ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

A+| A| A-

Dear Money Policy, Rising Yields and High Interest Costs

Dear Money Policy, Rising Yields and High Interest Costs

Increases in yields on government securities are indicative of a dear money policy of the central bank, which has decided to base its actions on market signals and on assigning "more weight to global factors than before while formulating the policy stance". This is to be contrasted with the earlier policy which had resisted such pressures with a view to establishing an environment conducive to economic recovery. The current policy thus makes a determined effort to push up interest levels. Apart from the adverse consequences on the economy, this will also have a possible serious impact on central and state government finances.

������������

Dear Money Policy, Rising Yields and High Interest Costs

Increases in yields on government securities are indicative of adear money policy of the central bank, which has decided to baseits actions on market signals and on assigning “more weight toglobal factors than before while formulating the policy stance”.This is to be contrasted with the earlier policy which had resistedsuch pressures with a view to establishing an environment conduciveto economic recovery. The current policy thus makes a determinedeffort to push up interest levels. Apart from the adverseconsequences on the economy, this will also have a possibleserious impact on central and state government finances.

EPW RESEARCH FOUNDATION

I High Gilt-Edged Yields Presagea Dear Money Policy

L
arge increases in primary yields of central and state government securities in the recent period seem to have already set the stage for the pursuit by the Reserve Bank of India (RBI) of a dear money policy, the consequences of which by any macroeconomic standards could only be considered distressing. It resembled the crude monetarist policies pursued until the middle of the 1990s when, as shown in Table 1 and Graph A, nominal yield rates on government securities were raised to dizzy heights of 14 per cent or thereabout and the corresponding real rates to even 9 per cent. Apart from imposing a heavy fiscal burden on central and state budgets, the policy of dear money spawned serious recessionary conditions in the economy, which persisted for over seven to eight years thereafter – a theme which has been alluded to earlier in this column. Such recessionary conditions could be arrested and an environment conducive for accelerated economic growth established only after the yield rates on the gilt-edged securities in particular and the cost of credit in the economy in general were drastically brought down by a process of central bank’s moral suasion. The weighted averages of coupon rates on government papers were brought down steadily from about 14 per cent in the case of states and 13.75 per cent for the centre to 7.49 per cent (2002-03) and 5.71 per cent (2003-04), respectively. This was accompanied by dips in many short-term and long-term rates of interest in the economy. This was in turn reflected in the savings in interest cost derived by the corporate sector, with their interest paid as percentage of gross profits dipping from a narrow range of 58.3 per cent to 61.2 per cent during 1998-99 to 2001-02 to

47.9 per cent in 2002-03. Corroborative evidence suggests that the ratio has further come down to lower levels, which “might be due to debt restructuring by corporates” in an environment of rapidly falling interest rates.

The above corrections to the high interest cost phenomena were achieved by a decisive monetary policy stance that refused to fall in line with market proclivities. No doubt, some macroeconomic factors such as a declining inflation rate, large capital inflows and an associated liquidity surge and softening of interest rates abroad, did help the adoption of a soft interest rate policy domestically, but what helped the most was the jettisoning of the blinkered approach to monetary policy formulation in the form of monetarism and the pursuit of a policy independent of the market forces that are guided solely by sectional interests. The present environment is also supported by such conducive macroeconomic factors (except for some cyclical firming up of interest rates abroad). The average annual inflation rate based on variations in the wholesale price index (WPI) which ruled at 6.4 per cent in 2004-05, has remained at 4.4 per cent since then (Table 1); on a year-on-year, point-to-point basis, this inflation rate has ranged between 4.1 per cent and 4.7 per cent between end-March 2006 and July 8, 2006. Inflation based on consumer prices has no doubt been higher but conceptually and operationally in the Indian context, it is an area for supply management and the government is seized of the matter. The overhang of liquidity has persisted as reflected in the combined measure of liquidity adjustment facility (LAF), the market stabilisation schemes

Table 1: Weighted Average Yields of Central and State Government Securitiesand Spread Over Inflation Rate

Year Weighted Average Weighted Average Annual Average Spread of Yields
Yields of Central Yields of State Inflation as Per Over Inflation
Government Securities GovernmentSecurities WPI (Base Year 1993-94=100)
1995-96 13.75 14.00 7.8 5.95
1996-97 13.69 13.83 4.7 8.99
1997-98 12.01 12.82 4.3 7.71
1998-99 11.86 12.35 6.0 5.86
1999-00 11.77 11.89 3.2 8.57
2000-01 10.95 10.99 7.2 3.75
2001-02 9.44 9.20 3.6 5.84
2002-03 7.34 7.49 3.4 3.94
2003-04 5.71 6.13 5.5 0.21
2004-05 6.11 6.44 6.4 -0.29
2005-06 7.31 7.62 4.4 2.91
2006-07* 7.79 7.93 4.4 3.39

*Data up to June 2006. Source:RBI Annual Reportand Office of Economic Adviser, Ministry of Industry (www.eaindustry.nic.in).

Economic and Political Weekly July 29, 2006

Graph A: Movements of Primary Yields andGraph B: Primary Yields on Centralweight to global factors than before whileInflation Rates and Spread between Them Dated Securities (5,10 and 30-years)

formulating the policy stance”. This is to

be contrasted with the earlier policy which

had resisted such pressures with a view to

establishing an environment conducive to

economic recovery. The current policy thus

Yield (per cent) 3.4 7.79 5.71 13.75 4.4 7.8 7.2 3.39 5.95 8.99 -0.29 -20246810121416e e n 7.39 4.69 11.54 5.96 12.15 8.29 8.75 7.95 6.33 4.00 5.00 6.00 7.00 8.00 9.00 10.00 11.00 12.00 13.00 Yield (per cent) 1998-991999-20002000-012001-022002-032003-042004-052005-062006-07July

makes a determined effort to push up

interest levels in the economy, which is

evident from, American style, a four-time

increase in RBI’s reverse repo rate from

5 per cent a year ago to 6 per cent in the

latest first quarter policy review announced

on July 25, 2006; correspondingly, the

repo rate, which has implications for the cost of borrowings for banks from RBI, has been pushed up from 6 per cent to 7 per cent. (In fact, this has effectively neutralised

1995-961996-971997-981998-991999-20002000-012001-022002-032003-042004-052005-062006-07*

5-year paper

10-year paper

Weighted Average Yield

30-year

Annual Average Inflation (WPI)

Spread

the importance of the bank rate kept unchanged at 6 per cent.)

