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Whither Exchange Rate Policy?

This is an attempt at uncovering the nuances of India's exchange rate policy as spelt out by the Reserve Bank of India from time to time and discerning the current challenges, based on a brief review of developments in rates since January 2007.

MONEY MARKET REVIEW

somewhat relegated to the background.

Whither Exchange Rate Policy?

The last few statements on monetary policy kept silence about exchange rate management or policy and the few impor-EPW Research Foundation tant speeches by Governor D Subbarao in

This is an attempt at uncovering the nuances of India’s exchange rate policy as spelt out by the Reserve Bank of India from time to time and discerning the current challenges, based on a brief review of developments in rates since January 2007.

Team led by K Kanagasabapathy and supported by V P Prasanth, R Rekha Rao, Rema K Nair, Anita B Shetty and Sharan P Shetty.

the most recent period also did not broach

I
ndia stands out in its management of this issue. While it is not clear whether the external sector all through its there is any rethink on exchange rate reform period since the early 1990s. policy, we attempt here to bring out the Calibrated and carefully paced and nuances of that policy as spelt out by the sequenced reforms encompassing policies central bank from time to time and try to and measures in respect of the capital discern the current challenges, based on a account, reserves and exchange rate man-brief review of developments in rates since agement – though initially viewed not so January 2007. conducive for rapid reforms – stood eventually vindicated by the test of time. 1 Issues in Exchange Therefore, India’s example is evidently Rate Management emulated by many central banks in the In his address on “Exchange Rate Managedeveloping world. While the objectives ment: An Emerging Consensus?”, on the and policies in regard to reserves and cap-14 August 2003, Bimal Jalan had brought ital account management are explicit and some clarity about the policy pursued in transparent, the exchange

Table 1: Monthly Movenent in ECB&FII Flows, RBI Net Foreign Currency rate management and policy Purchases(+)/Sales(-) and Fedai Indicative Rates-January 2007-June/July 2009 (Amount in $ million)

are mostly guided by certain

Month/Year ECB FIIs ECB+FIIs Net Foreign Fedai broad principles and therefore Currency Average Rates Purchases(+)/ in Rupees

appear somewhat ambiguous

Sales(-) Per Dollar

and often shrouded in mystery. Jan-07 1,296.98 -369.80 927.18 2,830.00 44.33
The complexity in its nuances Feb-07 3,194.74 1,833.60 5,028.34 11,862.00 44.16
is debated from time to time, Mar-07 5,096.05 81.50 5,177.55 2,307.00 44.03
but perceptions are varied. While the official position is that rupee is a managed float, Apr-07May-07Jun-07Jul-07 2,271.90 3,427.30 2,807.40 3,344.67 1,752.00 1,265.00 269.40 5,544.80 4,023.90 4,692.30 3,076.80 8,889.47 2,055.004,426.00 3,192.00 11,428.00 42.15 40.78 40.77 40.41
some believe that it is a crawl Aug-07 1,523.95 -1,772.10 -248.15 1,815.00 40.82
ing peg. What has been gener Sep-07 2,236.68 4,608.60 6,845.28 11,867.00 40.34
ally observed is that the Oct-07 3,604.86 5,683.50 9,288.36 12,544.00 39.51
Reserve Bank has been inter Nov-07 2,241.59 -1,566.60 674.99 7,827.00 39.44
vening in both the spot and forward markets to prevent undue fluctuations in rates. Dec-07Jan-08Feb-08Mar-08 2,273.16 1,887.66 862.11 4,476.90 2,203.90 -2,747.10 1,048.70 -250.30 4,477.06 -859.44 1,910.81 4,226.60 2,731.00 13,625.00 3,884.00 2,809.00 39.00 39.37 39.73 40.36
The management of rate fluc Apr-08 1,160.82 -155.20 1,005.62 4,325.00 40.02
tuations helped in preventing May-08 1,276.05 -1,282.80 -6.75 148.00 42.13
undue appreciation in the con Jun-08 1,615.25 -2,750.50 -1,135.25 -5,229.00 42.81
text of large inflows through Jul-08 2,471.81 441.70 2,913.51 -6,320.00 42.84
foreign currency purchases and augmenting supply through sales in the market to Aug-08Sep-08Oct-08Nov-08 1,603.37 2,834.95 1,125.23 1,702.48 11.70 -1,258.00 -4,265.30 400.80 1,615.07 1,576.95 -3,140.07 2,103.28 1,210.00 -3,784.00 -18,666.00 -3,101.00 42.94 45.56 42.49 49.00
prevent sharp depreciation in Dec-08 1,669.18 588.90 2,258.08 -318.00 48.63
times of higher demand for Jan-09 1,337.08 -853.20 483.88 -29.00 48.83
foreign currency. Currently, in Feb-09 452.60 -774.50 -321.90 230.00 49.26
the din of talks about exces Mar-09 1,113.89 -1,459.90 -346.01 -3,388.00 51.23
sive fiscal and monetary accommodation combined, the discussion on exchange Apr-09May-09Jun-09Jul-09 298.63 494.30 1,919.04 - 1,790.50 3,577.30 1,058.90 2,283.80 2,089.13 4,071.60 2,977.94 - -2,487.00 -1,437.00 1,044.00 - 50.06 48.53 47.77 48.53
rate management has been Source: www.rbi.org.in

