have generally remained firm during the month; the yields on 91day TBs have ruled above those on 364day, but as RBI refrained from sterilisation activities for some time and domestic inflation remained in the benign zone, longterm yields have fallen, giving rise to a flat yield curve at a time when GDP growth is touching new highs. RBI has endeavoured to widen the corporate bond market by allowing banks to raise funds through the issue of innovative bonds, which would be included in tier-I and II capital. Further, FIIs registered with SEBI and NRIs are allowed to subscribe to these instruments. In the forex market, the rupee has continued to appreciate against the dollar and all other major currencies, as the post-IMD inflows continued and the dollar weak-

Table 2: Weighted Averages of Daily Call/Notice Rates in Per Cent Per Annum: Simple Statistical Characteristics

Month/Week Simple Mean* Standard Deviation Coefficient of Simple Mean* Standard Deviation Coefficient of
Variation Variation
(Percentages)$ (Percentages)$
January 2006All four weeks 6.68 Call Money 0.68 10.13 6.46 Notice Money** 0.77 11.96
27 7.18 0.50 6.94 6.99 0.66 9.37
20 (RF)* 13 6.79 6.97 0.40 0.56 5.89 8.06 6.69 6.63 0.61 0.69 9.10 10.45
6 (RF)* December 2005 5.90 0.49 8.31 5.69 0.54 9.55
All five weeks 5.93 0.59 10.02 5.72 0.51 8.88
30 6.78 0.32 4.71 6.45 0.49 7.67
23 (RF)* 16 6.23 5.93 0.27 0.21 4.41 3.58 5.78 5.71 0.26 0.33 4.48 5.83
9 (RF)* 2 5.32 5.36 0.04 0.07 0.67 1.26 5.26 5.41 0.14 0.17 2.63 3.17

** Separate reportings began on March 15.

* Including data for reporting Fridays (RF). $ Based on original unrounded figures.

Table 1: Money Market Operations (RBI’s Daily Data)

Average January 2006 Average December 2005 Items for Four for Five Weeks 27 20(RF)* 13 6(RF)* Weeks 30 23(RF)* 16 9(RF)*

No of working days 22 5 6 5 630 6 6 6 6 6

Call Money

Weighted average of call rates:Per cent (weekly range) per annum 5.48-7.71 6.56-7.71 6.43-7.37 6.20-7.60 5.48-6.71 5.25-7.15 6.27-7.15 5.68-6.39 5.61-6.12 5.25-5.34 5.25-5.45

Daily averages (Rupees crore) (6.45) (5.48) (5.68) (5.33) Total call market borrowings 7805 7916 6477 8366 8574 9679 8340 10751 11151 8465 9689

(475) (820) (295) (496) Of which: by banks 6325 7162 5254 7052 6092 7337 6920 8047 8465 5963 7293

(468) (820) (293) (496)

Notice Money

Weighted average of notice money rates: Per cent (weekly range) per annum 5.29-7.88 6.28-7.88 6.08-7.67 5.99-7.56 5.21-6.63 5.06-7.19 5.87-7.19 5.49-6.12 5.33-6.15 5.06-5.36 5.15-5.58

Daily averages (Rupees crore) (6.53) (5.60) (6.12) (5.36)Total notice market borrowings 2476 2593 2103 2838 2389 2292 1779 2624 2811 2100 2145 (9190) (14259) (11030) (11974)Of which: by banks 2050 2352 1759 2419 1732 1789 1436 1842 2057 1625 1991 (7520) (10333) (15699) (7717)Turnover in term money market 268 365 231 392 84 331 361 312 270 260 475 (borrowings) $$ (300) (45) (125) (480)

*Data for reporting fridays are given within brackets and they are also included in the weekly range/daily averages. $$ No of reporting/traded days is fewer than given above.

Economic and Political Weekly February 18, 2006

ened against the major currencies. In Graph A: Trends in Weighted AveragesGraph B: Spot Quotations for the USof Call Rates, Repo Rates, CBLO RatesDollar in the Domestic Inter-Bank Market

sympathy with call money rates, forward

and Call Money Borrowing: January 2006

premia for short durations have sharply firmed up, which is probably why the RBI 8

is not intervening despite the rupee re

maining overvalued in NEER as well as

REER terms.

7.5

(Rupees thousand crore) 0.5 5.5 10.5 15.5 20.5 ll -i CBLO Rates Call Money Volume (Rs Cr) Repo Rates – Outside the RBI Call Rates January 2006 Rupees per US dollar 42.0 44.0 46.0 48.0 50.0 l il iMonthly Averages (Jan 2001 to Dec 2005) (Daily Working Days Jan 2006)

Weighted Average (Per Cent)

7

6.5

6

5.5

The Money Market

Except in the first few days, the weighted

averages of call borrowing rates have

exceeded even the new repo rate of 6.50

per cent – a feature not seen now for three 5 years or so. As spillover effect of the IMD redemption waned and liquidity improved due to large inflows of interest under the

special deposit scheme (SDS), the overnight rate eased from 6.71 per cent on January 2 to 5.51 per cent on January 5. On the first reporting Friday, January 6, it edged lower to 5.48 per cent. After this brief spell, the call rates ruled above 7 per cent throughout the month (Graph A). The outflows on account of central loans impinged on the already precarious liquidity scenario thereby pushing the overnight rate to 6.61 per cent on January 9 and to

