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Exuberance in Financial Markets: Towards What End?

Annual turnover in five financial markets is now equivalent to more than 300 per cent of GDP. Across the gilt, forex, equity, derivatives and commodity futures markets, an easy policy environment has led to the current mood of extreme exuberance. Secondary market trading and even speculation do have a legitimate role to play in hedging of risk, price discovery and providing liquidity. But we need a range of measures to discourage froth in the markets. Such measures must include a change in the tax regime, a ban on trading in individual stock futures, demutualisation of commodity exchanges, and closer surveillance of FII investments.

Money market

capital market-centric nature of public policies is widely known. Exemptions

Exuberance in Financial

granted to company dividend incomes and more significantly, the elimination of capital gains from out of the taxable in-

Markets: Towards What End?

Annual turnover in five financial markets is now equivalent to more than 300 per cent of GDP. Across the gilt, forex, equity, derivatives and commodity futures markets, an easy policy environment has led to the current mood of extreme exuberance. Secondary market trading and even speculation do have a legitimate role to play in hedging of risk, price discovery and providing liquidity. But we need a range of measures to discourage froth in the markets. Such measures must include a change in the tax regime, a ban on trading in individual stock futures, demutualisation of commodity exchanges, and closer surveillance of FII investments.

EPW RESEARCH FOUNDATION

I

T
he secondary market turnover in various segments of the financial markets has attained dizzy heights and yet continues to gallop month after month. When the Indian economy began to experience robust growth in 2003-04, its resonance was seen in an unprecedented bullishness in the financial markets spreading across gilt-edged, forex, equity and equity-derivative markets and now the commodity futures. As shown in Table 1, during 2005-06 the aggregate turnover in all the five markets together touched near five times the country’s annual GDP at current market prices. The two segments, namely, the capital and commodities markets alone were equivalent to 265 per cent of GDP. And based on the performance in the first eight months of 200607, the turnover in these two segments may gallop to over 335 per cent of GDP. These include notional amounts in the derivatives segment and the gains are determined by the changes in prices. Even so, on a crude and hypothetical basis, it can be surmised that in a situation of galloping trades and prices, the margins cornered by the traders will be very substantial. Willy-nilly the benefits of these unearned gains accrue to a minuscule segment of society, and this has serious social implications: it is contributing to accentuation of gross inequalities in incomes and opportunities and spawning mindless forms of conspicuous consumption amongst small but dominant sections of society. To an extent, this provides an impetus to the growth of the various components of the services sector (Table 1).

This exuberance in secondary market transactions in the financial markets has many sources of impetus. India has preponderantly large trading classes nurturing a historical tradition of vast trading and speculative instincts in society. Recent public policies are also geared towards supporting such trading proclivities. The comes, are a blatant surrendering by the state of potential revenues that are otherwise badly needed for social and economic development. Though securities transaction tax has been imposed, it is very marginal as the collections have been only Rs 2,513 crore for 2005-06 as compared to the possible collections that could be made through capital gains tax.

Permission granted to deal in futures trading in individual stocks which are risky and which are not allowed in most countries, the absence of physical settlement in the stock derivatives market giving rise to holding of large positions and rollover (though in all developed countries derivative trades are delivery settled and not cash settled), and now the indiscriminately large number of agricultural commodities that have been permitted to be traded on commodity exchanges – all fall into the same capital market and trade-centric category of public policies.

In such an easy policy environment, global investors too get attracted. Ostensibly buying India’s growth story, FII investments have begun to bulge precisely after the removal of tax on capital gains in 2003-04. Also, despite serious misgivings

Table 1: Secondary Market Turnover in Financial and Commodities Markets

(Amount in Rs crore)

Market Segments/Year April-April-November November 2002-03 2003-04 2004-05 2005-06 2005 2006 2006-07*
1 Government Securities 2 Forex Market 3 Total Stock Market Turnover I Capital Market Derivatives Cash Total II Capital Market Derivatives Cash Total 4 Commodites Market GDP at market prices Memo Item: Open Interest at the end for derivative contracts traded on NSE (Rs crore) 1941673 2639244 2692129 2559260 1710109 2572429 3863144 (79.0) (95.6) (86.2) (72.5) (96.0) 658035 2318531 4042435 5239674 2981344 4878950 7318425 (26.9) (84.0) (129.5) (148.4) (181.8) 1374403 3744841 4221952 7209892 3526457 5764357 9808556 (56.1) (135.6) (133.3) (204.2) (243.6) 439863 2130612 2547053 4824251 2229070 4077552 4662369 617989 1099535 1140072 1569558 826818 1062047 1877864 1057852 3230147 3687125 6393809 3055888 5139599 8871418 (43.2) (117.0) (181.1) (181.1) (220.4) 2478 12074 16112 9 3 8561 12842 314073 502620 518715 816074 470566 616197 924296 316551 514694 534827 816083 470569 624758 937138 (12.9) (18.6) (17.1) (23.1) (23.3) 66500 129400 571759 2134000 1242398 2490567 3735850 (2.7) (4.6) (18.3) (60.4) (92.8) 2449736 2760224 3121414 3531451 4025854 2194 7188 21052 38470

Notes: (i) Figures in brackets represent per cent to GDP at current market prices. * Estimated figures for 2006-07. Source: Rakshitra and other publications of CCIL, Sebi Bulletin and NSE NEWS.