Economic & Political Weekly

EPW
August 22, 2009 vol XLIV No 34

MONEY MARKET REVIEW

Graph A: ECB & FII Flows and RBI Net Purchases/Sales of Foriegn Currency float, without interven

(Amount in $ million)

tion, is clearly out of

15,000 Net Foreign Currency Purchases (+)/Sales(-) favour. Most of the 10,000

countries have adopted

5,000 intermediate regimes of various types, such as ECB+FIIs managed floats with no

-5,000

pre-announced path, the dilemma of exchange rate manage

-10,000

and independent floats -15,000 with foreign exchange intervention moderat

-20,000 1/07 3/7 5/07 7/07 9/07 11/07 1/08 3/08 5/08 7/08 9/08 11/08 1/09 3/09 5/09

ing the rate of change

Graph B: RBI Purchases/Sales of Foreign Currency and the Rupee Dollar and preventing undue

Exchange Rate Amount in $ million 14,000 –

11,000 –

8,000 –

5,000 –

Fedai Rates

2,000 –

-1,000 –

-4,000 –

-7,000 –

-10,000 –

-13,000 –

Net Foreign Currency Purchases (+)/Sales(-)

-16,000 –

-19,000 – 1/07 3/7 5/07 7/07 9/07 11/07 1/08 3/08 5/08 7/08 9/08 11/08

India since 1997 and also claimed that there had been an emerging consensus about the broad contours of exchange rate management. He made three important observations which are valid to date. First, on the question of the appropriate exchange rate regime, a fixed exchange rate regime is clearly out of favour and for most countries, floating or flexible rates are the only sustainable way of having a less crisis-prone exchange rate regime. Second, in regard to the desirable degree of flexibility in exchange rates, opinions and practices vary. But, a completely “free”

Table 2: Money Market Operations (RBI’s Daily Data)

Average

fluctuations. Third, a

Amount in rupees

  • 35 fundamental change that
  • 37 has taken place in recent
  • 39 years is the importance
  • 41 of capital flows in deter
  • 43 mining exchange rate
  • 45 movements as against trade deficits and eco
  • – 47

    nomic growth, which

    – 49

    were important in the

    – 51

    earlier days. In the light

    – 53 of volatility induced by

    1/09 3/09 5/09 7/09 – 55 capital flows and the

    self-fulfilling expectations that this can generate, there is a growing consensus that emerging market countries should, as a matter of policy, maintain “adequate” reserves. Earlier, the rule used to be defined in terms of number of months of imports. Now, increasingly it is felt that reserves should at least be sufficient to cover likely variations in capital flows or the “liquidity-at-risk”.