(MSS), and the central government’s cash that bank deposit rates have also been

balances with the RBI, which together has increased by about 25-100 basis points; It is not just the short-term LAF rates

averaged Rs 65,714 crore during January-likewise banks’ lending rates have risen that have been pushed up; the RBI has been

March 2006 and which has stood at by about 50 basis points. studiously pushing up the primary yields

Rs 91,231 crore as on July 20,2006. The Such a contradictory behaviour as on all government security floatations as

RBI which has reported these data and between short-term interest rates and the shown in Graph B. The latest reissue of

many other data on liquidity conditions, including very rapid growth in bank deposits, has also found easing of interest rates in the call, market repo and collaterised borrowing lending obligations (CBLO). Surprisingly, the RBI has not found it inconsistent that at the same time giltedged prices in the secondary market have fallen giving rise to considerable firming up of secondary yield rates (Table 2) and

Table 2: Secondary Market Yield – Month-end

Security March March March July Maturities 04 05 06 17-21

1-year 4.34 6.17 6.52 7.03 5-year 4.81 6.44 7.20 7.86 10-year 5.24 6.60 7.49 8.33 29-year 6.05 7.15 7.78 8.91

long-term ones which have a perceptible a 30-year security 7.50 per cent 2033 has impact on the working of the national been done at an YTM of 8.75 per cent – economy, is solely attributable to the new-about 2.50 percentage points more than found enthusiasm on the part of the RBI what it was in 2004-05. Likewise, state to vigorously pursue a policy dependent government security yields have been pushed on market signals and on assigning “more up from 6.50 per cent to 8.50 per cent

Table 4: Comparison of Call, Overnight CBLO and Repo Rates

Week-Ending Weighted Average Rates Daily Average Volumes
(in Per Cent) (Rs crore)
Call Overnight CBLO Repo Call Overnight CBLO Repo
5-May-0612-May-0619-May-0626-May-062-Jun-06 5.58 5.58 5.56 5.53 5.53 5.28 5.14 5.15 4.93 4.88 5.33 5.21 5.21 5.02 4.95 12570 10297 12074 8879 9068 16250 16833 20704 15275 14989 6323 9127 9154 10723 10187
9-Jun-06 5.60 5.17 5.21 8125 14905 10522
16-Jun-06 5.81 5.57 5.63 9500 13105 10421
23-Jun-06 5.81 5.62 5.69 10320 13852 11169
30-Jun-06 5.83 5.62 5.70 12036 12780 9649

Source:RBI SGL Press Releases. Source:CCIL.

Table 3: Money Market Operations (RBI’s Daily Data)

Average June 2006 Average May 2006 Items for Five for Four Weeks 30 23(RF) 16 9(RF) 2 weeks 26(RF) 19 12(RF)

No of working days 30 6 6 6 6 623 6 6 6 5

Call Money

Weighted average of call rates:per cent (weekly range) per annum 5.43-5.83 5.50-5.83 5.59-5.81 5.57-5.83 5.55-5.59 5.43-5.55 5.31-5.58 5.41-5.55 5.33-5.57 5.31-5.58 5.45-5.58

Daily averages (Rupees crore)Total call market borrowings 7658 9387 7782 7302 6267 7552 8038 6632 9336 7789 8723

(246) (72) (150) (2957)Of which: by banks .. .. .. .. .. .. .. .. .. .. ..

Notice Money

Weighted average of notice money rates:per cent (weekly range) per annum 5.00-5.92 5.23-5.92 5.25-5.90 5.54-5.81 5.00-5.81 5.35-5.55 4.90-5.94 4.90-5.94 5.35-5.77 5.38-5.76 5.32-5.89

Daily averages (Rupees crore)Total notice market borrowings 2277 2650 2539 2638 1858 1659 2035 1926 2151 1406 2806 (14398) (10773) (11023) (7703)Of which: by banks .. .. .. .. .. Turnover in term money market 480 567 335 499 474 538 235 212 218 269 243 (borrowings) $$ (397) (75) (266) (100)

*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. .. not available.

Economic and Political Weekly July 29, 2006

Weighted Average (Per Cent)

Graph C: Trends in Weighted AveragesGraph D: Spot Quotations for US Dollarproceeds at current rates of interest overof Call Rates, Repo Rates, CBLO Ratesin the Domestic Inter-Bank Market

a period of three years ending 2004-05 –

50.0

and Call Money Borrowing – June 2006

all imposed on the system by forcing unreasonably high rates of interest on

6 20.5

4.5 5.5 il i (Daily Working Days June 2006) Monthly Averages (Jan 2001 to June 2006)

gilt-edged securities of central and state

48.0

governments during 1995-96 and there

15.5

Rupees Thousand Crore Rupees per US dollar

about. In retrospect, it is now realised how such high yield rates created serious dis

46.0

tortions in the government’s debt structure

10.5

forcing the system to institute a restructuring programme both at the central and state levels. The market value of 19 high

5.5 44.0

coupon securities bought back amounted to Rs 19,394 crore and the government had to offer a premium amount of Rs 3,472

0.5

42.0

June 2006

Call Money Volume (Rs Cr)

Repo Rates - Outside the RBI Call Rates CBLO Rates

during the same period. As a result, as the RBI has reported, the 10-year yield in the secondary market has increased by 84 basis points from end-March 2006 to July 19, 2006 (see also Table 2) due to, inter alia, “hike in the reverse repo and repo rates effective June 9, 2006 and expectations of further hike” (RBI policy statement of July 25, 2006).

