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Blurring of Development Goals in Refinancing

The acute liquidity shortage occasioned by the Rs 32,000 crore redemption of India Millennium Deposits last December raises the larger question of the need for the RBI to be ready to inject funds into the banking system through sector-specific refinance facilities so that banks are encouraged to lend in favour of needy sectors - agriculture, small-scale industries, and other small borrowers. If the injection of massive liquidity by the central bank of the country is unrelated to broader developmental goals, the end result could only be a highly distorted one, as has been happening during the past few years: multiple layers of secondary market transactions unrelated to the development of the real sector.

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Blurring of DevelopmentGoals in Refinancing

The acute liquidity shortage occasioned by the Rs 32,000 crore redemption of India Millennium Deposits last December raises the larger question of the need for the RBI to be ready to inject funds into the banking system through sector-specific refinance facilities so that banks are encouraged to lend in favour of needy sectors – agriculture, small-scale industries, and other small borrowers. If the injection of massive liquidity by the central bank of the country is unrelated to broader developmental goals, the end result could only be a highly distorted one, as has been happening during the past few years: multiple layers of secondary market transactions unrelated to the development of the real sector.

EPW RESEARCH FOUNDATION

I Why Not Sector-SpecificRefinancing?

A
distinct development in the financial markets since the middle of December 2005 after the India Millennium Deposits (IMD) redemptions worth about Rs 32,000 crore, has been the emergence of an acute liquidity shortage so much so that the RBI has been forced to provide a “status note on liquidity conditions” explaining the nature and sources of liquidity constraints, the extent of liquidity injections made by it and generally assuring the market of appropriate monetary operations and the use of a range of instruments to manage liquidity in line with the given monetary policy stance.

There is no doubt that the instruments that the RBI has evolved for short-term liquidity management – liquidity adjustment facility (LAF) and market stabilisation scheme (MSS) – have stood their test of time; they have been extremely useful hitherto in maintaining stable shortterm interest rates and in generally ensuring stability in the financial markets. But, after the IMD redemptions, despite the injections of liquidity far beyond those redemptions, the call money rates have ruled far above even the RBI’s repo rate

(6.50 per cent). It is very likely that this has happened because there is a qualitative difference between the two sets of funds

– contraction of funds through IMD redemptions which are of a long-term nature, and daily injections of funds through LAF and other means which are essentially short-term in character. It is extremely difficult to pinpoint as to what has been the impact of IMD redemptions on credit operations of banks. No doubt, in the constant ebb and flow of funds, there is leeway for banks to meet the immediate requirements if such requirements are of a marginal nature. But, the sudden withdrawal of such a large quantumas Rs 32,000 crore stands on a different footing altogether. In such a situation, one is not surprised that NABARD is reportedly facing an unprecedented demand for its refinance facilities from commercial banks due to tightness in inter-bank liquidity; these refinance facilities are for investment credit for the farm sector.

This development raises the larger question of the need for the RBI to be ready to inject funds into the banking system through sector-specific refinance facilities so that banks are encouraged to lend in favour of needy sectors – agriculture, smallscale industries, and other small borrowers. In this respect, the refinance facilities that NABARD and SIDBI could provide can only be minuscule compared with the requirements of the banking system. Also, the RBI’s present system of supplying liquidity through indirect short-term instruments has spawned an extremely unhealthy credit structure amongst banks. It is found that the scheduled commercial banks have drastically reduced over the recent years the number of loan accounts for agriculture, small-scale industries and small borrowers. On the other hand, they have added about 14 million accounts as part of personal loans. During two years, 2002-03 to 2004-05, loans in favour of the capital market have risen more than sixfold, from Rs 2,917 crore to Rs 22,606 crore, and in favour of real estate, from Rs 12,464 crore to Rs 24,803 crore.

What is sought to be argued here is that injection of massive liquidity by the monetary authority should also aim at larger economic and social purposes. There are a number of purposeful goals of the financial system which have fallen by the wayside due to the pursuit of a very narrow monetary policy that depends only on indirect instruments of monetary control. A bill culture that allows for faster turnover of funds has been forgotten. Despite the presence of statutory provisions, delayed payments for small-scale industries by large-sized public as well as private sector companies remain rampant. Venture capital funds deserve to be encouraged so as to promote innovative entrepreneurship in the country. The microfinance development and equity fund (MFDEF) would require much more than the corpus of an additional Rs 100 crore just created by the contributions of RBI, NABARD and some commercial banks. Above all, a serious vacuum has been created in the supply of project financeinthecountry as a result of the closure of development financial institutions (DFIs). If the injection of massive liquidity by the central bank of the country is unrelated to any of these broader developmental goals, the end result could only be a highly distorted one, as has been happening during the past few years: multiple layers of secondary market transactions unrelated to the development of the real sector.