7.16 per cent on January 10 and it jumped to 7.60 per cent on January 13. As the RBI began injecting liquidity through LAF repo, the liquidity scenario improved and call rates edged lower but only marginally to

7.11 per cent on January 14, but it again rose to 7.37 per cent on January 16 due to an outflow on account of state loan floatations. There was a brief respite when the rate fell

Table 3: Comparison of Call, Overnight CBLO and Repo Rates

Week Ending Weighted Average Rates (in Per Cent) Call Overnight Repo CBLO Daily Average Volumes (Rs Crore) Call Overnight Repo CBLO
6-Jan-06 13-Jan-06 5.83 7.12 5.54 6.27 5.62 6.36 11459.95 11658.67 15439.02 10139.19 8716.71 5401.85
20-Jan-06 6.75 6.20 6.26 8695.85 11373.81 5407.73
27-Jan-06 7.18 6.40 6.41 9131.59 11141.95 6318.22

Source: CCIL.

to 6.43 per cent on January 19 and the next day being the second reporting Friday, it ruled at 6.45 per cent. Following the hike effected in benchmark rates, the call rate jumped to 7.15 per cent on January 24 and further peaked to 7.71 per cent on January

27. It edged lower to 7.22 per cent on January 28. But again surged to 7.67 per cent on January 30, and finally settled at

7.40 per cent on January 31. The call money turnover has declined somewhat to a daily average of Rs 10,105 crore in January against Rs 12,836 crore in December.

During the month, while the call rates remained volatile yet firm in the range of 5.50-7.88 per cent (Tables 1 and 2), the CBLO rates have ruled in a relatively narrow band of 5.42-6.50 per cent, and market repos in the range of 5.44-6.55 per cent. With the call rates ruling high, the overnight call volume fell by 30 per cent

Table 4: Auctions of 91-Day Treasury Bills

(Amount in rupees crore)

Date of Notified Bids Tendered Bids Accepted Subscription Cut-off Cut-off Amount Outstanding
Auction Amount
Devolved Price Yield on the Date of Issue
No Face Value No Face Value on RBI (Rupees) Rate
(Amount) (Amount) (Amount) (Per Cent) Total With RBI Outside RBI
(1) (2) (3) (4) (5) (6) (7)* (8) (9) (10) (11) (12)
2005
Jan 5 2000.00 80 4978.30 51 2000.00 0.00 98.71 5.23 22311.51 0.00 22311.51
Jan 12 2000.00 (0) 63 (0.00) 3402.00 (0) 48 (0.00) 2000.00 0.00 [98.72] 98.69 [5.19] 5.31 21911.51 0.00 21911.51
Jan 19 2000.00 (0) 74 (0.00) 4781.90 (0) 51 (0.00) 2000.00 0.00 [98.70] 98.68 [5.27] 5.35 21893.81 0.00 21893.81
Jan 25 2000.00 (0) 67 (0.00) 5970.00 (0) 43 (0.00) 2000.00 0.00 [98.68] 98.69 [5.35] 5.31 21911.74 0.00 21911.74
2006 (1) (17.94) (1) (17.94) [98.69] [5.31]
Jan 4 500.00 56 1993.05 19 500.00 0.00 98.54 5.94 18219.73 0.00 18219.73
Jan 10 500.00 (0)43 (0.00) 1283.25 (0)24 (0.00) 500.00 0.00 [98.54]98.48 [5.93]6.17 16727.21 0.00 16727.21
Jan 18 500.00 (1)38 (7.48) 1534.16 (1)16 (7.48) 500.00 0.00 [98.50] 98.48 [6.90]6.19 15237.36 0.00 15237.36
Jan 25 500.00 (1)36 (10.16) 918.21 (1)23 (10.16) 500.00 0.00 [98.49]98.36 [6.13]6.69 13890.44 0.00 13890.44
Feb 1 500.00 (1)47 (153.08) 2481.16 (1) 8 (153.08)500.00 0.00 [98.39] 98.39 [6.55] 6.56 12245.48 0.00 12245.48
(3) (206.54) (3) (206.54) [98.39] [6.55]

Figures in parentheses in cols 3 to 6 represent numbers and amounts of non-competitive bids which are not included in the total. Figures in the square brackets under cols 8 and 9 represent weighted average price and respective yield.

* Bracketed figures in col 7, if any, relate to devolvement on primary dealers, exclusive of RBI.

1 1-month i ll i i Weighted Averages of Call Rates (Right Axis) 3-month 6-month

Graph C: Annualised Forward Premia in Graph D: Yield Curves for Datedfrom an average of 2.38 per cent and 1.57Percentage for the US Dollar in theSecurities: Weighted Average for

per cent in the week ended January 6 to

Domestic Inter-Bank Market and WeightedWeeks of January 2006

3.60 per cent and 3.04 per cent in the week

8

Averages of Call Rates for Jan 2006

ended January 27, respectively. But, that

8.0

this was a short-term perspective was

7.5

evident from the meagre rise in the six-

Per cent per annum

Yield (per cent per annum)

month and other longer maturity premia

7

6.0

(Graph C). But, when the repo and reverse

3.5

3.0

2.5

repo rates were hiked, the longer duration

6.5

premia too began rising.