Economic and Political Weekly December 23, 2006

Graph A: Trends in Weighted Averagesof Call Rates, Repo Rates, CBLORates and Call Money Borrowing –November 2006

Rupees Thousand CroreWeighted Average (Per Cent) 4 4.5 5 5.5 6 6.5 7 7.5 0.5 5.5 10.5 15.5 20.5 25.5 November 2006 Rupees per US dollar

ll l

-i

Call Money Volume (Rs Cr)

Repo Rates – Outside the RBI

ll t

t

Call Rates

CBLO Rates

expressed by the Reserve Bank of India and many independent commentators, that FII funds mobilised through participatory notes (PNs) are not the right kinds of funds for our markets, the government refuses to introduce any rigorous regulations on PNs.

The presence of FIIs has increased manifold with their cumulative net investment touching about US $ 50,000 million so far, up to November 30, 2006. Also, their holding across companies has increased substantially as reflected in the data put out on the NSE website. For instance, in Gujarat Ambuja, FII holdings as a percentage of

Graph B: Spot Quotations for US Dollarin the Domestic Inter-Bank Market

50.0

48.0

46.0

44.0

42.0

total holdings have increased from 15 per cent in March 31, 2003 to 36 per cent as on September 30, 2006, in Dr Reddy’s Laboratories from 16 per cent to 31 per cent, and in case of HDFC, from 52 per cent to 69 per cent, respectively.

FIIs’ gross purchases and sales have a more telling story (Table 2). During 2005-06 alone, FIIs have sold shares worth Rs 3,05,512 crore which have constituted 210 per cent of their purchases made two years ago in 2003-04 (Rs 1,44,858 crore). This means, in a crude sense, they have gained more than 100 per cent in capital

il i (Daily Working Days Nov 2006) Monthly Averages (Jan 2001 to Oct 2006)

Table 2: FII Purchases and Sales

Year Gross Purchase Gross Sales Net Investment Net Investment Cumulative
(Rs Crore) (Rs Crore) (Rs Crore) (US $ mn) Net Investment
(US $ mn)
(1) (2) (3) (4) (5) (6)
2002-03 47,061 44,373 2,689 5 6 2 15,805
2003-04 1,44,858 99,094 45,765 9,950 25,755
2004-05 2,16,953 1,71,072 45,881 10,172 35,927
2005-06 3,46,978 3,05,512 41,467 9,332 45,259
2006-07
(up to November) 4,33,352 3,93,145 40,207 8,791 49,891

gains worth over Rs 1,60,654 crore which represents in a sense an outright sucking out from India’s domestic savings. Data on FII shareholdings in respect of a few individual companies along with their respective equity price quotations give a more revealing story. For example, Bharti Airtel had 995.27 lakh shares (5.37 per cent) held by FIIs in March 2003; its share price was Rs 28 at that time. By September 2006, FII holdings of this company shares shot up to 4,855.92 lakh (25.62 per cent) and the equity price galloped to Rs 468.

Yet another unhealthy feature in the trading in equities has been the acute concentration across securities and market participants. In equities, trading in 100 scrips accounts for 80 per cent of total turnover on NSE and 66 per cent on BSE. Similarly, trading in top 20 securities account for more than 95 per cent of total gilt-edged securities trading. In the forex market, the top 20 market participants account for about 80 per cent of total trading.

However, the most glaring example of concentration is reflected in the investorwise turnover analysis of equity derivatives, wherein retail investors account for about 60 per cent of the total derivatives turnover of NSE, and as per the NSE managing director’s statement at World Federation of Exchanges (Annual Report 2005, p 26), there are three lakh retail investors active in derivatives market as against one million investors in equities. This indicates the extent of concentration of trading in a few hands in the derivatives segment.

Even so, with the improved surveillance systems of the capital and derivatives market, the speculators have identified commodities futures trading as their next

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

Average November 2006 Average October 2006
Items for Four for Four
Dec 01 Weeks 24(RF)* 1 7 10(RF)* 3 weeks 27(RF)* 2 0 13(RF)* 6
No of working days 6 2 4 6 6 6 6 2 0 3 6 6 5
Call Money Weighted average of call rates:
per cent (weekly range)
per annum Daily averages (Rupees crore) 6.00-6.25 6.06-7.09 6.06-7.02 6.68-7.09 6.71-7.00 6.83-6.96 (7.04) (6.71) 6.26-7.14 6.57-7.14 (6.57) 6.50-6.96 6.29-6.42 6.26-7.07 (6.26)
Total call market borrowings 13587 11756 8843 11051 11297 15831 10956 3397 13788 11779 11107
Notice Money (644) (752) (580) (366)
Weighted average of notice money rates:
per cent (weekly range) per annum 5.95-6.28 6.16-7.43 6.16-6.82 6.32-7.43 6.24-7.20 6.64-6.98 5.69-7.16 6.99-7.16 6.13-6.97 5.69-6.54 6.32-6.94
Daily averages (Rupees crore) (6.16) (6.67) (7.02) (6.54)
Total notice market borrowings 2581 2752 2724 (16137) 2598 2326 (13496) 3360 3670 8103 2098 2878 3890
Turnover in term money market 360 210 106 259 266 208 333 287 447 225 304
(borrowings) $$ (10) (275)
*Data for reporting Fridays are given within brackets and they are also included in the weekly range/daily averages.
$$ No of reporting/traded days is fewer than given above. .. not available
Economic and Political Weekly December 23, 2006 5209

destination. The permission to trade in a Though the FMC has been making efforts large number of commodities, unlike in at restraining excessive speculation by most of other countries’ exchanges where imposing higher margins and cutting the only a few commodities are allowed to be open interest position, recently it has also traded, has allowed large traders to specu-banned four commodity futures traders late in commodities with lower volumes. who have been breaching open interest