II Money and Forex Markets

The spill-over effects of the developments in December 2005 and January 2006 have impinged on the operations in money and government securities market, in February. Liquidity scenario has undergone a sea change due to a frictional factor – IMD redemption worth over $ 7.1 billion or about Rs 32,000 crore towards end-December combined with sustained growth in bank credit and also other factors like increased cash surpluses of the central and state governments and huge currency holdings by the public together have contracted supply, while liquidity itself has grown at a sluggish rate as the inflow of foreign currency assets have been lower. As a result, RBI’s potent sterilisation activities have come to a standstill. Instead, the RBI has been injecting huge amounts of liquidity through LAF repo window. In addition, government has reduced the issue size of one of the early issuances of securities. Even so, the call rates have persistently ruled above the repo rate. In order to arrest the surge in short-term interest rates, RBI has rejected all the bids tendered for 182-day bills and the government has cancelled the second scheduled auction of the month; these have turned the market sentiments somewhat buoyant. Thereafter, the call rates have eased to an extent and even the RBI injection of liquidity through LAF repo have fallen gradually. Ahead of the budget announcement, the sentiments had turned cautious, as the market remained concerned about the size of government borrowings for the next fiscal year, but after the budget announcement, while the immediate sentiments became buoyant as the government endeavoured to contain the fiscal deficit, they were short-lived. Apart from the government’s borrowing requirement of another Rs 15,000 crore in the current fiscal year, concerns about the impending liquidity scenario in March have tended to caution the market. Caution has been further reinforced by the freshlyissued RBI’s securitisation guidelines which have insisted on profits on sale of assets being amortised and the first loss credit enhancement provided by the originator of the pool of assets being reduced from tier-1 capital – conditions which banks consider onerous. At the same time, the central budget has provided some special facilities for the financial sector: FIIs to increase their exposure in both the corporate debt and government securities market; long-term 5-year maturity bank deposits to be included amongst other financial assets for tax exemption purposes; and the removal of 10 per cent bonus on the fresh monthly income schemes of the post offices with effect from February 13, thereby reducing the returns on these investments.

Call Money Market

Despite the injection of liquidity by RBI through its LAF repo, the money market rates have generally ruled above the repo rate of 6.50 per cent (Table 1). Following the hike in the reverse repo rate by 25 basis points on January 24, the weighted averages of daily call borrowing rates have ruled above 7 per cent. As the banks began

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

Month/Week Simple Standard Coefficient Simple Standard Coefficient Mean* Deviation of Variation Mean* Deviation of Variation (Percentages)$ (Percentages)$

Call Money Notice Money** February 2006All four weeks 6.98 0.37 5.37 6.81 0.31 4.54

  • 24 6.93 0.11 1.60 6.86 0.33 4.83 17 (RF)* 6.87 0.28 4.04 6.67 0.18 2.77
  • 10 7.11 0.09 1.25 6.80 0.36 5.33 3 (RF)* 7.04 0.69 9.86 6.89 0.37 5.39
  • January 2006All five weeks 6.68 0.68 10.13 6.46 0.77 11.96

  • 27 7.18 0.50 6.94 6.99 0.66 9.37 20 (RF)* 6.79 0.40 5.89 6.69 0.61 9.10
  • 13 6.97 0.56 8.06 6.63 0.69 10.45 6 (RF)* 5.90 0.49 8.31 5.69 0.54 9.55
  • ** Separate reportings began on March 15.

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

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

    Week Ending Weighted Average Rates (in Per Cent) Daily Average Volumes (Rs Crore) Call Overnight CBLO Repo Call Overnight CBLO Repo

    3-Feb-06 7.20 6.37 6.42 7574.92 16562.03 4954.55 10-Feb-06 7.11 6.51 6.51 7680.63 13705.56 5726.31 17-Feb-06 6.92 6.38 6.44 6763.51 18139.97 6434.05 24-Feb-06 6.93 6.48 6.48 9237.15 18289.52 6255.81

    Source: CCIL.

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

    Average February 2006 Average January 2006 Items for Four for Four Weeks 24 17(RF)* 10 3(RF)* Weeks 27 20(RF)* 13 6(RF)*

    No of working days 23 6 6 5 6 22 5 6 5 6

    Call Money

    Weighted average of call rates:

    per cent (weekly range) per annum 5.69-7.67 6.73-7.05 6.41-7.11 6.97-7.20 5.69-7.67 5.48-7.71 6.56-7.71 6.43-7.37 6.20-7.60 5.48-6.71 Daily averages (Rupees crore) (6.45) (5.48) Total call market borrowings 138699 6914 5251 5039 6755 7805 7916 6477 8366 8574

    (146) (935) (475) (820) Of which: by banks 121808 6228 4555 4343 5900 6325 7162 5254 7052 6092

    (146) (935) (468) (820)

    Notice Money

    Weighted average of notice money rates:

    per cent (weekly range) per annum 6.24-7.25 6.43-7.25 6.33-6.84 6.24-7.12 6.45-7.53 5.29-7.88 6.28-7.88 6.08-7.67 5.99-7.56 5.21-6.63 Daily averages (Rupees crore) (6.53) (5.60) Total notice market borrowings 35951 1961 1048 2087 1244 2476 2593 2103 2838 2389

    (6231) (7361) (9190) (14259) Of which: by banks 29824 1802 831 1689 930 2050 2352 1759 2419 1732 (4929) (5506) (7520) (10333) Turnover in term money market 251 342 383 245 95 268 365 231 392 84 (borrowings) $$ (113) (35) (300) (45)

    * 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 March 25, 2006

    Graph A: Trends in Weighted AveragesFriday, February 17, the rate has dipped Also, the weighted averages of all the three

    to 6.41 per cent. Due to impending out-rates have steadily moved up thus:

    flows on account of a state loan floatation,

    20.5

    Month Weighted Averages of Rates

    the overnight rate has jumped to 7.05 per

    Call Market Repo CBLO

    cent on February 20. Thereafter as the

    December 2005 6.06 5.85 5.84

    liquidity situation improved following the

    15.5

    January 2006 6.79 6.19 6.12

    cancellation of the second scheduled cen-

    Weighted Average (Per Cent)

    (Rupees thousand crore)

    February 2006 6.94 6.45 6.42

    tral loan auction, the call rates have eased.