    To sum up, the three dominant views that shaped exchange rate policy in India since 1997 were: (a) exchange rates should be flexible and not fixed or pegged; (b) countries should be able to intervene or manage exchange rates; and (c) reserves should at least be sufficient to take care of fluctuations in capital flows and “liquidity at risk”.

    1.1 Nuances of Exchange Rate Policy

    Y V Reddy in his famous speech of 1997 on

    ment postulated the main objective of India’s exchange rate policy as to ensure that economic fundamentals are reflected in the external value of the rupee. Subject to this predominant objective, the conduct of exchange rate policy was guided by three major purposes: to reduce excess volatility, ensuring that market corrections are orderly and calibrated; to help maintain an adequate level of foreign exchange reserves; and, to help develop a healthy foreign exchange market. The nuances of India’s exchange rate policy were further shaped by Bimal Jalan through several of his statements between 1998 and 2003. The broad principles that have guided exchange rate management in this period were:

  • Careful monitoring and management of exchange rates without a fixed target, a pre-announced target or a band. Flexibility in the exchange rate together with ability to intervene, if and when necessary.
  • A policy to build a higher level of foreign exchange reserves which takes into account not only anticipated current account deficits but also “liquidity at risk” arising from unanticipated capital movements.
  • A judicious policy for management of capital account.
  • These nuances in policy mostly continued through Y V Reddy’s period of governorship and his parting July 2008 statement summed up these broad principles.

    July 2009 Average June 2009

    Items for Five Weeks 31(RF) 24 17(RF) 10 3(RF) for Four Weeks 26 19(RF) 12 5(RF)

    No working days 30 6 6 6 6 6 23 6 6 6of

    Call Money
    Weighted average of call rates: 2.63-3.27 3.19-3.27 3.24-3.27 3.20-3.25 3.13-3.22 2.63-3.24 3.07-3.27 3.20-3.27
    per cent (weekly range) per annum (0.00) (0.00) (2.63)
    Daily averages (Rupees crore) 6,313 5,715 9,914 6,094 4,338 5,507 8,647 7,945
    Total call market borrowings (0) (0) (85)
    Notice Money
    Weighted average of notice money rates: 2.00-3.30 2.29-3.30 2.00-3.25 2.28-3.25 2.10-3.21 2.99-3.21 1.04-3.32 2.49-3.23
    per cent (weekly range) per annum (3.16) (3.19) (3.11)
    Daily averages (Rupees crore) 1,391 1,122 1,986 1,729 1,328 792 4,653 1,645
    Total notice market borrowings (6,677) (9,293) (4,185)
    Turnover in term money market 193 154 101 281 180 156 99 116
    (borrowings) $$ (345) (180) (0)

    3.07-3.26 3.15-3.24 3.18-3.24

    (3.16) (0.00) 9,894 7,696 9,051

    (221) (0)

    1.04-3.32 2.25-3.23 2.24-3.18

    (3.20) (3.18) 1,805 1,688 13,476

    (10,667) (80,832) 80 64 135

    (11) (0)

    Data for reporting Fridays are given within brackets and they are also included in the weekly range/daily averages. (RF): Reporting Fridays . $$ No of reporting/traded days are fewer than given above.

    MONEY MARKET REVIEW

    Subbarao acknowledged this stance in his first October 2008 statement indicative of status quo in the nuances of exchange rate policy. But, in his latter statements of January, April and July 2009, while he retained the portion relating to management of foreign exchange reserves, he has kept silent in so far as exchange rate policy is concerned.