6

III

4.0

5.5

5

4t 1st Week 2nd Week 3rd Week 4th Week
Primary Market

Dated Securities

1 2 3 4 5 6 7 8 9 101112131415 16171821232729 30

2.0

Working Days

and the market repo too fell by 11 per cent; CBLO, on the other hand, experienced the highest turnover and increased by 8 per cent in January (Table 3). CBLO borrowing side was dominated by public sector banks, and on the lending side by mutual funds.

Forex Market

Against the backdrop of US dollar weakening vis-à-vis the major currencies, as the US fed hinted that it was closer to halting its 18-month policy of raising interest rates as well as a continued inflow of foreign currency assets, the rupee-dollar exchange rate has appreciated by 98 paise over the month (Graph B) in spite of the firm international crude oil prices. The RBI did not intervene in the market except for correcting the initial fluctuations and sharp appreciation. This is understandable, for the US dollar seems to lose the advantages of interest rate differential and the rupee, which has appreciated against the dollar, has also gained ground with other major currencies.

The month began with the rupee strengthening continuously against the US dollar from Rs 45.07 on December 30 to Rs 45.05 on January 2 and further to Rs 44.28 on January 9. The RBI intervened in the market to arrest the sharp movements, but they were sporadic and the rupee continued to be modulated by the market forces. Given the continued inflow of foreign currency assets, the rupee touched Rs 44.15 on January 12. But with the international crude oil surging and the better US trade data, the dollar strengthened and the rupee fell to Rs 44.26 on January 13. Next day, the rupee edged higher to Rs 44.17 on January 16, but it could not be sustained as the demand for dollars increased and inflow

Years to Maturity

of foreign currency assets turned subdued. Further, the European Central Bank (ECB) raised expectations of a rate hike, which affected the dollar’s strength, yet the rupee depreciated due to the demand for dollars, to Rs 44.31 on January 17. But, as the expectations of a further hike in US fed rates were built up rather briefly, the dollar strengthened and the rupee fell to Rs 44.51 on January 18. Thereafter, it ruled steady at Rs 44.36. Following the weakening of US dollar and despite the rise in global oil prices, the rupee edged to Rs 44.15 on January 23. It dipped on January 25 to Rs 44.29, but again continued its appreciating trend to close the month at Rs 44.07 on January 30. During the month, barring Hong Kong dollar and Chinese yuan, most of the Asian currencies have appreciated against the dollar and the rupee depreciated against them.

In the forward premia segment, the net forex inflow of $ 2.36 billion in the post-IMD period and the continued and prospective pressure for the rupee to appreciate were contradicted by the tight liquidity conditions which exerted upward pressure on the forward premia, particularly after the call rates firmed up on January 9 or thereabout. As a result, the one-month and three-month annualised premia jumped

Table 5: Auctions of 182-Day Treasury Bills

(Amount in rupees crore)

Date of Notified Bids Tendered Bids Accepted Subscription Cut-off Cut-off Amount
Auction Amount
Devolved Price Yield Outstanding
No Face Value No Face Value on RBI (Rupees) Rate on the Date
(Amount) (Amount) (Amount) (Per Cent) of Issue
2006
Jan 10 500.00 28 2206.99 8 500.00 0.00 96.99 6.22 13137.23
(0) (0.00) (0) (0.00) [97.01] [6.16]
Jan 25 500.00 19 (0) 628.00 (0.00) All bids rejected 13137.23

Figures in the square brackets represent weighted average price and the respective yield. Figures in brackets represent numbers and amounts of non-competitive bids which are not included in the total.

Despite the strained liquidity situation, the government mobilised Rs 10,000 crore as per the indicative calendar by reissuing

9.39 per cent 2011 and 7.40 per cent 2035 for notified amounts of Rs 6,000 crore and Rs 4,000 crore, respectively, on January 9, through price-based auction using multiple price method. For these, the RBI received 222 competitive bids worth Rs 10,015.89 crore and 258 competitive bids for Rs 11,605.78 crore for the five-year and 29-year papers, respectively. Of them, 137 bids for Rs 5,968.19 crore were accepted at a cut-off yield of 6.70 per cent for the fiveyear paper and 10 bids worth Rs 3,924.10 crore at a cut-off yield of 7.43 crore for the 29-year paper. In a unique development, the RBI has succeeded in persistently reissuing the long-term paper in the recent period at lower yields from 7.73 per cent in its second reissuance to the latest at 7.43 per cent, that is, just 3 basis points above the initial issue rate of 7.40 per cent.

Eight state governments offered to sell

7.61 per cent 2016 aggregating around Rs 700 crore by way of tap sale under the approved market borrowing programme on January 16. The issue was oversubscribed on the same day itself. Against the issue size, the RBI received bids worth Rs 3,750 crore; of this only the notified issue size amount has been retained.