    Between February 22 and February 24, Also, volumes in the call market and

    10.5

    they have ruled in a range of 6.73-7 per market repo have fallen from Rs 2,42,531

    cent. They have fallen to 6.46 per cent on crore and Rs 1,47,586 crore in January

    February 25, but have risen again to 6.64 to Rs 1,85,103 crore and Rs 1,38,548

    5.5

    5.5

    5 0.5

    February 2006

    -iCall Money Volume (Rs Cr)
    Repo Rates – Outside the RBI

    ll

    Call Rates

    CBLO Rates

    covering their positions ahead of the first reporting Friday, the rates have fallen from

    7.40 per cent on January 31 to 7.20 per cent on February 1 and further to 7.06 per cent on the next day. As the banks had already covered their positions, the rates have dipped to 5.69 per cent on the first reporting Friday of the month, February

    3. The overnight rate has risen to 7.20 per cent on February 4, but has fallen to 7.12 per cent on February 7 as the issue size of the central floatation had been reduced. Thereafter, it has fallen to 6.67 per cent to February 11. Ahead of the second reporting Friday, the overnight rate has risen to 7.05 per cent on February 13 and further to 7.11 per cent on February 15. On the reporting per cent on February 27 and have ruled crore in February, respectively, while those steady at it on February 28. The measure of CBLO have increased from Rs 3,07,603 of volatility, standard deviation, has fallen crore to Rs 3,92,866 crore (Table 3). The from 0.68 in January to 0.37 in February CBLO borrowing side has been domi(Table 2). nated by public sector banks, while the

    While call rates have ruled above the lending side by mutual funds. repo rate during the month, the CBLO and market repo rates have ruled around the

    Forex Market

    benchmark rate. Interestingly, over the month of February, while the overnight In February, the rupee-dollar exchange rates have fallen, those of market repo and rate has responded to the generally strength-CBLO have remained steady (Graph A). ening dollar movements against major

    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 Feb 8 500.00 25 813.00 All bids rejected 11137.23

    (2) (66.50) Feb 22 500.00 29 1253.00 7 500.00 0.00 96.75 6.73 10137.23

    Figures in brackets represent numbers and amounts of non-competitive bids which are not included in the total.

    Table 4: Auctions of 91-Day Treasury Bills

    (Amount in rupees crore)

    Date of Auction Notified Amount Bids Tendered Bids Accepted Subscription Devolved Cut-off Price Cut-off Yield Amount Outstanding on the Date of Issue
    No Face Value No Face Value on RBI (Rupees) Rate
    (1) (2) (3) (Amount) (4) (5) (Amount) (6) (Amount) (7)* (8) (Per Cent) (9) Total (10) With RBI (11) Outside RBI(12)
    2005
    Feb 2 2000.00 86 6937.75 51 2000.00 0.00 98.71 5.23 21911.74 0.00 21911.74
    (0) (0.00) (0) (0.00) [98.72] [5.19]
    Feb 9 2000.00 67 4536.19 45 2000.00 0.00 98.71 5.23 22931.74 0.00 22931.74
    Feb 16 2000.00 (0) 63 (0.00) 4377.00 (0) 45 (0.00) 2000.00 0.00 [98.71] 98.70 [5.23] 5.27 24431.74 0.00 24431.74
    (1) (200.00) (1) (200.00) [98.71] [5.23]
    Feb 23 2000.00 76 8094.55 39 2000.00 0.00 98.71 5.23 25931.74 0.00 25931.74
    (0) (0.00) (0) (0.00) [98.72] [5.19]
    Mar 2 2000.00 76 7085.05 34 2000.00 0.00 98.72 5.19 27525.02 0.00 27525.02
    2006 (1) (350.00) (1) (350.00) [98.72] [5.19]
    Feb 1 500.00 47 2481.16 8 500.00 0.00 98.39 6.56 12245.48 0.00 12245.48
    Feb 8 500.00 (3) 34 (206.54) 1453.47 (3) 9 (206.54) 500.00 0.00 [98.39] 98.39 [6.55] 6.56 12246.96 0.00 12246.96
    (2) (1.48) (2) (1.48) [98.40] [6.50]
    Feb 15 500.00 39 1095.22 20 500.00 0.00 98.36 6.68 12812.75 0.00 12812.75
    (4) (787.44) (4) (787.44) [98.37] [6.63]
    Feb 22 500.00 34 1048.74 20 500.00 0.00 98.36 6.68 13464.75 0.00 13464.75
    Mar 1 500.00 (3) 37 (652.00) 1479.10 (3) 22 (652.00) 500.00 0.00 [98.36] 98.36 [6.67] 6.68 13563.57 0.00 13563.57
    (2) (461.82) (2) (461.82) [98.37] [6.63]

    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.

    Graph B: Spot Quotations for the USGraph C: Annualised Forward Premia in However, due to dollar weakness, the rupee

    Dollar in the Domestic Inter-Bank Market Percentage for the US Dollar in the

    has surged to Rs 44.45 on February 24.

    50.0

    Averages of Call Rates for Feb 2006 Given the arbitrage opportunities between

    Working Days Per cent per annumi 1-month 3-month 6-month Weighted Averages of Call Rates (Right Axis)
    the domestic and non-delivery forward

    6.0

    8.0

    5.5

    market (NDF) as well as month-end demand

    48.0

    5.0

    for dollars, the rupee has fallen, but the

    4.5

    Rupees per US dollar

    union budget which increased the FII limits

    in the debt market has perked up the rupee

    4.0 6.0

    3.5

    to Rs 44.44 on February 28 (Graph B).