It appears indeed intriguing that apart from the adverse repercussions of such a dear money policy on the economic recovery process particularly in the manufacturing sector which is as yet at a nascent stage, the RBI has failed to take cognisance of the possible serious impact it would have on the central and state government finances. As it is, the country’s fiscal scene has just recovered from the shock of a domestic debt restructuring programme consisting of buyback by the central government of high

crore to the market participants to be able

to achieve the buy-back arrangement. coupon loans from banks and swapping of Banks also had to be allowed additional all high-cost central loans to the states with deduction for tax purposes on their nofresh market borrowings and small saving tional additional incomes provided they

Table 6: 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 PDs (Rupees) Rate on the Date (Amount) (Amount) (Amount) (Per Cent) of Issue

2005 June 1 1500.00 47 4493.00 26 1500.00 0.00 97.40 5.34 48212

  • (1) (170.00) (1) (170.00) [97.41] [5.32]June 15 1500.00 44 2775.00 22 1500.00 0.00 97.38 5.38 8770
  • (0) (0.00) (0) (0.00) [97.39] [5.36] June 29 1500.00 24 1507.10 24 1500.00 0.00 97.25 5.66 10170
  • (0) (0.00) (0) (0.00) [97.35] [5.44] 2006 May 31 1500.00 47 4182.50 24 1500.00 0.00 97.01 6.18 10591
  • (3) (513.43) (3) (513.43) [97.03] [6.12]June 14 1500.00 35 2642.00 27 1500.00 0.00 96.86 6.50 10591
  • (0) (0.00) (0) (0.00) [96.87] [6.46] June 28 1500.00 39 1417.50 15 600.00 0.00 96.73 6.78 11582
  • (1) (500.00) (1) (500.00) [96.74] [6.74]

    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 5: Auctions of 91-Day Treasury Bills

    (Amount in rupees crore)

    Date of Auction Notified Amount Bids Tendered Bids Accepted SubscriptionDevolved Cut-off Price Cut-off Yield Rate Amount Outstanding on the Date of Issue
    (1) (2) No (3) Face Value (Amount) (4) No (5) Face Value (Amount) (6) on PDs (Amount) (7) (Rupees) (8) Rate (Per Cent) (9) Total (10) With RBI (11) Outside RBI(12)
    2005
    Jun 1 2000.00 39 2498.50 30 2000.00 0.00 98.72 5.19 29830.15 0.00 29830.15
    June 8 2000.00 (1) 49 (363.00) 2958.50 (1) 39 (363.00) 2000.00 0.00 [98.72] 98.71 [5.19] 5.23 29755.04 0.00 29755.04
    June 15 2000.00 (1) 42 (911.71) 2374.67 (1) 39 (911.71) 2000.00 0.00 [98.72] 98.69 [5.19] 5.31 29856.97 0.00 29856.97
    June 22 2000.00 (2) 39 (106.93) 3570.00 (2) 25 (106.93) 2000.00 0.00 [98.70] 98.69 [5.27] 5.31 29890.64 0.00 29890.64
    June 29 2000.00 (1) 44 (265.84) 4030.00 (1) 12 (265.84) 2000.00 0.00 [98.69] 98.68 [5.31] 5.35 30547.90 0.00 30547.90
    2006 (4) (782.27) (4) (782.27) [98.69] [5.31]
    May 31 June 7 2000.00 2000.00 52 (3)58 4056.10 (770.00) 6325.37 10 (3)18 856.10 (770.00) 2000.00 0.00 0.00 98.59 [98.59] 98.59 5.74 [5.72]5.74 24404.05 26239.06 0.00 0.00 24404.05 26239.06
    June 14 2000.00 (2)56 (800.00) 2213.34 (2)50 (800.00) 2000.00 0.00 [98.60] 98.48 [5.68]6.19 26791.36 0.00 26791.36
    June 21 2000.00 (2)55 (257.30) 2314.36 (2)10 (257.30) 581.86 0.00 [98.49] 98.45 [6.13]6.31 27605.38 0.00 27605.38
    June 28 2000.00 (2)53 (1100.00) 2215.00 (2)8 (1100.00) 575.00 0.00 [98.45]98.44 [6.30]6.36 22680.12 0.00 22680.12
    (1) (500.00) (1) (500.00) [98.45] [6.30]

    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.

    Economic and Political Weekly July 29, 2006

    remained sumptuous throughout the month,

    given the seasonal slowdown in loan

    Graph E: Annualised Forward Premia in Percentage for the US Dollar in theDomestic Inter-Bank Market and WeightedAverages of Call Rates for June 2006 Yield (per cent per annum) Graph F: Yield Curves for DatedSecurities – Weighted Average for Weeks of June 2006 maturities resulting in a steeply rising yield curve; the yield on benchmark 10-year security touched a four-year peak of 8.2 per cent. Yet, the size of reverse repo bids -0.5 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 5.0 5.5 6.0 2.0 4.0 6.0 8.0 i fWeighted Averages of Call Rates (Right Axis) 1-month 3-month 6-month 5.5 6 6.5 7 7.5 8 8.5 9 1 2 3 4 5 6 7 8 9 11 12 13 1516 2330 31 1st Week 2nd Week 3rd Week 4th Week 5th Week

    portfolios of banks as well as redemptions

    Per cent per annum

    flows. However, the clarification by the

    finance minister that the government had

    already advanced part of it’s July borrow

    ings, provided respite to the market. Fol

    lowing the hike in US Fed rate on June 29,

    though with signals of a possible pause in

    Working Days Years to Maturity

    its monetary tightening cycle and firm

    were spent for provisioning of NPAs. The debt swap arrangements for the states aggregated over Rs 1,00,000 crore contracted at interest rates of over 13 per cent and the replacement of old loans by the new ones from the market and small savings proceeds were “expected to save at least Rs 81,000 crore in interest and deferred loan repayments over the residual maturity period of the loans”. The current step-up in secondary market yields on gilt-edged securities would also have serious repercussions on the balance sheets of banks; the recent experience of banks attempting to include all types of securities under the “held-to maturity” category and the consequential dip in secondary transactions is a telling example of the market distortions such a forced rise in yields will create.