In another instance, 10-year state loans

Economic and Political Weekly February 18, 2006

of Andhra Pradesh and Haryana were January 19. For the Andhra Pradesh loan, the Haryana state loan, 66 bids for auctioned through a yield-based auction the RBI received 107 bids worth Rs 1,304.82 crore were received but only using the multiple price auction method Rs 2,313.09 crore, of which six bids worth seven bids for Rs 165.933 crore were acfor notified amounts of Rs 316.525 crore Rs 316.525 crore were accepted at a cut-cepted at a cut- off yield of 7.33 per cent; and Rs 165.933 crore, respectively, on off yield of 7.32 per cent, while that for these cut-off yields have been much lower than those issued earlier during the month.

Table 6: Auctions of 364-Day Treasury Bills

(Amount in rupees crore)

Treasury Bills

Date of Notified Bids Tendered Bids Accepted Subscription Cut-off Cut-off Amount Auction Amount Devolved Price Yield Outstanding

Despite having cancelled the MSS bor-

No Face Value No Face Value on RBI (Rupees) Rate on the Date

rowings under T-bills for two consecutive

(Amount) (Amount) (Amount) (Per Cent) of Issue

months, the liquidity has remained con2005 strained; as a result, the RBI has again

Jan 5 2000.00 56 4346.00 35 2000.00 0.00 94.69 5.61 42126

(1) (2.50) (1) (2.50) [94.70] [5.60] suspended the MSS borrowings for theJan 19 2000.00 87 3920.56 47 2000.00 0.00 94.56 5.75 42126

time being. Responding to the underlying

(1) (1.58) (1) (1.58) [94.58] [5.73]

2006 strain and the increase in the reverse repo Jan 4 1000.00 51 2836.00 25 1000.00 0.00 94.24 6.13 47859 rate, the yields have firmed up across

(1) (4.08) (1) (4.08) [94.25] [6.10]

treasury bills. In a unique development,

Jan 18 1000.00 47 2601.00 20 1000.00 0.00 94.09 6.30 46859

(1) (2.05) (1) (2.05) [94.13] [6.24] the RBI rejected all the bids tendered forFeb 1 1000.00 48 2486.00 17 1000.00 0.00 93.70 6.72 46109

the 182-day bills auctioned on January 25;

(1) (250.00) (1) (250.00) [93.72] [6.70]

for the other auctions for the same TBs

Figures in the square brackets represent weighted average price and the respective yield.

held during the month, the yields had risen

Figures in brackets represent devolvement on primary dealers (PDs).

from 6.14 per cent on December 28 to 6.22 Table 7: Profile of Major Commercial Bond Issues during January 2006 per cent on January 10 (Table 5). In case of 91-day bills, the yield has risen from

Issuing Company/Rating Nature of Coupon in Per Cent Per Annum Amount in Instrument and Tenor Rs Crore 5.94 per cent on January 4 to 6.17 per cent

(1) (2) (3) (4)

on January 10 and remained steady even FIs/Banks on January 18. It jumped to 6.69 per cent

1 ICICI Bank Tier-II bonds 7.95 per cent for 10 years. 225

on January 25 in response to the hike in

AAA by Care and

LAAA by Icra 8.05 per cent for 15 years. the benchmark rates (Table 4). Similarly, 2 Bank of Maharashtra NCD 7.50 per cent for 7 years. 200 the primary yield on 364-day bills hasAA by Crisil and Care

firmed up from 6.13 per cent on January

3 IDBI NCD 7.35 per cent for 5 years. AA + by Crisil and Icra 7.70 per cent for 10 years. 400 4 to 6.30 per cent on January 18. Inter4 HDFC Bank Tier-II bonds 7.65 per cent-7.75 per cent

estingly, the average yield spread between

AAA by Fitch for 111 months. 5 NABARD NCD 7.60 per cent for 10 years. 200 91-day and 364-day TBs which was at 20 AAA+ by Crisil basis points in December has turned nega

6 HDFC NCD 7.55 per cent for 10 years. 500

AAA by Crisil and Icrative in January by 4 basis points as yields Central Government Undertakings on 91-day bills have exceeded those of

7 Rural Electrification Corporation NCD 7.65 per cent for 10 years. 1800

364-day securities (Table 6).

AAA by Crisil and Icra

State Government Undertakings

8 Punjab Finance Corporation NCD 7.85 per cent 10 years. 120

Unrated. Corporate Debt 9 Karnataka State Financial Corporation NCD 7.35 per cent for 5 years. In January, the firming up of interestAA-(SO) by Crisil 7.45 per cent for 7 years.

rates in both the domestic as well as in

7.64 per cent for 10 years. 300 (50)* Total: 3995 ternational markets, coupled with the

sustained liquidity crunch in the financial

Total for January 2005 (a year ago): Rs 3,868.5 crore. Total for December 2005 (a month ago): Rs 4,809 crore. Note: * Represents greenshoe option. markets, rendered the corporate debt market

Table 8 : Operations of RBI’s Liquidity Adjustment Facility**

(Amount in Rupees crore)