    46.0

    3.0

    Given the pressure on liquidity, banks

    2.5

    have begun to buy dollars forward and

    2.0

    4.0

    convert them into rupees, which has put

    1.5

    44.0

    pressure on forward premia for the US

    1.0

    i

    (Daily

    tl

    Monthly Averages

    dollar. Prior to the emergence of liquidity

    i 0.5

    Working Days

    (Jan 2001 to Jan 2006)

    shortage after the IMD redemption, the

    Feb 2006) 0.0

    42.0

    currencies such as yen, euro and the British pound, and to the RBI interventions in the currency market. The RBI interventions seem to achieve multiple objectives. The market-based exchange rates are unstable and fluctuating in nature, which the RBI would like to avoid for the rupee. Nor would it like to depreciate the rupee beyond a point for it would hurt capital flows; increased capital flows are becoming a major objective so as to finance infrastructure investment. At the same time, there is tremendous pressure on the authorities to prevent the appreciation of the rupee faced as they are with the slowing export growth rate and growing merchandise deficit; even competitor south-east Asian countries are depreciating their currencies; China has done precious little to upvalue its grossly undervalued currency. As against an appreciation of 98 paise in January, the rupee has depreciated by 29 paise against the US dollar in February. The inflow of foreign currency assets during the month has stood at US $ 1,874 million as against $ 2,263 million in the previous month.

    The month began with the rupee-dollar exchange rate depreciating, following the 14th hike in the US fed rate, from Rs 44.07 on January 31 to Rs 44.15 on February 1 and further to Rs 44.31 on the next day. But, as the dollar weakened against the yen, the rupee has firmed up to Rs 44.20 on February 6. The RBI has intervened in the market to streamline the movements and the rupee has fallen to Rs 44.27 on February 7. Given the buoyant foreign currency inflows, the rate has risen to Rs 44.20. As the expectations of a further hike in the US benchmark rate built up, the rupee has depreciated and with its confirmation by the US Fed, the rate has dipped to Rs 44.46 on February 17. It has edged up to Rs 44.40 on February 21, but has

    -0.5

    2.0

    forward premia curve was flat. Despite the

    narrowing of interest rate differentials fallen sharply to Rs 44.56 on February 23, following the hike in US Fed rate to 4.50 due to the dollar’s strength as well as per cent, the forward premia have ruled firm demand for dollars by corporates, firming over the month due to the domestic market up of international crude oil prices and conditions. The six-month annualised forfears of receding foreign currency inflows. ward premia weekly average has increased

    Table 6: Auctions of 364-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

    2005 Feb 2 2000.00 76 4536.00 36 2000.00 0.00 94.66 5.64 44124.51

  • (0) (0.00) (0) (0.00) [94.67] [5.63]Feb 16 2000.00 81 6690.00 32 2000.00 0.00 94.67 5.63 45124.51
  • (1) (91.00) (1) (91.00) [94.68] [5.62]Mar 2 2000.00 75 6390.00 23 2000.00 0.00 94.70 5.60 46125.51
  • (0) (0.00) (0) (0.00) [94.71] [5.59]

    2006 Feb 1 1000.00 48 2486.00 17 1000.00 0.00 93.70 6.74 46110.43

  • (1) (250.00) (1) (250.00) [93.72] [6.70] Feb 15 1000.00 52 2926.00 15 1000.00 0.00 93.64 6.81 45260.93
  • (2) (241.60) (2) (241.60) [93.66] [6.77] Mar 1 1000.00 37 2646.00 9 1000.00 0.00 93.65 6.80 44260.93
  • [93.67] [6.76]

    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.

    Table 7: Profile of Major Commercial Bond Issues during February 2006

    Issuing Company/Rating Nature of Coupon in Per Cent Per Annum Amount in Instrument and Tenor Rs Crore

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

    FIs/Banks

    1 Canara Bank Tier-II bonds 8.15 per cent for 110 months 425 AAA by Crisil and Icra 2 UTI Bank Tier-II bonds 8.15 per cent for 7 and 10 years 500 AA + by Icra and Fitch 3 IDBI NCD 7.60 per cent for 5 yearsAA + by Crisil and Icra 7.80 per cent for 7 years 8 per cent for 10 years 250 (150) 4 UCO Bank Tier-II bonds 7.85 per cent for 111 months 250 AA by Crisil and Care5 EXIM Bank NCD 7.53 per cent for 5 years 300 AAA by Crisil and Icra6 State Bank of Patiala NCD 7.80 per cent for 115 months 750 AAA, LAAA by Care, Fitch

    Central Govt Undertakings

    7 Power Finance Corporation NCD 7.95 per cent for 10 years 300 AAA by Crisil and Care Total 3265*

    Total for Feb-05 (a year ago): Rs 5,635 crore. Total for Jan-06 (a month ago): Rs 3,995 crore. Notes: *Total includes two more issues for Rs 200 crore or less ( 2 bank’s issues).

    The amount shown in brackets above denotes the greenshoe option of the issue.