    II Money and Forex Markets

    In June, the outlook for money and government securities markets was policydriven influenced as it was by such steps as the increase in domestic fuel prices along with the assurance from finance ministry that measures to curtail inflation would be taken and the RBI governor’s unexpected decision on June 8 to hike the reverse repo and repo rate by 25 basis points each to 5.75 per cent and 6.75 per cent, respectively. The RBI admitted that the measure was guided by the firming up of foreign interest rates as it followed the hikes affected by a number of central banks in their respective benchmarks; though the domestic market had anticipated a hike, the timing caught it unaware. Besides, expectations of a further increase in the US Fed rate on June 29 along with rising global oil prices, firm domestic inflation rate and the RBI governor’s statement regarding global central banks being concerned about inflation, fuelled expectations of yet domestic inflation rate, the expectations of another hike in the impending quarterly a hike in rates in RBI’s July review gathreview of monetary policy. The increase ered momentum. In the case of innovative in the notified amount of the second dated tier-I and tier-II bonds, the RBI advised securities auction of the month further banks to refrain from indulging in swap fuelled such expectations, perceiving that transactions. In a significant development, the move was to absorb liquidity and that the Reserve Bank of India (Amendment) the regulator was for firmness in yield. Bill has been enacted, whereby, sub-Sec-Consequently, the market remained tion 42(1) allows RBI to prescribe CRR cautious with a declining secondary mar-for scheduled banks without any floor or ket turnover and firming up of yields across ceiling rate.

    Table 7: 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 PDs (Rupees) Rate on the Date (Amount) (Amount) (Amount) (Per Cent) of Issue

    2005 June 8 2000.00 55 4130.00 36 2000.00 0.00 94.71 5.59 48409

  • (1) (200.00) (1) (200.00) [94.73] [5.56]June 22 2000.00 43 3110.00 31 2000.00 0.00 94.69 5.61 49181
  • (1) (2.00) (1) (2.00) [94.71] [5.59] 2006 June 7 2000.00 59 3855.00 36 2000.00 0.00 93.93 6.48 42354
  • (4) (1666.78) (4) (1666.78) [93.95] [6.44]June 21 2000.00 95 4580.00 39 2000.00 0.00 93.43 7.05 43268
  • (4) (915.83) (4) (915.83) [93.45] [7.01]

    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 8: Profile of Major Commercial Bond Issues during June 2006

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

    1 FIs/BanksICICI Bank
    2 AAA by Icra, Care ICICI Bank AAA by Crisil, Care Bonds Upper Tier-IIBonds 9 per cent for 10 years 8.95 pre cent for 15 years with call option at the end of 10th year 200 250
    3 UCO Bank AA by Care, AA- by Fitch 9.28 per cent for 15 years with call options at the end of 10th year 500 (200)
    4 UTI Bank AA + by Icra, Fitch Lower Tier-II Bonds 8.50 per cent (revised to 8.95 per cent on June 14) for 7 years,8.75 per cent (revised to 9.10 per cent on June 14) for 10 years 200 (100)
    5 Kotak Mahindra Bank AA + by Icra, Fitch Tier-II Bonds 8.90 per cent for 10 years 30(30)
    6 NABARD AAA by Crisil Bonds 8.60 per cent for 10 years Total: 1500 3102*

    Total for June-05 (a year ago): Rs 6856 crore. Total for May-06(a month ago): Rs 4377 crore

    Notes: * Total includes two more issues of less than Rs 100 crore (one NBFC and one state government undertaking). The amount shown in brackets above denotes the greenshoe option of the issue.

    Economic and Political Weekly July 29, 2006

    Call Money Market

    June experienced an upward bias in call rates with their weighted averages quickly catching up with the new reverse repo rate (Graph C). Due to coupon and redemption payments, liquidity remained comfortable with the overnight rate falling from 5.54 per cent on June 1 to 5.43 per cent the next day. Despite outflows towards the first loan flotation, the rate ruled steady at 5.55 per cent until June 8 and rose to 5.59 per cent on June 9, the first reporting Friday. Following the hike in reverse repo rate, the call rate realigned itself and jumped to 5.83 per cent on June 10 and ruled around 5.80 per cent till June 14, given also the advance tax outflows. The overnight rate slipped to

    5.57 per cent and 5.59 per cent on June 16 and 17, respectively due to low turnover. The rate firmed up to 5.81 per cent between June 19 and 22 following the second loan floatation, and on the second reporting Friday, June 23, the rate fell to 5.76 per cent duetoadvanced covering. Thereafter, until June 29, it ruled in a narrow range of 5.81

    5.83 per cent. On June 30, the rate dipped to 5.5 per cent as only one trade was executed (Table 3). While the turnover in call and CBLO markets declined in June, that of repo outside RBI increased substantially (Table 4) indicating market preference for bilateral collateralised borrowings as against the multilateral ones.

    Forex Market

    The rupee-dollar exchange rate gyrated in June as the international oil prices remained firm impinging on the country’s trade and current account while the pace of foreign currency inflows slowed down pushing the rupee lower, but at times increased inflow due to exporters’ sale of dollars as well as buoyancy in domestic equity markets, accompanied by support from RBI, propelled the rupee value (Graph D). As against an inflow of US $ 1,911 million in May, the inflow of foreign currency assets in June stood at $ 460 million. The US economy showing signs of softness as per data as against growing strength in the euro zone fuelled expectations of a rate hike by ECB, which in turn rendered the dollar weak. As a result, the rupee strengthened against the dollar, but due to huge demand for dollars following a jump in international crude oil prices, the rupee weakened, which was worsened by the presence of arbitrage opportunities in the non-delivered forward (NDF) market. At the end of the month, following the hike in US Fed rate accompanied by soft economic data, the dollar fell, thereby pushing the rupee upwards.