Table 4: 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**
October 2006
All four weeks 6.62 0.27 4.04 6.55 0.40 6.04
27 (RF)* 6.89 0.29 4.21 7.06 0.09 1.29
2 0 6.76 0.16 2.42 6.58 0.38 5.85
13 (RF)* 6.39 0.05 0.76 6.24 0.30 4.74
6 6.57 0.30 4.63 6.59 0.28 4.31
November 2006
All four weeks 6.81 0.26 3.79 6.73 0.34 5.05
24 (RF)* 6.55 0.40 6.05 6.44 0.26 4.03
1 7 6.92 0.16 2.34 6.94 0.38 5.42
10 (RF)* 6.85 0.12 1.72 6.72 0.37 5.46
3 6.91 0.05 0.75 6.83 0.15 2.16

** Separate reportings began on March 15, 2005.

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

Table 5: 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

6-Oct-06 6.48 6.12 6.30 14219 13938 9250 13-Oct-06 6.44 6.07 6.24 14657 14488 8573 20-Oct-06 6.82 6.47 6.61 15886 18179 9406 27-Oct-06 7.06 6.39 6.72 15082 20067 9440

3-Nov-06 6.90 6.32 6.67 19191 19604 11297 10-Nov-06 6.84 6.21 6.62 13623 18169 11029 17-Nov-06 6.97 6.88 6.89 13649 17538 10531 24-Nov-06 6.46 6.23 6.52 11567 15958 7757 1-Dec-06 6.16 5.97 6.13 16350 17279 9450

Source: The Clearing Corporation of India Ltd (CCIL).

Table 6: Auctions of 91-Day Treasury Bills

(Amount in rupees crore)

positions for the last 10 months across products. Moreover, the regulator has asked the exchanges to withhold the profits from breach of open interest positions during the last five days before the expiry of contract and also be levied additional penalty.

Though the efforts of FMC have been in the right direction, what stands out is that the market participants, particularly the traders, have been selecting one of the smaller commodities to speculate and generate huge gains and then when the FMC has sought to bring in sobriety in their trading, they have been on the lookout for some newer commodities. As a result, the similar pattern of trades has been used for continued speculation, to begin with guar seeds, guar gum, mentha oil and now maize. Hence, unless the regulator exercises stringent regulations, the speculative tendencies are bound to grow.

As has been emphasised in this column, secondary market transactions and even speculation have a legitimate role to play: they help the investors to hedge, to arbitrage and to achieve competitive price discovery; above all they provide liquidity to individual scrips. At an advanced stage of development, commodity exchanges are expected to serve as catalysts for the development of a vast set of the value chains for marketing services as well as facilitate price discovery and risk management. As the Forward Markets Commission (FMC) seems to have now realised, there is a need to impose trading limits and undertake rigorous surveillance. But, after allowing the floodgates of commodities

Date of Notified Bids Tendered Bids Accepted Subscription Cut-off Cut-off Amount Outstanding Auction Amount Devolved Price Yield Rate on the Date of Issue No Face Value No Face Value on PDs (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 November 2 2000.00 57 2885.50 52 2000.00 0.00 98.60 5.68 39130.47 0.00 39130.47

  • (2) (351.50) (2) (351.50) [98.62] [5.60] November 9 2000.00 55 2727.20 11 500.00 0.00 98.57 5.80 37612.08 0.00 37612.08
  • (0) (0.00) (0) (0.00) [98.57] [5.80] November 16 500.00 50 1799.44 24 500.00 0.00 98.57 5.80 36130.73 0.00 36130.73
  • (2) (221.65) (2) (221.65) [98.58] [5.76] November 23 500.00 47 2228.90 19 500.00 0.00 98.59 5.72 34630.73 0.00 34630.73
  • (0) (0.00) (0) (0.00) [98.59] [5.72] November 30 500.00 46 2015.50 18 500.00 0.00 98.59 5.72 28630.73 0.00 28630.73
  • (1) (363.00) (1) (363.00) [98.60] [5.68] 2006 November 1 2000.00 39 2567.40 6 602.40 0.00 98.37 6.65 30359.01 0.00 30359.01
  • (1) (2000.00) (1) (2000.00) [98.37] [6.65]November 8 2000.00 43 3196.74 15 988.74 0.00 98.37 6.65 28847.75 0.00 28847.75
  • (1) (200.00) (1) (200.00) [98.37] [6.65]November 15 2000.00 34 1670.00 6 620.52 0.00 98.37 6.65 28263.27 0.00 28263.27
  • (5) (2305.00) (5) (2305.00) [98.37] [6.65]November 22 2000.00 40 3502.10 24 2000.00 0.00 98.37 6.65 30513.27 0.00 30513.27
  • (3) (2750.00) (3) (2750.00) [98.37] [6.65]November 29 2000.00 40 2361.47 30 2000.00 0.00 98.36 6.69 30976.27 0.00 30976.27
  • (2) (563.00) (2) (563.00) [98.37] [6.65]

    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 December 23, 2006

    Graph C: Annualised Forward Premia in Graph D: Yield Curves for Datedsurveillance on FII investments; participa-

    Percentage for the US Dollar in theSecurities – Weighted Average for

    tory notes deserve to be discouraged and

    Domestic Inter-Bank Market and Weeks of November 2006

    1st Week 2nd Week 3rd Week 4th Week
    limits on holdings of individual company

    9

    Weighted Averages of Call Rates for November 2006

    scrips should be lowered to 10 per cent or

    thereabout.