For the Week Range of Repo (Injection) Reverse Repo (Absorption) Net Injection Net
Repo/RR Bids Received Bids Accepted Bids Received Bids Accepted (+) / Outstanding
Period Day Number Amount Number Amount Number Amount Number Amount Absorption Amount at the
(-) of Liquidity Week End@
1 2 3 4 5 6 7 8 9 10 11 12
2 Jan - 6 Jan 06 1-3 27 16240 27 16240 57 16140 57 16140 100 3290
9 Jan - 13 Jan 06 1-3 197 99450 197 99450 16 2700 16 2700 96750 -32575
16 Jan - 20 Jan 06 1-3 201 80825 201 80825 24 2195 24 2195 78630 -13770
23 Jan - 27 Jan 06 1-3 148 82550 148 82550 10 1115 10 1115 81435 -20555
30 Jan - 3 Feb 06 1-3 167 57350 167 57350 28 13055 28 13055 44295 -2610
6 Feb - 10 Feb 06 1-3 191 69690 191 69690 4 450 4 450 69240 -19315

* With effect from January 24, 2006 the Repo Rate is 6.50 per cent and Reverse Repo Rate at 5.50 per cent. ** Includes Second LAF Auctions under Repo and Reverse Repo. @ Net of Repo and Reverse Repo Outstandings.

Appendix Table: Secondary Market Operations in Government Paper – RBI’s SGL Data

(Amount in rupees crore)