    With the rupee weakening against the dollar, the currency’s overvaluation in effective terms appears to be getting corrected, with the REER (Base: 2003-04 = 100), which was at 105.48 for April 2006, slipping to 102.81 as of May 13, 2006, and NEER (Base: 2003-04 = 100) similarly slipping from 100.68 to 97.78 over the same period.

    June began with the spillover effect of month-end demand for dollars with rupeedollar exchange rate appreciating from Rs 46.43 on May 31 to Rs 46.22 on June 1. Over the month, the rupee appreciated against the dollar (Graph E) as well as other currencies such as Euro, Yen and South Korean Won. The Economist’s effective exchange rate for the US dollar (2000=100) nevertheless edged up to 84.4 as on June 28 from 82.0 a month ago, while that of Euro stayed firm during the period.

    The six-month annualised forward premia increased from 0.47 per cent on May 31 to 0.64 per cent on June 1 and thereafter ruled in a range of 0.67-0.76 till June 8 due to increased demand for dollars, given the weakness in domestic stock markets as well as importers’ demand. With a hike in domestic benchmark rate, the interest rate differential widened pushing the premia upwards, but with the improved domestic stock indices, it eased. Following the month-end demand for dollars along with expectation of a hike in US Fed rate as well as the spot rupee depreciating, importers began covering their positions and the forward premia rose to 1.13 per cent on June 21. With the expectation of a rate hike by ECB as well as by Bank of Japan, the premia jumped to 1.24 per cent on June 22; however, it could not sustain such a high level given the arbitrage between NDF and domestic market and it plunged to 1.14 per cent on June 26 or to 1.18 per cent on June

    29. Following the hike in US Fed rate, it fell to 1.11 per cent on June 30 (Graph F).

    III Primary Market

    Dated Securities

    In June, the government mobilised Rs 19,000 crore instead of Rs 15,000 crore as envisaged in the indicative calendar of

    Table 10: Repo Transactions inGovernment Paper@ (Other thanwith the RBI) – June 2006

    Repo Period in Number of Days Amount (RupeesCrore) Range of Interest(Per Cent Per Annum)
    1 2 3 4 5 6 7 11 20 84 91 All Issues 252593.10 1270.20 61947.96 319.75 85.30 32.00 257.00 44.00 5.00 3.00 2.00 4.25-6.10 (5.42) 4.25-5.70 (5.39) 4.50-5.95 (5.52) 5.15-5.65 (5.49) 5.65 (5.65) 5.50-6.50 (6.34) 5.10-6.71 (5.63) 6.00-6.50 (6.28) 7.70 (7.70) 8.10 (8.10) 8.25 (8.25)
    1-91 [1-90] 316559.31 [200602.01] 4.25-8.25 (5.44) [3.50-8.25] [5.17]

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

    Table 9: Operations of RBI’s Liquidity Adjustment Facility**

    (Amount in rupees crore)

    Range of Repo (Injection) Reverse Repo (Absorption) Net Injection Net For the Week Repo/RR Bids Received Bids Accepted Bids Received Bids Accepted (+)/ Outstanding (May-June 2006) Period Number Amount Number Amount Number Amount Number Amount Absorption (-) Amount

    Days of Liquidity at the Week End@

    02 May - 05 May 1-3 0 0 0 0 250 249825 250 249825 -249825 49545 08 May - 12 May 1-3 0 0 0 0 356 305945 356 305945 -305945 49845 15 May - 19 May 1-3 0 0 0 0 344 293415 344 293415 -293415 61815 22 May - 26 May 1-3 0 0 0 0 367 316840 367 316840 -316840 57245

    29 May - 02 Jun 1-3 0 0 0 0 342 321335 342 321335 -321335 66170 05 Jun - 09 Jun 1-3 0 0 0 0 381 315025 381 315025 -315025 47520 12 Jun - 16 Jun 1-3 0 0 0 0 295 236230 295 236230 -236230 40565 19 Jun - 23 Jun 1-3 0 0 0 0 326 196230 326 196230 -196230 30310 26 Jun - 30 Jun 1-3 0 0 0 0 285 208430 285 208430 -208430 42565

    Notes:* With effect from June 8,2006 the Repo Rate is 6.75 per cent and Reverse Repo Rate at 5.75 per cent.** Includes Second LAF Auctions under Repo and Reverse Repo. @ Net of Repo and Reverse Repo Outstandings.

    Economic and Political Weekly July 29, 2006 issuances. On June 6, in the first instance,

    9.39 per cent 2011 was reissued along with a new 30-year paper for Rs 6,000 crore and Rs 4,000 crore, through price-based auction using multiple price method and yieldbased auction using uniform price method, respectively. For these, the minimum underwriting commitment (MUC) and additional competitive underwriting (ACU) were set at Rs 177 crore and Rs 2,991 crore, and Rs 118 crore and Rs 1,994 crore, for the 5-year and 30-year papers, respectively. For the 5-year paper, 194 competitive bids worth Rs 14,732 crore were received, of which, 60 bids for Rs 5,990 crore were accepted at a cut-off yield of 7.39 per cent; the prevailing secondary market yield on June 5 ruled around 7.30 per cent. In the case of 30year paper, 96 competitive bids for Rs 8,778.5 crore were received, of which 28 bids worth Rs 3998.6 were accepted at a cut-off yield of 8.33 per cent; this turned out to be the highest YTM offered on a 30-year security in many years.