    Economic and Political Weekly March 25, 2006

    Graph D: Yield Curves for DatedSecurities: Weighted Average for Weeks of February 2006

    Yield (per cent per annum)

    8

    .5

    7

    .5

    6

    .5

    1st Week 2nd Week 3rd Week 4th Week

    12 34567 89 1011121314151617182123272930

    Years to Maturity

    from 2.34 per cent in the week ended January 27 to 2.39 per cent in the week ended February 3. As the liquidity improved, it has fallen to 1.93 per cent in week ended February 10. As the dollar strengthened following the expectation of further rate hike in the US, the premia has jumped to 2.19 per cent. With the arbitrage opportunity in the NDF market, the premia has risen further to 2.30 per cent in the week ended February 24 and to 2.46 per cent in the week ended March 3 (Graph C).

    III Primary Market

    Dated Securities

    The government’s decision to pare down the size of one of its issues in the month’s first borrowing and cancelling the second scheduled borrowing provided the much needed respite from the pressure on liquidity. The government mobilised Rs 6,000 crore during the month as against Rs 14,000 crore planned. Instead of Rs 9,000 crore scheduled for the first issue on February 7, the government mobilised Rs 6,000 crore through two papers; both reissues through price-based auctions: 7.46

    per cent 2017 for a notified amount of Rs 3,000 crore using uniform price method and 7.40 per cent 2035 for Rs 3,000 crore using multiple price method. The RBI received 152 competitive bids worth Rs 7,443 crore and 202 bids for Rs 7,475 crore for the 11-year and 29-year papers, respectively. Of these, 92 bids worth Rs 2,960 crore and 150 bids for Rs 2,974 crore were accepted for the 11-year and 29-year papers, respectively. The cut-off yield for the 11-year paper has been set at 7.38 per cent, while for the 29-year paper RBI had to offer 7.63 per cent as against 7.43 per cent offered in its reissuance in January. Yet, the yields were set below the market expectations on both the papers, which buoyed the market sentiments.

    Twelve state governments offered to sell 10-year state development loans, on February 27, maturing in 2016 for an aggregate amount of Rs 3,724.21 crore through a yield-based auction using multiple price method. The underwriting bids were accepted in the case of Goa, Punjab, Uttaranchal and Uttar Pradesh from the primary dealers in the range of 20-60 paise per Rs 100. All state government loans were oversubscribed. Except for Uttar Pradesh, for which the RBI allowed the issue to partly devolve on primary dealers to the extent of Rs 94.52 crore out of the issue size of Rs 599.33 crore despite receiving bids worth Rs 719.81 crore, all other bids were accepted. While Rajasthan was able to mobilise funds at the lowest rate of 7.64 per cent, Uttar Pradesh had to pay a higher rate of 7.78 per cent; for all other loans, the cut-off yield was set between 7.65 per cent and 7.70 per cent.

    Treasury Bills

    The underlying liquidity conditions have manifested themselves in sharp increases in yields on all treasury bills issued in the recent period. In fact, the RBI had to reject all bids tendered for the 182-day bills auctioned on February 8; for this TB, the yield has risen from 6.22 per cent on January 10 to 6.73 per cent on February 22 (Table 5). Likewise, the yield on 364-day bills has increased steadily from 6.30 per cent on January 18 to 6.74 per cent on February 1 and further to 6.81 per cent on February 15 (Table 6). However, the yield on 91-day bill has moved in a staggered fashion; it ruled steady at 6.56 per cent for the first two auctions held on February 1 and 8, but has risen to 6.68 per cent on February 8 and has remained steady at it for the auction held on February 22 (Table 4).

    Corporate Debt

    With a view to increasing the depth of the corporate debt market, the Union Budget for 2006-07 has hiked the limit of FII investment in corporate debt from the existing $ 0.5 billion to $ 1.5 billion. Further, the finance ministry has proposed to launch a single unified exchange traded market

    Table 9: Repo Transactions in Government Paper@ (Other than with the RBI) – February 2006

    Repo Period Amount Range of Interestin Number (Rupees (Per Cent of Days Crore) Per Annum)

    1 95479.49 5.50-6.60 (6.48) 2 8097.96 5.50-7.15 (6.51) 3 27642.15 5.75-7.50 (6.36) 4 136.70 6.00-6.50 (6.34) 5 876.19 6.49-6.52 (6.51)

  • 6 1.00 6.25 (6.25) 7 362.75 6.45-8.50 (6.60)
  • 8 23.50 7.50 (7.50) 13 28.00 8.50 (8.50) 14 60.00 6.45 (6.45)
  • 30 5.00 7.75 (7.75)
  • 90 6.00 8.25 (8.25)
  • All Issues 1-90 132718.74 5.50-8.50 (6.40) [1-14] [134581.73] [5.25-7.00] [6.09]

    @ Cover all types of securities.Figures in round brackets are weighted averageinterest rate; in square brackets, the figuresrepresent the previous month’s turnover/interest rate.

    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
    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
    13 Feb - 17 Feb 06 1-3 200 84110 200 84110 19 1710 19 1710 82400 -8920
    20 Feb - 24 Feb 06 1-3 183 87635 183 87635 11 430 11 430 87205 -12715
    27 Feb - 03 Mar 06 1-3 83 24505 83 24505 24 3730 24 3730 20775 -6360
    06 Mar - 10 Mar 06 1-3 109 42325 109 42325 13 1396 13 1396 40929 -6980