    8.0

    8.5

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

    Yield (per cent per annum)

    II

    8

    Money, Gilt-Edged andForex Markets

    Per cent per annum

    6.0

    3.5

    3.0

    7.5

    During November, the outlook for the

    gilt-edged market turned buoyant with

    4.0

    turnover touching the highest level in the

    7

    current financial year along with easing of

    1.0

    0.5

    yields at the medium and long end result

    6.5

    ing in a flatness of the yield curve amidst

    1 2 3 4 5 6 7 8 9 10111213141516171821232729

    2.0

    a robustly growing economy, surging

    Working Days Years to Maturity

    trading to private trading classes, it would In the case of the stock exchanges be a losing battle for the FMC as the traders too, a series of measures are required to adopt multiple tricks to get past the regu-introduce greater degree of discipline in lations. What is, therefore, required is the the market. Apart from reintroducing demutualisation of the commodity ex-taxes on dividends and capital gains, changes as trust bodies in the case of futures in individual stocks should be Bombay Stock Exchange (BSE) so that the banned and derivative dealings should management of the exchanges is detached be delivery-settled and not cash-settled. from their shareholders. Finally, there should be more rigorous

    Table 7: Auctions of 182-Day Treasury Bills

    (Amount in rupees crore)

    Date of Auction Notified Amount Bids Tendered No Face Value (Amount) Bids Accepted Subscription Cut-off Cut-off Amount Devolved Price Yield Outstanding No Face Value on PDs (Rupees) Rate on the Date (Amount) (Amount) (Per Cent) of Issue
    2005
    Nov 2 1500.00 45 2500.50 33 1500.00 0.00 97.19 5.78 17056.50
    (0) (0.00) [97.21] [5.74]
    Nov 16 500.00 33 1334.50 20 500.00 0.00 97.14 5.89 17056.50
    (0) (0.00) [97.15] [5.87]
    Nov 30 500.00 27 1095.13 13 500.00 0.00 97.14 5.89 16886.50
    (0) (0.00) [97.16] [5.85]
    2006
    Nov 1 1500.00 36 1695.00 5 615.00 0.00 96.66 6.93 20893.08
    (1) (54.51) (1) (54.51) [96.67] [6.91]
    Nov 16 1500.00 39 1700.00 21 1115.00 0.00 96.66 6.93 20008.08
    (1) (203.00) (1) (203.00) [96.67] [6.91]
    Nov 29 1500.00 39 2105.00 24 1500.00 0.00 96.68 6.89 20267.83
    (2) (773.18) (2) (773.18) [96.70] [6.84]

    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: 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 Nov 9 2000.00 65 3991.00 11 1000.00 0.00 94.37 5.97 49690

    (0) (0.00) (0) (0.00) [94.38] [5.95] Nov 23 1000.00 57 2919.78 28 1000.00 0.00 94.41 5.92 49690

    (0) (0.00) (0) (0.00) [94.43] [5.90]

    2006 Nov 8 2000.00 59 4510.00 30 2000.00 0.00 93.48 6.99 44267

    (0) (0.00) (0) (0.00) [93.49] [6.98] Nov 22 2000.00 56 5460.00 26 2000.00 0.00 93.49 6.98 45267

    (0) (0.00) (0) (0.00) [93.51] [6.96]

    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.

    inflation and concerns being expressed about the liquidity scenario, reinforced by the RBI governor hiking the repo rate in the mid-term review of credit policy. Following the finance minister’s assurance that fiscal measures would be used to address the inflationary pressure, the market turned buoyant, but the strain on liquidity remained as manifested through the smaller size of reverse repo bids and firm overnight rates, which eased only towards the end of the month with the improvement in liquidity. Following the RBI sterilisation activities, the rupee liquidity improved in the domestic market. Also, as the finance minister asserted that there were no signs of overheating and that the repo rate hike was intended to moderate credit growth in specific sectors also underpinned bond gains. Despite the repo rate hike, gilt yields declined as they drew inspiration from the weakness in the US economy and began anticipating a neutral policy stance there, which would be followed in domestic policy, though the robustly growing economy indicated by the high GDP growth rate instilled fears of an impending rate hike. Despite decreasing liquidity, the two instances of dated securities auction were sumptuously oversubscribed given the banks’ appetite for gilt-edged papers in the face of growing bank deposits and other sources of short-term liquidity. Also, the cut in domestic fuel prices towards the end of the month supported the sentiments. The two significant developments in the foreign exchange market induced the RBI to intervene and arrest the sharply appreciating rupee against the US dollar; these were a huge inflow of foreign currency assets and the decline of the dollar to a historic low of $1.32 against the euro (a 20-month low) following a series of weak economic data for the US economy. RBI issued changes in the “when-issued” market as

    Economic and Political Weekly December 23, 2006 well as liberalised the external commercial borrowing norms thereby encouraging offshore borrowings.

    Call Money Market

    The weighted averages of call rates ruled during November within the repo-reverse repo corridor as their spread had widened to 125 basis points following the unexpected hike in the repo rate by 25 basis points to 7.25 per cent in the mid-term review of the credit policy on October 30. The simple mean of call money rates was

    6.81 per cent during November, against

    6.62 per cent in October (Table 4). The overnight rates eased towards the end of the month with the improvement of liquidity so much so that the rates, which were ruling around the repo rate until third week of the month, began ruling near the reverse repo rate. The month began with call rates ruling firm at 6.92 per cent on November 1 given the central loan floatation and then rose to 7 per cent on November 6. With the increased government spending and banks having covered their positions, the rates eased to 6.92 per cent and dipped to

    6.71 per cent on the first reporting Friday, November 10. Yet, the pressure on liquidity remained pushing the overnight rates to rule firm and touched a peak of 7.09 per cent on November 16 due to outflows towards second dated auction and excess covering by the banks. The rates eased with the improvement in liquidity ahead of the second reporting Friday and dipped to 6.06 per cent on the reporting Friday, November 24. Thereafter, the rates remained easy and closed the month at 6.17 per cent on November 30 (Graph A).