    In the second instance, 7.37 per cent 2014 and 7.94 per cent 2021 were reissued for notified amounts of Rs 5,000 crore and Rs 4,000 crore through price-based methods using multiple price and uniform price methods, respectively, on June 22. For these, MUC and ACU were set at Rs 148 crore and Rs 2,484 crore, and Rs 118 crore and Rs 1,994 crore for the 8-year and 15-year papers, respectively. For the 8-year paper, 216 competitive bids for Rs 8,168 were received, of which 164 bids worth Rs 4,997 crore were accepted at a cut-off yield of 7.92 per cent; on June 21, the secondary market yield for this security had ruled at 7.75 per cent. In the case of 15-year paper, 112 competitive bids for Rs 6,633 crore were received, of which 86 bids worth Rs 3,984 crore were accepted at a cut-off yield of 8.46 per cent, while

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

    (Amount in rupees, crore)

    Descriptions Week Ending June 2006: Yield to Maturity on Actual Trading Total for the Month
    30 23 16 9 2 of June 2006
    AMT YTM CY AMT YTM CY AMT YTM CY AMT YTM CY AMT YTM CY AMT YTM CY
    1 Treasury BillsA 91-Day Bills B 182-Day BillsC 364-Day Bills2 GOI Dated Securities 754.93 849.33 1098.05 6.02 6.70 6.66 262.05 399.80 1863.53 6.27 6.61 6.78 918.56 872.94 658.12 6.10 6.27 6.08 243.42 668.84 1744.04 5.73 5.90 6.02 774.51 1608.72 1026.99 5.72 6.10 6.05 2953.47 4399.63 6390.73 5.96 6.27 6.36
    A Regular (Per Cent: Year)11.90, 2007 90.00 12.50, 2007 28.00 13.05, 2007 28.00 9.50, 2008 30.00 11.50, 2008 -12.00, 2008 43.15 12.10, 2008 -12.22, 2008 -12.25, 2008 -5.48, 2009 -6.96, 2009 Oil mkt Bonds 15.00 7.07, 2009Oil mkt Bonds 70.00 11.50, 2009 -11.99, 2009 25.00 7.55, 2010 10.00 11.30, 2010 35.00 11.50, 2010 23.60 12.25, 2010 30.00 12.29, 2010 -9.39, 2011 147.40 10.95, 2011 -12.32, 2011 0.05 7.40, 2012 0.15 7.27, 2013 50.00 12.40, 2013 10.00 7.37, 2014 394.38 10.00, 2014 -5.87, 2015 FRB -9.85, 2015 2.40 11.50, 2015 -7.59, 2016 114.21 10.71, 2016 -7.46, 2017 1.18 8.07, 2017 19.99 6.25, 2018 23.24 10.45, 2018 -6.05, 2019 2.89 6.35, 2020 -7.94, 2021 351.12 6.01, 2028 3.00 6.13, 2028 0.08 7.95, 2032 -7.50, 2034 3.21 7.40, 2035 16.61 8.33, 2036 1.21 Sub-total 1602.31 7.04 6.91 6.99 7.17 -7.22 ----8.01 8.07 -7.46 7.61 7.65 7.59 7.64 -7.66 -7.82 7.75 7.95 8.09 8.02 --8.20 -8.12 -8.19 8.19 8.43 -8.59 -8.52 8.65 8.15 -8.71 8.58 8.40 7.94 11.42 12.03 12.47 9.18 -11.10 ----7.14 7.25 -10.79 7.57 10.04 10.17 10.59 -8.77 -10.53 7.52 7.55 10.08 7.66 --8.91 -7.87 -7.87 8.14 7.43 -7.53 -8.34 8.08 7.71 -8.58 8.46 8.40 8.60 95.99 -100.00 0.80 0.62 120.00 -0.58 150.11 ---0.08 -10.00 -25.00 10.50 25.00 225.70 --45.49 -0.01 2511.10 1.71 ---218.31 -0.71 46.59 13.75 0.84 40.81 0.55 1350.21 1.05 3.00 5.76 -0.25 20.66 5050.67 7.01 -7.04 7.30 6.96 7.02 -6.97 7.01 ---7.08 -7.56 -7.34 7.35 7.34 7.61 --7.63 -9.77 7.89 7.88 ---7.97 -7.94 7.98 8.22 8.00 8.31 8.36 8.44 8.22 8.29 8.43 -8.68 8.42 7.95 11.40 -12.46 9.19 10.65 11.06 -11.10 11.08 ---10.33 -7.55 -10.08 10.49 10.65 8.75 --7.48 -10.94 7.60 9.07 ---7.79 -7.74 8.02 7.31 8.82 7.36 7.57 8.29 7.73 7.83 8.37 -8.55 8.41 8.25 --32.70 ---80.00 300.00 300.00 --85.00 145.00 -15.00 -50.02 80.00 -241.32 0.02 10.00 13.61 -30.00 0.12 -74.85 50.00 25.00 219.10 -56.85 65.50 17.25 1.40 1.25 6.00 41.16 3.45 3.48 -0.05 1.50 11.41 1981.43 --6.88 ---6.91 7.01 7.03 --7.86 7.10 -7.27 -7.28 7.29 -7.43 7.24 7.46 7.56 -7.78 7.63 -5.85 7.85 7.87 7.80 -7.98 7.92 7.83 7.92 8.29 8.01 8.19 8.36 8.26 -8.20 8.43 8.37 7.33 --12.43 ---11.04 11.11 11.08 --7.21 10.32 -7.48 -10.06 10.46 -8.69 9.51 10.38 7.46 -9.92 7.48 -5.90 8.72 9.35 7.70 -7.75 7.99 7.09 8.76 7.34 7.35 8.11 7.84 7.80 -8.13 8.32 8.36 9.45 105.00 ---10.00 50.00 --0.04 --1060.00 15.00 -55.00 ----1441.15 -0.02 26.33 -0.02 3.10 10.00 ---325.67 30.00 -10.60 19.00 42.96 -3.00 84.41 2.50 0.12 35.05 40.20 0.75 230.36 3613.11 6.54 ---6.70 6.74 --10.07 --7.65 7.03 -7.18 ----7.39 -7.52 7.53 -7.72 7.74 7.69 ---7.71 7.86 -7.79 7.87 8.25 -7.87 8.06 7.91 8.24 8.23 8.27 8.39 8.33 7.57 11.33 ---10.58 10.99 --11.75 --7.17 10.30 -7.46 ----8.67 -10.40 7.45 -9.88 7.53 8.96 ---7.65 8.98 -7.91 7.11 8.97 -7.26 8.02 7.48 7.79 8.20 8.19 8.29 8.33 8.18 90.00 ---20.00 10.00 --0.22 25.00 ---5.00 ---55.00 -192.09 40.00 -116.54 45.00 -10.00 62.90 ---320.76 -5.00 76.73 60.72 -0.60 3.00 190.89 3.61 4.50 55.43 67.51 5.49 -1484.34 6.44 ---6.71 6.69 --6.62 6.92 ---6.88 ---7.19 -7.28 7.27 -7.34 7.38 -7.50 7.60 ---7.66 -7.63 7.71 7.82 -7.94 7.87 7.98 7.96 8.07 8.20 8.22 8.24 -7.54 11.31 ---10.57 10.97 --10.97 5.70 ---10.61 ---10.41 -8.63 9.51 -7.38 7.32 -7.43 8.76 ---7.63 -7.55 7.87 7.09 -7.13 7.26 7.97 7.52 7.65 8.17 8.14 8.16 -8.28 380.99 28.00 160.70 30.80 30.62 223.15 80.00 300.58 450.37 25.00 15.00 1215.00 160.08 30.00 90.00 35.00 98.62 175.50 25.00 2247.65 40.02 10.07 202.11 95.00 40.03 2918.70 74.61 74.85 52.40 25.00 1198.05 30.00 63.74 219.41 133.96 45.20 45.55 12.55 2017.78 13.61 11.18 96.24 110.97 24.60 263.64 13731.85 6.75 6.91 7.00 7.17 6.71 6.98 6.91 7.01 7.02 6.92 8.01 7.69 7.09 7.36 7.28 7.65 7.37 7.32 7.34 7.42 7.27 7.46 7.45 7.68 7.86 7.91 7.62 5.85 7.87 7.87 7.80 7.86 7.95 7.88 7.98 8.23 8.33 7.96 8.39 8.22 8.19 8.23 8.25 8.49 8.34 7.71 11.37 12.03 12.45 9.18 10.58 11.05 11.04 11.11 11.08 5.70 7.14 7.18 10.32 10.76 7.48 10.04 10.09 10.47 10.65 8.68 9.51 10.38 7.42 7.44 9.96 7.61 8.79 5.90 8.73 9.35 7.70 8.98 7.74 7.96 7.17 8.96 7.37 7.32 8.25 7.73 7.75 8.19 8.17 8.38 8.348.45
    B RBI’s OMO: Sales 643.00 - - - - - - - - 50.00 - - 125.00 - - 818.00 - -
    Purchase 10.00 - - 35.00 - - - - - 10 - - 10 - - 65.00 - -
    Sub-total 653.00 - - 35.00 - - 0.00 - - 60.00 - - 135.00 - - 883.00 - -
    (A+B)3 Market RepoGovt Securities 2255.31 58630.38 7.94 8.60 5085.67 69701.73 7.95 8.25 1981.43 63298.79 7.33 9.45 3673.11 63871.68 7.57 8.18 1619.34 61057.71 7.54 8.28 14614.85 316560.29 7.71 8.45
    Sub-total 58630.38 69701.73 63298.79 63871.68 61057.71 316560.29
    4 State Govt Securities 216.08 8.19 9.92 292.09 8.10 9.80 359.79 7.67 10.46 160.44 7.78 9.98 160.96 7.64 9.44 1189.36 7.88 10.00
    Grand total (1 to 4) 63804.08 77604.87 68089.63 70361.53 66248.23 346108.33