    Notes: * 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 February 2006: Yield to Maturity on Actual Trading Total for the Month
    24 17 10 3 of February 2006
    AMT YTM CY AMT YTM CY AMT YTM CY AMT YTM CY AMT YTM CY
    1 Treasury Bills A 91-Day Bills B 182-Day Bills 625.11 293.42 6.64 6.64 419.96 174.46 6.64 6.59 208.68 109.90 6.64 6.55 476.02 465.09 6.51 6.60 1729.77 1042.87 6.60 6.60
    C 364-Day Bills 2 GOI Dated Securities 471.68 6.66 931.56 6.68 241.30 6.65 1764.24 6.68 3408.78 6.68
    A Regular (Per Cent: Year) 4.83 , 2006 - - - 42.50 6.86 4.88 - - - - - - 42.50 6.86 4.88
    11.25, 2006 - - - - - - 120.00 6.85 11.03 - - - 120.00 6.85 11.03
    11.50, 2006 - - - - - - - - - 50.00 6.63 11.36 50.00 6.63 11.36
    11.68, 2006 105.00 6.70 11.61 - - - 65.00 6.60 11.59 95.00 6.60 11.57 265.00 6.64 11.59
    11.75, 2006 - - - - - - - - - 49.00 6.62 11.64 49.00 6.62 11.64
    13.85, 2006 INSTAL - - - 32.00 6.82 13.54 15.00 6.78 13.52 70.00 6.77 13.49 117.00 6.78 13.51
    6.75 , 2007 - - - - - - - - - 61.27 6.83 6.76 61.27 6.83 6.76
    11.50, 2007 - - - 20.42 6.85 10.74 - - - - - - 20.42 6.85 10.74
    11.50, 2007 40.00 6.87 10.75 - - - - - - - - - 40.00 6.87 10.75
    11.90, 2007 15.00 6.91 11.24 155.01 6.75 11.20 110.00 6.72 11.19 - - - 280.01 6.75 11.20
    12.50, 2007 - - - - - - 50.00 6.85 11.80 - - - 50.00 6.85 11.80
    13.05, 2007 10.00 6.86 12.22 20.00 6.84 12.21 71.25 6.85 12.20 20.00 6.86 12.19 121.25 6.85 12.20
    11.40, 2008 12.80 6.90 10.34 200.12 6.92 10.34 - - - - - - 212.92 6.92 10.34
    11.50, 2008 - - - 10.90 6.91 10.50 - - - - - - 10.90 6.91 10.50
    12.00, 2008 266.47 6.88 10.89 155.14 6.85 10.87 - - - 10.00 6.75 10.83 431.61 6.87 10.88
    12.10, 2008 25.00 6.91 10.91 - - - 0.02 8.27 11.20 - - - 25.02 6.91 10.91
    12.25, 2008 44.55 6.92 10.92 74.50 6.92 10.91 - - - 0.20 6.62 10.82 119.25 6.92 10.91
    6.65 , 2009 - - - - - - - - - 65.80 6.88 6.69 65.80 6.88 6.69
    11.99, 2009 1.50 6.89 10.51 1.00 7.01 10.54 5.00 6.88 10.49 1.17 6.74 7.30 8.66 6.87 10.07
    7.55 , 2010 13.12 6.99 7.40 15.10 6.94 7.39 5.06 6.91 7.38 70.00 6.88 7.37 103.28 6.90 7.38
    12.25, 2010 5.00 7.00 10.26 10.09 6.95 10.24 - - - - - - 15.09 6.97 10.24
    12.29, 2010 - - - 25.00 7.01 10.42 - - - - - - 25.00 7.01 10.42
    9.39 , 2011 432.45 7.07 8.52 214.84 7.01 8.50 190.60 6.95 8.47 431.95 6.95 8.47 1269.84 7.00 8.49
    12.32, 2011 75.00 7.06 10.13 5.00 7.00 10.10 10.00 7.14 10.16 - - - 90.00 7.07 10.13
    6.85 , 2012 26.56 7.09 6.93 15.30 7.05 6.92 21.48 6.99 6.90 15.00 7.01 6.90 78.34 7.04 6.92
    7.40 , 2012 30.55 7.15 7.31 10.15 6.97 7.25 0.04 7.01 7.26 0.20 7.14 7.31 40.94 7.10 7.29
    10.25, 2012 - - - 15.60 7.07 8.84 - - - - - - 15.60 7.07 8.84
    7.27 , 2013 153.40 7.16 7.22 15.25 7.14 7.22 1.15 7.09 7.20 74.15 7.12 7.21 243.95 7.14 7.22
    12.40, 2013 10.00 7.18 9.55 - - - - - - 20.00 7.24 9.57 30.00 7.22 9.56
    7.37 , 2014 15.05 7.26 7.32 29.59 7.17 7.28 - - - 112.58 7.21 7.30 157.22 7.21 7.30
    11.83, 2014 130.00 7.31 9.19 10.00 7.32 9.19 - - - - - - 140.00 7.31 9.19
    5.87 , 2015 FRB 25.00 5.94 5.94 5.00 5.92 5.93 - - - 5.00 5.92 5.93 35.00 5.93 5.94