    1.2 Differing Policy Views

    A number of suggestions have been made from time to time calling for a shift in the RBI’s exchange rate policy. One strong recommendation made by S S Tarapore in 1997 in his first report on convertibility, which he reiterated in his second report of 2006, is that the RBI should attempt to follow a policy of maintaining a real effective exchange rate (REER) band which is tantamount to a fixed target within a wider band. The RBI, while acknowledging that REER could be an indicator from a medium-term perspective, refrained from using it for managing short-term rate movements. In the last two years, it should be added that the REER, as a measure, has lost its efficacy because of considerable divergence in inflation measures as depicted by the Wholesale Price Index (WPI) and the Consumer Price Index (CPI). As the REER formula adopted by the RBI uses WPI to measure Indian inflation and CPI to measure other countries’ inflation, the inflation differential as captured by this formula cannot be considered any more representative and studying REER trends based on recent data could give a distorted picture. Furthermore, since India moved away in practice from targeting rates, there is no question of revival of targeting an REER band.

    Another view that found support among some prominent economists, including Kenneth Rogoff, is that rupee should be allowed to appreciate freely in line with market trends. According to this view, there is no strong case for the RBI’s further intervention as reserves are already very high. The RBI’s purchases create substantial additional domestic liquidity, which may be destabilising in the long run. All indications are that improvements in productivity and profitability in Indian businesses have been deep enough for exporters to withstand the kind of appreciation we

    Economic & Political Weekly

    EPW
    August 22, 2009

    have seen. Secondly, Graph C: Trends in Weighted Averages of Call Rates, Repo Rates and CBLO Rates – July 2009

    intervention in the forex 3.5 – market has become very

    3

    difficult in the face of the kinds of inflows we 2.5 are facing. It leads to a

    2

    huge injection of liquid-1.5 ity which fuels inflation.

    1

    Rupee appreciation, in contrast, is a useful 0.5 instrument in battling a 0

    27/6 29/6 1/7 3/7 5/7 7/7 9/7 11/7 13/7 15/7 17/7 19/7 19/7 21/7 23/7 25/7 29/7 31/7

    high rate of inflation. Thirdly, by intervening and keeping the move in a much wider band compared to a rupee from appreciating, the RBI encour-few years ago. ages greater inflows – there is no cost

    1.3 Current Challenge:

    to those who borrow abroad. These pro-

    Appreciating Appreciation

    ponents currently lie low partly because of the languishing export sector after Given the above divergent views, what do the global financial turmoil and the we discern if we analyse exchange rate general scepticism surrounding any radi-movements since January 2007? The year cal policy changes in the management of 2007 saw a considerable appreciation in the external sector. the rupee, both in nominal and real terms

    An exactly opposite view – consistently till about January 2008, despite persistent pressed by some economists and trade net purchases of foreign currency by the associations in general – is that RBI should RBI, buoyed by a surge in net capital intervene more

    Table 3: Weighted Averages of Daily Call/Notice Rates in Per Cent Per Annum:

    aggressively in the Simple Statistical Characteristics
    market to further Month/Week Simple Mean * StandardDeviation Coefficient of Variation Simple Mean * StandardDeviation Coefficient of Variation
    reduce the degree of (in %)$ (in %)$
    appreciation. The main argument in June 2009 All four weeks 3.08 Call Money 0.66 21.35 2.69 Notice Money ** 0.64 23.81
    – – – – – – – Call Rates Repo Rates – Outside the RBI CBLO Rates
    favour of this view is 26 3.23 0.02 0.75 2.90 0.31 10.56
    that India must main 19(RF)* 3.20 0.07 2.26 2.54 1.05 41.28
    tain its global “com 12 3.21 0.04 1.27 2.74 0.69 25.29
    petitiveness”, partic 5(RF)* 2.69 1.32 49.00 2.57 0.53 20.45
    ularly in relation to China. Yet another July 2009 All five weeks 2.87 0.98 34.13 2.71 0.48 17.77
    view originates from 31(RF)* 24 2.69 3.25 1.32 0.01 49.00 0.36 2.72 2.34 0.45 0.52 16.4822.04
    the fact that the 17(RF)* 2.69 1.32 48.99 2.91 0.44 15.27
    present policy of con 10 3.16 0.03 1.05 2.49 0.50 19.99
    trolled volatility has 3(RF)* 2.58 1.29 49.83 3.10 0.09 2.90
    provided at times virtually risk-less gain to ** Separate reportings began on 15 March 2005. * Including data for reporting Fridays (RF). $ Based on original unrounded figures. Source: RBI.
    market participants Table 4: Comparison of Call, Overnight CBLO and Repo Rates
    since the rupee has Week Ending Weighted Average Rates (in %) Daily Average Volumes (Rs crore)
    been expected to June 2009 Call Overnight CBLO Repo Call Overnight CBLO Repo
    appreciate or depre 5-Jun-09 3.23 2.50 2.49 10,394 49,468 25,087
    ciate consistently over 12-Jun-09 3.23 2.81 2.91 9,384 58,481 19,952
    a horizon and there 19-Jun-09 3.23 2.23 2.23 11,700 58,486 24,990
    fore, the volatility 26-Jun-09 3.23 2.83 2.93 11,360 60,844 24,753
    tolerance level should July 2009
    be widened. There is 3-Jul-09 3.21 2.21 2.04 7,558 35,111 12,838
    some merit inargument and this the 10-Jul-09 17-Jul-09 24-Jul-09 3.17 3.22 3.24 2.90 2.83 2.99 2.97 2.81 3.08 5,666 7,823 14,025 44,764 46,378 57,846 19,74721,31425,171
    RBI has of late been 31-Jul-09 3.21 2.83 2.87 8,055 55,570 22,063
    allowing the rates to Source: The Clearing Corporation of India Ltd (CCIL).
    vol XLIV No 34 27

    MONEY MARKET REVIEW

    flows, particularly portfolio and external to the market till about May 2009, to some rupee-dollar rate to recover after it reached commercial borrowing (ECB) flows. The extent counteracting the dip in supply a low of Rs 51.23 in March 2009 to Rs 47.77 Rupee appreciated by about 9% against through ECB and FII flows, helped the in June 2009 (Graphs A and B, p 26).

    US dollar. The rupee-dollar rates showed
    a gradual depreciation from Rs 39.37 in Table 5: Auctions of 91-Day Treasury Bills (Amount in rupees crore)
    January 2008 to Rs 42.94 in August 2008, Date of Auction Notified Amount Bids Tendered Bids Accepted Subscription Devolved Cut-off Price Cut-off Yield Amount Outstanding
    the September crisis month showing a sharp depreciation to Rs 45.56. The October (1) (2) No (3) Face Value (Amount) (4) No (5) Face Value (Amount) (6) on PDs (Amount) (7) (Rupees) (8) Rate (%) (9) on the Date of Issue (10)
    month revealed a very sharp appreciation to Rs 42.49 thanks to huge net sales of 2008 July 2 500.00 (66) (2) (2,130.75) (750.00) (8) (2) (500.00) (750.00) (0.00) 97.87 [97.87] 8.73 [8.73] 56,454.00
    foreign currency by the RBI, only to be July 9 3,500.00 113 6,508.94 21 500.00 0.00 97.80 9.02 52,632.00
    followed by a sudden dip to Rs 49 in (5) (4,100.00) (5) (4,100.00) [97.80] [9.02]
    November and with some fluctuations, the rupee touched its record low of Rs 51.23 in March 2009. Beginning in current July 16 July 23 3,000.00 3,000.00 127 (3) 113 (2) 8,219.61 (2,250.00) 6,685.73 (750.00) 63 (3) 41 (2) 3,000.00 (2,250.00) 3,000.00 (750.00) 0.00 0.00 97.78 [97.80] 97.79 [97.80] 9.11 [9.02]9.06 [9.02] 54,882.00 55,632.00
    financial year, the rupee tended to appre July 30 3,000.00 130 9,274.83 60 3,000.00 0.00 97.72 9.36 56,432.00
    ciate against dollar and touched Rs 48.53 (2) (800.00) (2) (800.00) [97.73] [9.32]
    in July 2009. Three major factors seem to have influ 2009 July 1 2,000.00 44 (0) 12,557.00 (0.00) 1 (0) 2,000.00 (0.00) 0.00 99.23 [99.23] 3.11 [3.11] 82,000.00
    enced the rate movements during the July 8 8,000.00 82 25,695.00 37 8,000.00 0.00 99.20 3.23 76,500.00
    period. First is foreign institutional invest (0) (0.00) (0) (0.00) [99.21] [3.19]
    ment (FII) flows, second, ECB flows, and third, RBI interventions. During 2007, July 15 July 22 8,000.00 8,000.00 77 (0) 68 24,462.18 (0.00) 29,287.85 61 (0) 41 8,000.00 (0.00) 8,000.00 0.00 0.00 99.19 [99.20] 99.19 3.28 [3.23]3.28 76,500.00 76,500.00
    though the net FII flows showed wild fluc (0) (0.00) (0) (0.00) [99.20] [3.23]