    The borrowings from the call market and term money market increased, while that of from the notice money market declined (Table 3). Among the three short-term rates, the CBLO rates as usual ruled in a lower range as compared to the call and repo rates (Table 5). Daily average volumes have also been considerably higher in CBLO dealings than in call and market repo transactions.

    Forex Market

    The RBI had to intervene in the foreign exchange market as the rupee sharply appreciated against the dollar on the back of a huge inflow of foreign currency assets and weaknesses in the dollar reflecting the softer economic data for the US economy particularly about the housing market’s troubles over there; the US dollar touched a 20-month historic low against the euro and it remained depreciated against most of the key currencies. Moreover, the lower level of international crude oil prices and bullish domestic stock markets supported a strong rupee. The inflow of foreign currency assets were the second highest in the fiscal year so far at US $ 8,209 million – just lower than the peak which touched US $ 8,490 million in April 2006. The rupeedollar exchange rate appreciated continuously from Rs 44.93 on November 1 to Rs

    44.45 on November 10 when the rupee on trade-weighted basis in real terms was overvalued by 6.4 per cent and annual appreciation stood at 3.1 per cent, which attracted massive intervention by the RBI and the rate touched a low of Rs 45.34 on November 15. However, with a robust inflow of foreign currency assets from corporates, the rupee began appreciating again touching Rs 44.99 on November 21 and then jumped by 24 paise to Rs 44.75 on the next day as the dollar weakness resulted in the rupee strengthening and fears of RBI intervention subsided. Again, RBI sought to intervene in the market and pushed the rate to Rs 44.87 on November 24.

    Thereafter the rupee oscillated in a range of Rs 44.64-Rs 44.74 and touched Rs 44.76 on November 30. As on November 30, the rupee stood overvalued on an annual basis against the dollar by 2.64 per cent and depreciated against the euro, pound sterling and yen by 8.52 per cent, 9.36 per cent and 0.07 per cent, respectively. Even the offshore market supported the appreciating trend of the rupee (Graph B).

    As the spot market for the rupee-dollar exchange rate turned volatile with the RBI intervening in the forex market, the forward premia also turned volatile with the importers covering their positions, but with the easing of global crude oil prices the demand for oil companies remained subdued. Also, heavy dollar short-covering forced traders to enter into sell-buy swaps. Further, the news of additional inflows from corporates and easing of call rates, the forward premia eased. However, towards the end of the month, they edged up due to month end demand for dollars. Among the three tenures of forward premia, the one-month premia generally ruled above the three and six-month premia indicating that the market expectation of the rupee to depreciate in short-term is more than that in the other two tenures. The month of November is found to be an exception in this respect (Graph C).

    III Primary Market

    Dated Securities

    The government mobilised Rs 14,000 crore in November through two instances by issuing three securities. In the first instance, 7.40 per cent 2012 and 7.50 per cent 2034 were reissued on November 3 for notified amounts of Rs 6,000 crore and Rs 3,000 crore, respectively through a

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

    (Amount in rupees crore)

    Range of Repo (Injection)* Reverse Repo (Absorption)* Net Net For the Week Repo/RR Bids Received Bids Accepted Bids Received Bids Accepted Injection(+)/ Out(Oct-Nov 2006) Period Number Amount Number Amount Number Amount Number Amount Daily Absorp-standing

    Days Averages tion (-) Amount at of Bids of the Week Accepted Liquidity End@

    02 Oct - 06 Oct 06 1-3 0 0 0 0 72 99885 72 99885 24971 -15405 29070 09 Oct - 13 Oct 06 1-3 1 35 1 35 115 121080 115 121080 24216 -121045 18240 16 Oct - 20 Oct 06 1-3 10 2585 7 2585 42 9605 42 9605 1921 -7020 -1480 23 Oct - 27 Oct 06 1-3 8 1805 13 1805 49 29660 49 29660 9887 -27855 12270

    30 Oct - 03 Nov 06 1-3 0 0 0 0 51 24755 51 24755 4951 -24755 8315 06-Nov - 10-Nov-06 1-3 0 0 0 0 74 41730 74 41730 8346 -41730 8960 13 Nov - 17 Nov 06 1-3 0 0 0 0 26 21905 26 21905 4381 21905 5135 20 Nov - 24 Nov 06 1-3 0 0 0 0 110 84805 115 86840 17368 86840 15995 27 Nov - 01 Dec 06 1-3 0 0 0 0 117 78420 117 78420 15684 78420 24530

    Notes: * with effect from October 31, 2006 the Repo Rate is 7.25 per cent and Reverse Repo Rate 6.00 per cent. ** Includes Second LAF Auctions under Repo and Reverse Repo.@ Net of Repo and Reverse Repo Outstandings.

    Economic and Political Weekly December 23, 2006 price-based auction using multiple price yield of 7.50 per cent. In case of the 28-year, set at the auction held on September 8, yet method. For the six-year paper, the RBI the RBI received 145 competitive bids for the yield set was higher than that set in received 274 competitive bids worth Rs 7,319 crore of which 8 bids worth Rs November 2005 at 7.73 per cent. Rs 15,288 crore of which 113 bids for 2,993 crore were accepted at a cut-off yield In the second instance, the government Rs 5,988 crore were accepted at a cut-off of 8.02 per cent as against 8.45 per cent re-issued 8.07 per cent 2017 for a notified

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

    (Amount in rupees crore)