    7.38 , 2015 50.00 7.34 7.36 - - - - - - - - - 50.00 7.34 7.36
    9.85 , 2015 - - - 6.97 7.32 8.40 - - - - - - 6.97 7.32 8.40
    10.47, 2015 20.15 7.36 8.72 4.75 7.41 8.74 1.00 7.34 8.70 - - - 25.90 7.37 8.72
    10.79, 2015 10.00 7.37 8.80 - - - - - - - - - 10.00 7.37 8.80
    11.43, 2015 106.00 7.37 8.98 - - - 0.01 7.66 9.14 - - - 106.01 7.37 8.98
    11.50, 2015 50.35 7.39 9.05 31.03 7.32 9.00 0.03 7.65 9.19 0.18 7.24 8.95 81.59 7.36 9.03
    5.66 , 2016 FRB 15.00 5.92 5.78 - - - - - - - - - 15.00 5.92 5.78
    12.30, 2016 10.00 7.40 9.11 - - - 0.02 7.65 9.26 0.10 7.24 9.01 10.12 7.40 9.11
    7.46 , 2017 - - - 315.54 7.40 7.42 1948.70 7.39 7.42 5.00 7.34 7.39 2269.24 7.39 7.42
    7.46 , 2017 338.69 7.42 7.44 - - - - - - - - - 338.69 7.42 7.44
    7.49 , 2017 102.96 7.43 7.46 2.25 7.34 7.41 38.00 7.31 7.39 45.80 7.36 7.42 189.01 7.39 7.43
    8.07 , 2017 1293.39 7.35 7.66 1077.70 7.34 7.66 663.42 7.34 7.65 2487.23 7.37 7.67 5521.74 7.36 7.67
    5.69 , 2018 2.33 7.37 6.59 10.00 7.41 6.61 4.50 7.31 6.56 13.64 7.32 6.56 30.47 7.35 6.58
    6.25 , 2018 1.61 7.39 6.86 3.50 7.38 6.86 8.06 7.36 6.85 20.85 7.44 6.89 34.02 7.41 6.87
    10.45, 2018 22.00 7.39 8.41 - - - - - - 0.60 7.36 8.38 22.60 7.39 8.41
    12.60, 2018 ON TAP - - - 10.03 7.35 8.81 0.01 7.65 9.01 - - - 10.04 7.35 8.81
    5.64 , 2019 0.20 7.27 6.52 5.55 7.27 6.52 - - - 0.80 7.30 6.54 6.55 7.27 6.52
    6.05 , 2019 0.02 7.30 6.76 9.60 7.33 6.78 9.38 7.36 6.80 2.68 7.41 6.83 21.68 7.36 6.80
    10.03, 2019 22.55 7.35 8.17 17.51 7.43 8.23 0.33 7.40 8.21 0.40 7.41 8.21 40.79 7.38 8.20
    6.35 , 2020 34.15 7.41 6.98 26.32 7.44 7.01 32.00 7.42 6.99 9.05 7.46 7.02 101.52 7.42 6.99
    10.70, 2020 1.00 7.47 8.37 40.00 7.38 8.30 0.07 7.44 8.34 - - - 41.07 7.38 8.30
    11.60, 2020 5.00 7.52 8.53 5.00 7.50 8.51 - - - - - - 10.00 7.51 8.52
    10.25, 2021 110.49 7.49 8.21 72.92 7.44 8.18 50.32 7.64 8.30 446.41 7.47 8.20 680.14 7.49 8.20
    8.35 , 2022 170.96 7.51 7.75 85.18 7.46 7.71 26.20 7.45 7.70 244.25 7.48 7.73 526.59 7.49 7.73
    6.05 , 2023 - - - - - - - - - 7.00 7.39 6.82 7.00 7.39 6.82
    6.17 , 2023 12.10 7.39 7.00 8.70 7.39 7.00 4.19 7.46 7.05 14.70 7.50 7.07 39.69 7.44 7.03
    6.30 , 2023 2.00 7.29 6.97 1.68 7.41 7.05 - - - 40.40 7.33 7.00 44.08 7.33 7.00
    6.01 , 2028 0.60 7.43 7.10 3.60 7.44 7.10 1.05 7.42 7.09 0.25 7.40 7.07 5.50 7.43 7.10
    7.95 , 2032 - - - 1.00 7.51 7.57 0.03 7.71 7.74 5.00 7.42 7.49 6.03 7.44 7.51
    7.50 , 2034 0.40 7.49 7.49 0.20 7.42 7.43 1.80 7.59 7.58 28.78 7.45 7.46 31.18 7.46 7.47
    7.40 , 2035 537.31 7.61 7.59 772.67 7.60 7.57 1061.26 7.58 7.56 25.21 7.48 7.48 2396.45 7.59 7.57
    Sub-total 4362.40 7.28 8.25 3601.97 7.28 8.31 4514.97 7.35 7.93 4555.35 7.27 8.02 17034.70 7.30 8.11
    B RBI’s OMO: Sales 18.00 - - - - - 462.00 - - 44.00 - - 524.00 - -
    Purchase 105.00 - - 95.00 - - 10.00 - - - - - 210.00 - -
    Sub-total 123.00 - - 95.00 - - 472.00 - - 44.00 - - 734.00 - -
    3 Market Repo 4 State Govt Securities 39006.07 365.95 -7.51 -39077.19 7.64 268.72 -7.38 -9.16 23500.08 52.33 -7.40 -31135.40 8.61 321.82 -7.46 132718.74 7.53 1008.82 7.45 8.06
    Grand Total (1 to 4) 45247.63 44568.86 29099.26 38761.92 157677.67