    (-) 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 10 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 (FRB’s) Current yields are based on the latest half-year yield determined in the auction.

    Economic and Political Weekly July 29, 2006

    Table 11: Operations of National Stock Exchange (NSE) during June 2006 –- Actual Traded Amount

    (Rupees in crore)

    Descriptions Week-Ending June Total during 30 23 16 9 2 June 2006 May 2006 Apr 2006

    1 Treasury Bills 945.28 1190.66 528.92 1367.84 741.79 4774.47 2985.65 6729.44 i) 91-day Bills 185.00 50.00 148.92 75.00 30.00 488.92 278.87 142.04 ii) 182-day Bills 98.00 209.70 130.00 432.84 180.00 1050.53 596.73 492.26 iii) 364-day Bills 662.28 930.96 250.00 860.00 531.79 3235.02 2110.06 6095.14 iv)Repo -----0.00 0.00 0.00

    2 Dated Securities 1154.31 1970.08 806.41 1934.34 1153.06 7018.20 12168.33 15503.84

    A GOI Securities 1072.21 1776.55 757.50 1862.91 1126.84 6596.01 11703.43 15346.09 i) Converted -----0.00 0.00 0.00 ii) Regular 1072.21 1776.55 757.50 1862.91 1126.84 6596.01 11703.43 15346.09 iii) Zero Coupon -----0.00 0.00 0.00 iv) Cap Indexed Bonds -----0.00 0.00 0.00 v)GCB -----0.00 0.00 0.00 vi)Repo -----0.00 0.00 0.00

    B State Govts Stocks 82.10 193.53 48.91 71.44 26.22 422.20 464.91 157.75

    3 PSU Bonds 72.20 41.50 125.40 101.30 71.20 411.60 170.80 192.00 i) Tax free -----0.00 0.00 0.00 ii) Taxable 72.20 41.50 125.40 101.30 71.20 411.60 170.80 192.00