    Descriptions Week-ending November 2006: Yield to Maturity on Actual Trading Total for the Month
    24 17 10 3 of November 2006
    AMT YTM CY AMT YTM CY AMT YTM CY AMT YTM CY AMT YTM CY
    1 Treasury BillsA 91-Day BillsB 182-Day BillsC 364-Day Bills2 GOI Dated Securities 753.43 722.34 2284.85 6.62 6.68 6.76 744.37 1030.15 1007.92 6.62 6.83 6.62 147.57 1274.49 1303.82 6.55 6.73 6.67 664.20 1063.55 584.90 6.63 6.81 6.82 2309.57 4090.53 5181.49 6.626.776.71
    A Regular (Per Cent: Year)6.30 , 2006 FRB - - - - - - - - - 10.00 7.12 6.30 10.00 7.12 6.30
    11.90, 2007 213.14 7.10 11.33 40.00 7.10 11.61 330.00 7.13 11.60 198.00 7.04 11.59 781.14 7.10 11.53
    9.50 , 2008 11.50, 2008 -- -- -- 10.00 235.00 7.14 7.16 9.24 10.83 -130.00 -7.17 -10.83 -50.15 -7.12 -10.81 10.00 415.15 7.14 7.16 9.24 10.83
    12.00, 2008 65.00 7.11 11.26 110.00 7.17 11.26 250.00 7.17 11.25 - - - 425.00 7.16 11.25
    6.65 , 2009 7.07 , 2009 OIL MKTG BONDS 25.00 55.00 7.11 7.73 6.72 7.17 -240.00 -7.76 -7.18 -1150.00 -7.72 -7.17 -- -- -- 25.00 1445.00 7.11 7.72 6.72 7.17
    7.33 , 2009 OIL MKTG BONDS 195.00 7.72 7.39 100.00 7.75 7.40 - - - - - - 295.00 7.73 7.39
    11.99, 2009 6.20 , 2010 UTI SPL BONDS -160.00 -7.81 -6.49 0.10 - 7.48 - 10.93 - 25.00 - 7.25 - 10.87 - 50.15 - 7.23 - 10.86 - 75.25 160.00 7.24 7.81 10.86 6.49
    7.55 , 2010 123.19 7.23 7.48 175.30 7.32 7.50 155.50 7.31 7.50 53.25 7.34 7.50 507.24 7.30 7.49
    11.50, 2010 12.25, 2010 601.00 15.00 7.34 7.27 10.20 10.61 -- -- -- 75.00 75.00 7.42 7.43 10.21 10.64 100.00 - 7.39 - 10.20 - 776.00 90.00 7.35 7.40 10.20 10.63
    12.29, 2010 - - - - - - - - - 25.00 7.34 10.78 25.00 7.34 10.78
    9.39 , 2011 12.32, 2011 1127.75 60.00 7.32 7.32 8.70 10.47 812.81 35.00 7.41 7.44 8.72 10.50 551.86 110.00 7.42 7.46 8.73 10.50 468.60 80.00 7.44 7.47 8.73 10.50 2961.02 285.00 7.38 7.43 8.72 10.49
    6.72 , 2012 225.00 6.77 6.74 - - - - - - - - - 225.00 6.77 6.74
    6.85 , 2012 7.40 , 2012 -226.10 -7.27 -7.36 5.00 305.45 7.41 7.36 7.02 7.39 -507.19 -7.43 -7.41 1.75 - 7.51 - 7.05 - 6.75 1038.74 7.43 7.38 7.03 7.39
    7.44 , 2012 - - - - - - - - - 15.00 8.05 7.64 15.00 8.05 7.64
    7.44 , 2012 OIL MKTG BONDS 745.00 7.27 , 2013 5.00 7.86 7.27 7.58 7.27 190.00 315.08 7.92 7.45 7.60 7.34 610.00 30.00 8.03 7.52 7.64 7.37 100.00 17.11 8.06 7.53 7.65 7.37 1645.00 367.19 7.94 7.46 7.61 7.34
    7.39 , 2013 FRB - - - - - - 110.00 7.33 7.37 - - - 110.00 7.33 7.37
    9.81 , 2013 7.37 , 2014 25.00 70.00 7.40 7.35 8.74 7.36 -15.85 -7.43 -7.40 -293.58 -7.51 -7.43 -57.40 -7.51 -7.43 25.00 436.82 7.40 7.48 8.74 7.42
    10.00, 2014 25.00 7.45 8.74 - - - - - - 25.00 7.62 8.81 50.00 7.54 8.77
    11.83, 2014 7.38 , 2015 5.00 3.25 7.48 7.40 9.41 7.39 3.75 1.55 7.52 7.49 9.42 7.44 5.75 0.85 7.70 7.66 9.51 7.51 -- -- -- 14.50 5.65 7.58 7.46 9.45 7.42
    7.59 , 2015 - - - - - - - - - 15.00 8.17 7.86 15.00 8.17 7.86
    7.59 , 2015 OIL MKTG BONDS 95.44 7.61 , 2015 OIL MKTG BONDS 245.00 7.91 7.91 7.74 7.75 195.00 340.00 8.02 8.03 7.79 7.81 120.00 565.00 8.16 8.18 7.86 7.88 160.00 105.00 8.19 8.18 7.88 7.88 570.44 1255.00 8.08 8.09 7.82 7.84
    10.79, 2015 25.00 7.53 8.98 - - - - - - - - - 25.00 7.53 8.98