    (-) 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. OMO = Open Market Operations. Securities with small-size transactions (Rs 5 crore or less) have been dropped from the above list but included in the respective totals. 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 (FRBs) current

    yields are based on the latest half-year yield determined in the auction.

    Economic and Political Weekly March 25, 2006 for corporate bonds and also allow mutual funds, pension and provident funds to trade on the NDS platform.

    In February, given the persistent liquidity pressure, interest rates have firmed up, thereby rendering the corporate debt market subdued. As a result, there was a decline in the amount mobilised from Rs 3,995 crore in January to Rs 3,265 crore by the same number of nine issuers in February. Out of the nine issuers, eight have been FIs and banks which mobilised around Rs 2,965 crore, while the remaining amount has been mopped up by a sole central government undertaking. Corporates have continued to refrain from tapping the market even in this month (Table 7)

    Among FIs and banks, IDBI has mobilised Rs 400 crore by offering 7.60 per cent as against 7.35 per cent in January for five years; similarly for its 10-year paper, it has offered 8 per cent as against

    7.70 per cent – an increase of 30 basis points within a span of one month. Likewise, HDFC has been able to mobilise Rs 200 crore by offering a higher rate of 8 per cent for a 10-year paper as against

    7.55 per cent in the previous month.

    Notably, irrespective of enjoying a similar rating, UTI Bank had to pay 8.15 per cent as compared to 7.80 per cent offered by IDBI for a seven-year paper.

    Meanwhile, Power Finance Corporation, a central government undertaking, had to offer a higher coupon rate of 7.95 per cent for a 10-year paper as against 7.45 per cent-7.60 per cent for a similar maturity paper in December 2005.

    Securitisation is a process where banks and non-banking finance companies (NBFCs) sell loan assets to a special purpose vehicle (SPV) in return for an immediate cash payment. Subsequently, the claims on incoming cash flows from the pool of assets are repackaged and sold to third parties by issuance of tradable securities. Credit enhancement is the support provided to enhance the credit rating of these assets. The originators of these securitised assets also provide credit enhancements. The first loss credit enhancement is normally provided to ensure that securitised assets get an investment grade rating and second loss enhancement is provided to get a higher rating. The RBI, in its final guidelines for securitisation of standard assets, has attempted to address a number of ambiguities in the market and has also codified a number of generally-accepted market practices. As per the guidelines, RBI has allowed banks to provide funds to firms (SPVs) formed to transfer securitised assets separated from the banks. In case, a bank is providing liquidity facility, an independent third party, other than the originator’s (bank’s) group entities, should provide at least 25 per cent of the liquidity that should be drawn and repaid on a pro rata basis. It also further states that this facility should not be available for (i) meeting recurring expenses of securitisation, (ii) funding acquisition of additional assets by SPV, (iii) funding the final scheduled repayment of investors, and (iv) funding breach of warranties.

    Moreover, the RBI has brought in two levels of credit enhancements, wherein the banks are required to deduct the entire credit enhancement provided from both tier I and tier II capital for 50 per cent each. Further, the sale of assets to an SPV should be entirely on cash and without any recourse; the premium or profit arising out of the sale should be amortised over the life of the securities issued or to be issued by the SPV. Some of the market participants perceive these guidelines to be restrictive as well as inconsistent with the Basel-II norms, which require banks to provide capital for operational risk. Presently, Fixed Income Money Markets and Derivative Association (FIMMDA) is examining all the issues and collating them for a consolidated approach to be presented to the RBI.

    IV Secondary Market

    Given the pressure on liquidity, turnover in the secondary market for gilt-edged securities has remained subdued and has progressively declined over the month. First, it has fallen from a weekly average Rs 10,869 crore in the week ended February 3 to Rs 9,781 crore in the week ended February 10 due to outflows on account of central loan floatation. As the market participants remained cautious and apprehensive of the next scheduled auction, the turnover has fallen further to Rs 8,597 crore in the next week and again to Rs 7,836 crore in the week ended February 24. Following the announcement of the budget, however, there has been some recovery to Rs 9,121 crore in the week ended March 3.

    During the current financial year, the yield curve has turned flat amidst rising interest rates as the yields on short-term papers have risen much more sharply than those on medium and long-term yields thereby narrowing the spread. The same trend has continued even in February.

    Within the month, there has been a jump in the yields of the medium and long-term papers in the second week of the month, while those on short-term papers have remained sticky. Thereafter, the yields have risen gradually across maturities, thereby retaining the flatness of the curve (Graph D). The spread between 13.05 per cent 2007 and 7.40 per cent 2035 has risen from 62 basis points in the first week ending February 3 to 75 basis points in the week ending February 24.

    RBI Reverse Repos, OMOs and MSS

    With a view to providing liquidity support to the market starved of funds after the IMD redemption, the RBI has been injecting huge amounts of funds through its repo, which have exceeded the reverse repo subscriptions now for three consecutive months, with the highest amount being injected in the month of February at Rs 2,98,785 crore as compared with Rs 2,79,605 crore and Rs 1, 49,115 crore in January and December, respectively. The liquidity injected by the RBI has increased week-by-week as the month progressed; in the first week, the RBI supported the market to the extent of Rs 57,350 crore which has risen to Rs 69,690 crore in week ended February 10 due to outflows on account of central loan floatation and further to Rs 84,110 crore in the week ended February 17. It has peaked at Rs 87,635 crore in the week ended February 24. The liquidity absorption through reverse repo has been unduly meagre (Table 8) but it has still existed when the reverse repo rate has stood only at 5.50 per cent; it may be that the deals require collaterals. Despite a fall in the secondary market turnover, the repo transactions outside RBI have remained sizeable at Rs 1,34,582 crore in January in the range of 5.25-7 per cent as compared with Rs 1,32,719 crore in February in the range of 5.50-8.50 per cent (Table 9).

    Commercial Bonds

    Following the liquidity constraints, the daily average trading in corporate bonds has fallen from Rs 77 crore in January to Rs 58 crore in February. Interestingly, there have been declines in almost all types of securities, but the sharpest fall has occurred in PSU bonds. [ll

    [The review has been drafted by Piyusha Hukeriand V P Prasanth has compiled the regulardata set.]

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