    4 Commercial Papers -----0.00 0.00 0.00 5 Certificates of Deposits -----0.00 0.00 0.00 6 Debentures 20.00 0.05 25.00 25.00 57.20 127.25 895.00 259.30 7 Floating Rate Bonds 75.00 10.00 84.85 50.00 205.00 424.85 200.00 60.00 8 Others* 8.70 59.60 169.30 26.70 82.30 346.60 252.80 439.70 Grand Total (volume) 2275.48 3271.89 1739.88 3505.18 2310.54 13102.97 16672.58 23184.27 Average per working day

    a Government Paper (1+2) 419.92 632.15 267.07 660.44 378.97 471.71 797.58 1307.84 b Others (3+4+5+6+7+8) 35.18 22.23 80.91 40.60 83.14 52.41 79.93 55.94

    -No trading. GCB Government Compensation Bonds. * Includes Non-SLR Institutional Bonds, SLR Institutional Bonds, Bank Bonds, Promissory Notes, Units of UTI, Company Notes and Zero Coupon PSU Bonds and others.

    Economic and Political Weekly July 29, 2006

    adopted by a number of countries including the US, led to narrowing of interest rate differentials. It was also perceived that with advancing domestic inflation rate, the RBI was staying behind the yield curve. Consequently, RBI’s decision to hike reverse repo rate and to increase the notified amount of second dated auction brought about distinct shifts in the yield curve week by week as well as made it steeply upward sloping (Graph F). The yield on 10-year benchmark paper jumped from 7.66 per cent in the week ended June 2 to 7.71 per cent in the next week following the rate hike, and firmed up to 7.80 per cent and also to 7.97-8.12 per cent range following the increase in the notified amounts in dated securities auction; thus over the month the yield increased by 46 basis points (Appendix Table).

    RBI Reverse Repos, OMOs and MSS

    In June, the market participants preferred to park surplus funds with RBI under the LAF reverse repo, given the interest rate uncertainty and volatility prevailing in the market even as call rates very often ruled above the reverse repo rate. The average daily reverse repo bids tendered and accepted declined from Rs 61,678 crore in May to Rs 51,090 crore in June, while the size of bids declined following the outflows towards advance tax payments, the outflows towards the two dated securities had marginal effect on these bids (Table 9).

    With the increased volatility in the market, repo transactions outside RBI increased substantially by about 58 per cent over the month of May to Rs 3,16,559 crore, with the bulk of transactions executed for one-day maturity (Table 10). As per CCIL data, the share of public sector banks fell from 10.4 per cent in May 2005 to 5.4 per cent in May 2006, while that of foreign banks has increased from 10.8 per cent to 30.0 per cent over the same period.

    Commercial Bonds

    Following the subdued primary corporate debt market, the secondary market for the same also turned subdued with daily average turnover falling from Rs 80 crore in May to Rs 52 crore in June; yet the trading in floating rate bonds doubled from Rs 200 crore to Rs 425 crore, while that of debentures fell from Rs 895 crore to Rs 127 crore (Table 11).

    l1i

    [While Piyusha Hukeri has prepared the initial draft, the required tabular data have been compiled by V P Prasanth.]

    the ruling secondary market yield was at

    8.21 per cent.

    Treasury Bills

    The yields offered on all the freshly issued treasury bills were higher than in the previous month and also higher week by week and fortnight by fortnight throughout the month driven by the new dear money policy thrust inspired by higher inflation rates and higher international rates of interest (Tables 5 to 7). Despite a surfeit of liquidity, 182-day T-bills remained undersubscribed and RBI chose to accept bids below the notified amounts in case of a 182-day and two 91-day T-bills. All these TB yields have in fact overtaken the yields offered to 10-year or even longer maturities two years ago in 2004-05.

    Corporate Bonds Market

    The firming up of domestic interest rates, coupled with expectations of yet another hike in US Fed rate as well as in other countries, rendered the primary corporate bonds market subdued in June; it mobilised only Rs 3,102 crore as against Rs 6,856 crore in June 2005 and Rs 4,377 crore in May 2006. Further, there was a marked shift in the preferences of the issuers from floating rate bonds (FRBs) to fixed coupon bonds. Among the eight issuers that tapped the market in June 2006, FIs and banks dominated by mobilising the bulk amount of Rs 3,010 crore with the remaining Rs 92 crore being mobilised by a sole NBFC and a state government undertaking (Table 8).

    As a part of the government’s attempt to give a boost to the development of urban infrastructure in the country, municipal corporations are allowed to issue bonds, which will carry 8 per cent tax-free rate of return as well as government guarantee. The rate of returns on these tradable bonds of varying maturities would be equivalent to 11.4 per cent taxable. While the municipal bodies can issue bonds with higher coupon rates of above 8 per cent, they will not qualify for a tax-free status.

    IV Secondary Market

    The secondary market for gilt-edged securities remained subdued during the month under review, despite surplus liquidity in the system, as market participants preferred to follow caution in view of uncertainties around interest rates. The weekly turnover ranged between Rs 7,365 crore and Rs 8,253 crore as against a range of Rs 11,583 crore and Rs 14,407 crore in May. As per CCIL data, the market share of public sector banks in the buy side of outright transactions declined from 19 per cent in June 2005 to 15 per cent in June 2006, while that of foreign banks increased from 19 per cent to 37 per cent over the same period.

    Apart from looming firm international oil prices, the monetary tightening measures

    Dear reader,

    To continue reading, become a subscriber.

    Explore our attractive subscription offers.

    Click here

    Comments

    (-) Hide

    EPW looks forward to your comments. Please note that comments are moderated as per our comments policy. They may take some time to appear. A comment, if suitable, may be selected for publication in the Letters pages of EPW.

    Back to Top