    11.43, 2015 7.59 , 2016 25.00 1433.63 7.47 7.45 9.15 7.52 -2357.92 -7.55 -7.57 45.05 1330.95 7.65 7.61 9.24 7.60 0.13 1052.32 7.64 7.61 9.23 7.60 70.18 6174.81 7.59 7.55 9.21 7.57
    10.71, 2016 90.00 7.58 8.87 1.00 7.70 8.93 - - - - - - 91.00 7.58 8.87
    7.46 , 2017 7.49 , 2017 2.50 0.50 7.46 7.50 7.46 7.50 6.50 - 7.60 - 7.53 - 9.07 0.90 7.65 7.65 7.56 7.58 14.87 4.23 7.69 7.72 7.59 7.61 32.94 5.63 7.64 7.69 7.56 7.60
    8.07 , 2017 1524.56 7.43 7.72 800.62 7.51 7.77 398.74 7.60 7.82 544.94 7.63 7.83 3268.86 7.50 7.76
    5.69 , 2018 6.25 , 2018 1.50 19.40 7.57 7.56 6.66 6.93 -15.06 -7.61 -6.95 6.91 11.50 7.68 7.69 6.72 7.00 6.35 15.60 7.78 7.72 6.78 7.01 14.76 61.56 7.71 7.64 6.74 6.97
    10.45, 2018 - - - 5.00 7.65 8.63 5.00 7.66 8.64 - - - 10.00 7.66 8.63
    12.60, 2018 5.64 , 2019 -2.05 -7.63 -6.68 10.20 1.50 7.66 7.64 9.10 6.69 -8.15 -7.80 -6.78 -7.00 -7.76 -6.76 10.20 18.70 7.66 7.75 9.10 6.75
    6.05 , 2019 1.10 7.45 6.82 1.26 7.65 6.94 10.05 7.73 6.98 9.68 7.80 7.03 22.09 7.74 6.99
    10.03, 2019 6.35 , 2020 50.25 41.00 7.59 7.61 8.39 7.09 0.50 33.32 7.74 7.67 8.48 7.12 -2.50 -7.76 -7.17 10.00 1.00 7.84 7.90 8.54 7.26 60.75 77.82 7.64 7.65 8.41 7.11
    10.70, 2020 5.00 7.61 8.52 5.00 7.85 8.67 - - - 14.00 7.84 8.66 24.00 7.80 8.63
    11.60, 2020 7.94 , 2021 5.00 130.50 7.60 7.56 8.64 7.69 20.00 182.54 7.71 7.64 8.71 7.74 15.00 138.10 7.82 7.71 8.79 7.78 -273.00 -7.78 -7.84 40.00 724.14 7.73 7.69 8.73 7.77
    8.13 , 2021 OIL MKTG BONDS 120.00 7.91 7.98 - - - - - - - - - 120.00 7.91 7.98
    10.25, 2021 8.15 , 2022 10.08 121.64 7.58 7.95 8.32 8.01 -219.14 -8.00 -8.05 -1746.91 -8.10 -8.12 -- -- -- 10.08 2087.69 7.58 8.08 8.32 8.10
    6.17 , 2023 16.00 7.70 7.19 18.50 7.74 7.21 10.50 7.86 7.31 38.00 7.95 7.37 83.00 7.84 7.29
    6.30 , 2023 10.18, 2026 5.40 5.00 7.64 7.70 7.20 8.15 9.80 1.00 7.77 7.67 7.29 8.12 16.40 6.10 7.86 7.82 7.35 8.24 16.60 - 7.92 - 7.39 - 48.20 12.10 7.84 7.76 7.33 8.19
    6.01 , 2028 49.21 7.66 7.26 58.81 7.81 7.38 32.40 7.91 7.46 16.80 8.07 7.59 157.22 7.81 7.38
    6.13 , 2028 7.95 , 2032 14.60 57.25 7.71 7.65 7.34 7.69 26.20 35.25 7.76 7.77 7.38 7.80 12.30 5.25 7.95 7.91 7.53 7.92 21.50 - 8.11 - 7.67 - 74.60 97.75 7.88 7.71 7.48 7.74
    7.50 , 2034 461.13 7.65 7.63 588.69 7.79 7.76 361.99 7.95 7.89 588.82 8.05 7.99 2000.63 7.86 7.82
    7.40 , 2035 8.33 , 2036 20.01 104.03 7.65 7.68 7.62 7.74 33.00 328.22 7.79 7.79 7.75 7.85 1.91 209.98 7.98 7.96 7.91 8.00 1.60 330.72 8.10 8.06 8.02 8.09 56.52 972.96 7.76 7.91 7.72 7.95
    Sub-total 8661.19 7.48 8.06 7889.73 7.60 7.92 9488.64 7.74 8.12 4505.44 7.71 8.24 30545.00 7.62 8.07
    B RBI’s OMO: Sales 43.00 - - 60.00 - - - - - 38.00 - - 141.00 - -
    Purchase - - - 5.00 - - - - - 5.00 - - 10.00 - -
    Sub-total 43.00 - - 65.00 - - 0.00 - - 43.00 - - 151.00 - -
    (A+B) 8704.19 3 Market Repo 48418.00 4 State Govt Securities (per cent year) 242.05 Grand total (1 to 4) 61124.86 7.48 7.64 8.06 7954.73 65549.14 7.83 218.95 76505.26 7.60 7.71 7.92 8.05 9488.64 67950.31 161.79 80326.62 7.74 7.79 8.12 4548.44 70740.68 8.10 99.57 77701.34 7.71 7.65 8.24 30696.00 252658.13 9.84 722.36 295658.07 7.62 7.70 8.07 8.23