Descriptions Week Ending January 2006: Yield to Maturity on Actual Trading Total for the Month
27 20 13 6 of January 2006
AMT YTM CY AMT YTM CY AMT YTM CY AMT YTM CY AMT YTM CY
1 Treasury BillsA 91-Day Bills B 182-Day Bills C 364-Day Bills 2 GOI Dated Securities 443.40 306.93 825.20 6.57 6.60 6.48 289.66 213.86 1484.61 6.18 6.21 6.26 324.37 272.71 1470.83 6.13 6.17 6.23 459.02 727.78 2218.17 5.84 5.94 5.90 1516.45 1521.28 5998.81 6.18 6.15 6.15
A Regular (Per Cent: Year)4.83 , 2006 6.75 , 2006 11.50 , 2006 11.68 , 2006 13.85 , 2006 INSTAL 13.85 , 2006 14.00 , 2006 6.75 , 2007 11.50 , 2007 11.90 , 2007 12.50 , 2007 13.05 , 2007 13.65 , 2007 9.50 , 2008 11.40 , 2008 12.00 , 2008 12.10 , 2008 12.25 , 2008 6.65 , 2009 7.00 , 2009 11.50 , 2009 11.99 , 2009 11.99 , 2009 7.50 , 2010 7.55 , 2010 7.55 , 2010 12.29 , 2010 8.00 , 2011 9.39 , 2011 10.95 , 2011 11.50 , 2011 12.00 , 2011 6.85 , 2012 7.40 , 2012 9.40 , 2012 10.25 , 2012 11.03 , 2012 7.27 , 2013 9.00 , 2013 12.30 , 2013 12.40 , 2013 6.72 , 2014 7.37 , 2014 7.55 , 2014 10.00 , 2014 10.50 , 2014 5.78 , 2015 FRB 5.87 , 2015 FRB 7.38 , 2015 10.47 , 2015 11.43 , 2015 11.50 , 2015 5.59 , 2016 10.71 , 2016 12.30 , 2016 7.46 , 2017 7.49 , 2017 8.07 , 2017 5.69 , 2018 6.25 , 2018 10.45 , 2018 12.60 , 2018 ON TAP 5.64 , 2019 6.05 , 2019 10.03 , 2019 6.35 , 2020 10.70 , 2020 11.60 , 2020 10.25 , 2021 8.35 , 2022 6.17 , 2023 6.30 , 2023 10.18 , 2026 6.01 , 2028 6.13 , 2028 7.95 , 2032 7.50 , 2034 7.40 , 2035 Sub-total -0.00 -5.00 ---0.00 15.00 42.00 50.03 0.20 0.05 --75.00 -5.40 5.00 0.00 --0.24 1.05 -160.00 -0.00 405.15 -0.15 -25.00 5.00 1.22 0.00 0.25 160.00 0.36 ---132.12 -7.88 1.38 ---0.20 -0.66 --6.00 31.25 -1104.59 22.56 11.66 8.30 0.25 -62.93 5.18 2.00 5.00 10.00 382.72 120.19 32.76 0.05 8.80 0.40 1.41 23.50 7.10 57.03 3002.02 -13.50 -6.96 ---7.34 6.43 6.37 6.38 7.15 6.27 --6.36 -6.47 6.90 7.34 --6.59 6.79 -6.86 -8.00 6.83 -6.89 -7.01 7.14 6.87 7.26 6.98 7.07 6.78 ---7.23 -7.13 7.07 ---7.15 -7.17 --7.20 7.32 -7.36 7.21 7.36 7.22 7.35 -7.27 7.30 7.53 7.32 7.32 7.42 7.42 7.32 7.27 7.41 7.34 7.42 7.44 7.42 7.42 7.18 -6.89 -11.57 ---6.82 10.65 11.12 11.71 12.21 12.69 --10.74 -10.77 6.70 7.07 --10.40 7.31 -7.37 -8.00 8.42 -9.44 -6.91 7.31 8.30 8.91 9.13 7.19 7.99 ---7.31 -8.49 8.60 ---8.59 -8.91 --8.98 7.37 -7.67 6.51 6.84 8.30 8.81 -6.75 8.14 7.06 8.26 8.38 8.16 7.68 6.95 6.96 7.89 7.03 7.12 7.51 7.43 7.42 7.95 26.25 -15.00 35.00 -0.08 5.00 1.18 10.00 70.00 -15.00 0.54 --60.00 -5.02 -0.01 -10.00 -0.12 70.00 ---580.00 ---20.20 -1.09 0.11 0.01 70.00 0.70 0.35 0.06 10.00 57.56 -20.66 --5.15 90.04 1.00 0.02 --0.30 2.68 4.20 47.98 754.14 41.20 26.05 21.85 26.59 -47.97 5.30 -6.09 5.00 334.02 145.70 51.10 0.05 7.80 0.35 4.50 41.00 68.10 209.59 3031.70 6.21 -6.18 6.22 -6.17 6.10 6.16 6.41 6.29 -6.37 6.36 --6.33 -6.35 -6.75 -6.47 -6.56 6.59 ---6.70 ---6.79 -6.88 7.02 6.78 6.94 6.89 7.19 7.39 7.03 7.00 -7.13 --5.89 7.08 7.19 7.17 --7.17 7.19 7.20 7.22 7.20 7.26 7.22 7.23 7.34 -7.28 7.31 -7.34 7.33 7.34 7.36 7.35 7.30 7.38 7.32 7.31 7.43 7.42 7.41 7.05 4.87 -11.32 11.54 -13.26 13.80 6.68 10.64 11.10 -12.09 12.69 --10.73 -10.74 -6.95 -10.35 -7.25 7.29 ---8.38 ---6.83 -8.30 8.81 9.04 7.13 8.03 8.97 9.64 6.85 7.21 -8.49 --5.92 7.23 8.62 8.85 --8.55 8.97 7.31 7.34 7.57 6.53 6.77 8.30 8.79 -6.75 8.15 -8.27 8.39 8.10 7.64 6.97 6.98 7.87 7.01 7.04 7.51 7.43 7.41 7.95 -----0.07 25.00 --1.35 --0.08 0.03 52.50 275.00 6.60 --0.21 -5.86 -0.10 75.00 -0.84 0.01 1696.20 0.10 -5.00 10.50 -0.31 2.00 -1.15 0.20 -0.12 -67.15 5.00 0.73 0.01 --25.75 1.20 0.02 --0.10 0.78 9.64 100.26 446.48 36.63 5.13 32.75 2.22 0.96 86.34 1.36 -10.07 0.03 353.41 192.87 11.25 11.00 20.06 6.65 1.00 0.20 47.95 221.92 3857.14 -----6.12 5.99 --6.13 --6.45 6.30 6.34 6.32 6.36 --6.40 -6.52 -6.59 6.58 -6.63 7.12 6.69 6.64 -6.75 6.77 -6.91 6.89 -6.87 6.89 -7.05 -6.99 6.99 7.10 7.39 --7.08 7.31 7.36 --7.17 7.22 7.22 7.21 7.19 7.24 7.21 7.29 7.31 7.27 7.28 7.31 -7.34 7.50 7.34 7.35 7.37 7.33 7.40 7.33 7.42 7.46 7.44 7.42 6.91 -----13.25 13.80 --11.07 --12.69 8.95 10.17 10.72 10.73 --6.88 10.36 -7.26 7.29 -10.26 7.71 8.37 9.18 -9.62 6.82 -8.31 8.75 -7.11 8.03 -9.46 -7.20 7.38 8.47 8.76 --7.23 8.67 8.96 --8.54 8.99 7.32 7.33 7.57 6.52 6.76 8.33 8.77 6.52 6.76 8.14 -8.27 8.50 8.10 7.63 6.98 7.00 7.88 7.02 7.13 7.52 7.45 7.42 8.23 55.00 1.00 -20.00 0.50 --0.90 -140.00 --1.49 --505.00 ---0.40 0.16 0.29 --237.03 -0.08 -529.48 ---81.65 -0.30 2.42 1.20 74.80 --0.13 -205.72 -10.79 -35.00 55.00 10.00 0.20 -4.08 25.00 -11.93 1.55 290.95 1594.43 130.24 2.78 1.50 -4.87 44.23 1.20 0.24 --1001.95 428.86 53.45 2.00 13.08 31.06 6.45 -42.85 287.60 5948.83 6.16 6.02 -6.10 6.16 --6.03 -6.17 --6.60 --6.33 ---6.43 6.60 6.95 --6.56 -6.73 -6.65 ---6.76 -6.92 6.90 6.79 6.89 --7.25 -6.98 -7.14 -5.90 5.92 7.07 7.33 -7.19 7.20 -7.22 7.22 7.20 7.18 7.25 7.24 7.29 -7.30 7.30 7.42 7.34 --7.33 7.35 7.33 7.32 7.42 7.38 7.37 -7.46 7.43 7.02 4.87 6.73 -11.51 13.38 --6.67 -11.06 --12.70 --10.71 ---6.88 10.04 10.48 --7.28 -10.28 -8.35 ---6.82 -8.31 8.75 9.04 7.11 --9.56 -7.20 -8.48 -5.83 5.93 7.22 8.68 -8.91 6.33 -8.98 7.32 7.33 7.56 6.53 6.78 8.33 -6.54 6.76 8.21 6.95 --8.09 7.63 6.96 7.00 7.90 7.06 7.09 -7.46 7.43 7.95 81.25 1.00 15.00 60.00 0.50 0.15 30.00 2.08 25.00 253.35 50.03 15.20 2.16 0.03 52.50 915.00 6.60 10.42 5.00 0.62 0.16 16.15 0.24 1.27 382.03 160.00 0.92 0.01 3210.83 0.10 0.15 5.00 137.35 5.00 2.92 4.53 1.46 305.95 1.26 0.35 0.31 10.00 462.55 5.00 40.07 1.39 35.00 60.15 125.79 2.60 0.04 4.73 25.00 0.40 21.39 46.64 439.19 3899.64 230.63 45.62 64.40 29.06 5.83 241.47 13.03 2.24 21.16 15.03 2072.10 887.63 148.56 13.10 49.74 38.46 13.36 64.70 166.00 776.13 15839.69 6.18 6.02 6.18 6.24 6.16 6.15 6.01 6.11 6.42 6.24 6.38 6.38 6.53 6.30 6.34 6.33 6.36 6.41 6.90 6.43 6.60 6.49 6.59 6.76 6.57 6.86 6.64 7.13 6.70 6.64 6.89 6.75 6.81 7.14 6.89 6.90 6.83 7.00 6.86 7.19 7.20 7.03 7.06 6.99 7.13 7.07 5.90 5.92 7.08 7.25 7.26 7.18 7.20 7.17 7.21 7.29 7.21 7.24 7.24 7.25 7.26 7.33 7.29 7.28 7.32 7.51 7.33 7.33 7.35 7.36 7.33 7.33 7.41 7.37 7.36 7.44 7.44 7.42 7.03 4.87 6.73 11.32 11.53 13.38 13.25 13.80 6.68 10.64 11.08 11.71 12.09 12.69 8.95 10.17 10.71 10.73 10.76 6.70 6.88 10.04 10.36 10.40 7.30 7.28 7.37 10.26 7.71 8.37 9.18 9.44 9.62 6.84 7.31 8.30 8.75 9.05 7.16 8.02 8.97 9.54 6.85 7.23 7.38 8.49 8.60 5.83 5.93 7.23 8.65 8.91 8.91 6.33 8.54 8.98 7.35 7.33 7.60 6.52 6.79 8.32 8.79 6.54 6.75 8.15 7.05 8.27 8.38 8.11 7.64 6.96 7.00 7.89 7.05 7.08 7.51 7.44 7.42 8.02
B RBI’s Open Market Operations (A+B)3 REPO -3002.02 28734.33 -7.18 -7.95 164.00 3195.70 32833.11 -7.05 -7.95 -3857.14 28609.12 -6.91 -8.23 497.00 6445.83 44405.21 -7.02 -661.007.95 16500.69 134581.77 7.03 8.02
4 State Govt Securities 233.38 7.39 7.74 188.92 7.27 7.36 184.91 7.24 7.86 257.65 7.28 7.40 864.86 7.30 7.58
Grand Total (1 to 4) 33545.26 38205.86 34719.08 54513.66 160983.86

(-) means no trading YTM = Yield to maturity in percentage per annum CY = Current yield in per cent per annum. SGL = (RBI’s) Subsidiary General Ledger.

Notes: (1) Yields are weighted yields, weighted by the amounts of each transaction. (2) Current yield has not been worked out for treasury bills. (3) For Floating Rate Bonds (FRB’s) Currentyields are based on the latest half-year yield determined in the auction.

Economic and Political Weekly February 18, 2006 subdued. The total amount of funds mobilised declined to Rs 3,995 crore (by nine issuers) in January from Rs 4,809 crore (by 10 issuers) in the previous month (Table 7). Among the issuers that tapped the market, the highest amount of Rs 1,800 crore has been mobilised by a sole central government undertaking, followed by Rs 1,525 crore by six financial institutions and banks, and the remaining amount has been mobilised by two state government undertakings; again corporates have refrained from tapping the market.

Among the FIs and banks that tapped the market, ICICI Bank has mobilised Rs 225 crore but at a higher cost; for its 10-year paper it has paid 7.95 per cent as against

7.60 per cent in December, similarly for 15 years, it has offered 8.05 per cent as against 7.80 per cent. Likewise, NABARD could mobilise only Rs 200 crore at 7.60 per cent for 10-year paper as against Rs 1,000 crore at 7.50 per cent for a similar maturity paper in December.