    (-) 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 (FRB’s) Current

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

    Economic and Political Weekly December 23, 2006 amount of Rs 5,000 crore through pricebased auction using multiple price method. The underwriting commission offered at

    0.44 paise per Rs 100 has been the lowest since the beginning of the current financial year for a 10-year or so maturity. For this, the RBI received 285 competitive bids worth Rs 13,679 crore, of which 141 bids for Rs 4,969 crore at a cut-off yield of 7.43 per cent as against 8.12 per cent set at the auction held on August 18.

    On November 16, 11 state governments offered to sell a 10-year state development loan for an aggregate amount of Rs 2,431 crore through a yield-based auction using multiple price auction method. The yields were offered between 7.74-7.82 per cent, which are lowest compared to the other state loans auction during the fiscal year so far.

    The central government, up to December 1, 2006, raised gross and net market borrowings of Rs 1,33,548 crore and Rs 77,951 crore, respectively; as a percentage of budget estimates, gross and net market borrowings stood at 74.3 per cent and 68.5 per cent compared with 69.9 per cent and 62.5 per cent, respectively, in the corresponding period last year.

    Treasury Bills

    Despite the pressure on liquidity, the primary TB yields ruled somewhat steady throughout the month. The yield on 91day bills ruled steady at 6.65 per cent on all the auctions held in November except for the auction held on November 29 when it rose to 6.69 per cent (Table 6). Similarly, the yield on 364-day bills ruled steady at

    6.99 per cent on October 26 as well as on November 8 only to fall marginally to 6.98 per cent on November 22 (Table 8). Unlike them, the yield on 182-day bills rose from

    6.89 per cent on October 18 to 6.93 per cent on November 1 and ruled at it on November 15, but again eased to 6.89 per cent on November 29 (Table 7).

    Corporate Bonds Market

    The primary yields offered on corporate bonds and those on gilt-edged securities moved in diverse direction as the yields on gilt-edged securities declined while those on corporate bonds increased consistently. For instance, NABARD for its three-year paper offered a coupon of 8.05

  • 8.20 per cent in October while in November it had to offer 8.15-8.25 per cent. Also, Oriental Bank of Commerce had to offer
  • 9.40 per cent for 15 years while in July for the same tenure it offered 9.25 per cent.
  • The market remained buoyant despite concerns about liquidity with Rs 9,602 crore being mobilised in November as against Rs 4,905 crore in October and Rs 900 crore in November 2005. Unlike previous months, the bulk of the borrowings were not by banks and financial institutions, but by three public sector units who mobilised Rs 7,060 crore, of which 80 per cent was mobilised by the Indian Railways Finance Corporation (IRFC).

    Speaking at a session on ‘Financial Markets’ at the India Economic Summit 2006, N Krishnan, joint secretary in the finance ministry said that post-Patil committee recommendations on corporate bond market, the finance ministry had asked a law firm to identify the legislative changes that may be required to implement the recommendations of the committee. “It was found that about 78 pieces of legislation require a change. These changes include administrative as well as legislative change. We are now identifying those that could be done through executive orders and those that may require change in law,” Krishnan said. He pointed out that an issue like definition of “corporate bond” needs attention. “There is no specific definition of a corporate bond. We may have to amend the Companies Act and the SCRA Act for this”, he said. On the issue of deepening the capital market, he underscored the need for more good quality issues to tap the capital market.

    IV Secondary Market

    Despite the hike in repo rate and with inflation rate rising, the secondary market for gilt-edged securities saw the weekly average turnover range between Rs 20,968 crore and Rs 42,627 crore – the highest level witnessed in the fiscal year so far, wherein the traditional indicators of liquidity such as the call rates and reverse repo under LAF demonstrated pressure on liquidity (Table 9). The disjunction between the RBI indicating pressures, due to inflation and liquidity constraints, and markets expectations as reflected by the easing of yields across maturity were put to rest by the deputy RBI governor approving the slope of the yield curve reflecting the medium-term view of inflation. Further, with the cut in domestic fuel prices, the market sentiments turned buoyant.

    The yield curve displayed flatness as well as shifted lower with yields declining across maturities but more in the medium and long-term which have ignored the higher inflation rate as well as concern for liquidity. The spread between 11.90 per cent 2007 and 7.59 per cent 2016 narrowed from 57 basis points in week ended November 3 to 35 basis points on November 24, while the spread between above 10-year paper and 7.40 per cent 2035 narrowed from 48 basis points to 20 basis points and the spread between the above 1-year paper and 29-year paper narrowed from 105 basis points to 55 basis points – all pointing to a flat yield curve. It is interesting that, unlike in the developed country markets, the flatness in the yield curve has occurred at the time of buoyancy in economic activity (Graph D) (Appendix Table).

    RBI Reverse Repos, OMOs and MSS

    The ebb and flow in the underlying liquidity scenario was reflected in the weekly variations in the reverse repo bids tendered and accepted. In the week ended November 3, the weekly aggregate bids fell from Rs 29,660 crore in the week ended October 27 to Rs 24,755 crore due to outflows towards dated securities auction, but soon the bids galloped to Rs 41,730 crore in the next week. Following second instance of dated securities auction, the bids dipped to Rs 21,905 crore in the week ended November 17; reflecting the liquidity strain during this phase the call rates ruled well above the reverse repo rate of 6.0 per cent due to excess covering by banks and outflows towards state auctions. Following the improvement in liquidity due to RBI’s sterilisation activities in the foreign exchange market, the bids jumped to Rs 84,805 crore in the week ended November 24 and then edged lower to Rs 78,420 crore in the last week ended December 1 (Table 9).

    In sync with the secondary market, the repo transactions outside RBI increased to Rs 2,52,658 crore from Rs 1,95,677 crore in October.

    Commercial Bonds

    Following the buoyancy in the secondary market for gilt-edged securities, the secondary market turnover for corporate bonds rose to Rs 54 crore from Rs 32 crore in October; it nevertheless remained moderate. With the fall in yields, the turnover in floating rate bonds increased substantially from Rs 20 crore in October to Rs 335 crore.

    EPW

    [While Piyusha Hukeri has prepared the initialdraft, the required tabular data have been compiledby V P Prasanth.]

    Economic and Political Weekly December 23, 2006

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