Interestingly, Rural Electrification Corporation (REC), a central government undertaking, has been able to mobilise Rs 1,800 crore by offering a coupon rate of 7.65 per cent for 10 years as compared with 7.30 per cent for a similar maturity paper in June 2005 – an increase of 35 basis points in a span of six months, whereas a similar increase has been observed in the case of ICICI Bank in a span of one month.

Among the state government undertakings, in spite of being unrated, Punjab Finance Corporation has mobilised Rs 120 crore at a high rate of 7.85 per cent for a maturity period of 10 years as compared with 7.64 per cent offered by the Karnataka State Financial Corporation for a similar maturity paper. The issue was rated AA-(SO) by Crisil.

The expert committee on corporate bonds and securitisation, set up as outlined by the Union finance minister in his budget speech last year and headed by R H Patil, has come out with several proposals to boost the corporate bond market. Key recommendations put forth by the committee are as follows: (i) Tax deduction at source (TDS) rules on corporate bonds to be similar to the ones applicable on government securities; (ii) Uniform stamp duty on corporate bonds across the country; (iii) Banks should be allowed bonds of maturity of over five years for assets-liability management purposes and not only for the infrastructure sector as at present; (iv) To encourage the corporates to raise a part of their requirements through bonds, the time and costs for public issuance and the disclosure and listing requirements for private placements should be reduced and made similar; (v) To enhance the scope of investments by provident/pension/gratuity funds and insurance companies, ratings should form the basis of such investments rather than the category of issuers; (vi) Investments in corporate bonds should be considered as part of the total bank credit while computing credit-deposit ratio by banks so as to encourage banks to invest in corporate bonds; (vii) Immediate creation of a centralised database of all the bonds issued by corporates; (viii) Development of an online order matching platforms for trading of corporate bonds; and (ix) Set-up of a specialised debt funds to cater to the needs of infrastructure sector. Investments by banks in these funds not to be subjected to the capital market exposure limits that the RBI applies to banks.

RBI has issued draft guidelines to banks for raising capital funds through the issue of innovative perpetual debt instruments for inclusion as tier I capital; debt capital instruments eligible for inclusion as upper tier II capital; perpetual non-cumulative preference share eligible for inclusion as tier I capital; and redeemable cumulative preference shares eligible for inclusion as tier II capital. Further, with a view to permitting banks in India to augment their capital through issue of perpetual debt instruments eligible for inclusion as tier I capital and debt capital instruments as upper tier II capital, RBI has permitted FIIs registered with SEBI and non-resident Indians to subscribe to these instruments.

IV Secondary Market

The secondary market turnover for giltedged securities remained subdued in January. Initially, with the improvement of liquidity due to SDS inflows following the successful redemption of IMD, the weekly average turnover increased from Rs 9,884 crore in the week ended December 30 to Rs 16,204 crore in January 6. Due to the central loan floatation, the pressure on liquidity manifested itself through a fall in turnover to Rs 8,083 crore. In the last two weeks of the month, the turnover ranged between Rs 9,831 crore and Rs 9,520 crore, respectively, with the improvement in the liquidity situation.

Though pressure on liquidity was experienced throughout the last three weeks of the month, yields for different maturities behaved differently, thus resulting in some fluctuations in their spreads (appendix table). The yield on short-term gilt-edged securities fell in the second week and continuously rose thereafter, whereas the long–term ones remained stable for the first three weeks and shot up in the last week. The steep rise in the last week’s yield rate was universal as it followed the RBI’s increase in repo/reverse repo rates. Overall, the yield curve remained relatively flat in the first three weeks but became somewhat upward sloping in the last week of the month (Graph D).

RBI Reverse Repos, OMOs and MSS

In the recent period, liquidity management operations have been for the most in the form of net liquidity injection under the LAF. The liquidity support extended by the RBI through repo (under both LAF and second LAF) of Rs 2,79,065 crore exceeded the amount injected in December at Rs 1,49,115 crore. Despite the hike effected in repo rate, the RBI continued to inject liquidity, which was cheaper than the prevailing call rates, which were ruling above 7 per cent. In the week ended January 6, the RBI injected Rs 16,240 crore, while it absorbed Rs 16,140 crore (Table 8). Thereafter, the reverse repo bids have fallen sharply to Rs 2,700 crore to Rs 2,195 crore and further to Rs 1,115 crore, while repo bids tendered and accepted have increased to Rs 99,450 crore, but fell marginally to Rs 80,825 crore to rise again to Rs 82,550 crore, in the weeks ending January 13, 20 and 27, respectively. While the repo with the RBI has increased, those outside RBI have fallen from Rs 193,018 crore in December to Rs 134,582 crore.

Commercial Bonds

Given the interest rate uncertainty, trading in floating rate bonds has increased from Rs 36 crore in December to Rs 151 crore in January. Though the trading in other bonds fell over the month, the secondary market for corporate bonds has witnessed an increase in its turnover from Rs 61 crore in December to Rs 77 crore in January.

m

[V P Prasanth has compiled the regular data set for this review; the review itself has been drafted by Piyusha Hukeri.]

Reference

Chidambaram, P (2005): Statements Laid before Parliament as Required under the Fiscal Responsibility and Budget Management Act, 2003, Ministry of Finance, Government of India.

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