    tuations, it remained positive throughout July 29 8,000.00 61 26,942.55 19 8,000.00 0.00 99.20 3.23 76,500.00

    (0) (0.00) (0) (0.00) [99.20] [3.23]

    the year. Since January 2008, FII flows for

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

    turned significantly positive only during Table 6: Auctions of 182-Day Treasury Bills (Amount in rupees crore)

    early 2009-10. ECB flows remained posi-Date of Notified Bids Tendered Bids Accepted Subscription Cut-off Cut-off Amount Auction Amount Devolved Price Yield Outstanding tive throughout the period, but these No Face Value No Face Value on PDs (Rupees) Rate on the Date (Amount) (Amount) (Amount) (%) of Issue

    moved in tandem with FII flows, were low

    2008 after September 2008, and picked up only July 9 1,500.00 83 3,923.46 46 1,500.00 0.00 95.58 9.27 20,288.00 in June 2009 (Table 1, p 25). (1) (500.00) (1) (500.00) [95.55] [9.34]

    July 23 1,500.00 83 4,232.25 23 1,500.00 0.00 95.56 9.32 19,683.00

    RBI intervention in the foreign exchange

    (0) (0.00) (0) (0.00) [95.58] [9.27]

    market resulted in substantial purchases

    2009of foreign currency equivalent to $74.88 July 8 1,500.00 52 4,717.00 5 1,500.00 0.00 98.32 3.43 20,375.00 billion during January to December 2007, (0) (0.00) (0) (0.00) [98.32] [3.43]

    July 22 1,500.00 47 3,870.00 28 1,500.00 0.00 98.30 3.47 20,375.00

    much above the FII and ECB flows of $52.85

    (0) (0.00) (0) (0.00) [98.33] [3.41]

    billion during the same period. Despite

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

    The RBI continued with its net purchases 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

    position till about May 2008 amounting to

    Auction Amount Devolved Price Yield Outstanding

    No Face Value No Face Value on PDs (Rupees) Rate on the Date (Amount) (Amount) (Amount) (%) of Issue

    $24.79 billion, FII flows tended to become

    negative, though ECB flows remained posi-2008tive, together accounting for a total flow of

    July 2 1,000.00 106 3,385.55 13 1,000.00 0.00 91.62 9.17 56,220.00

    (1) (8.75) (1) (8.75) [91.78] [8.98]

    only $6.28 billion. RBI purchases, combined

    July 16 2,000.00 109 4,703.50 48 2,000.00 0.00 91.39 9.45 55,886.00

    with a sharp fall in ECB and FII flows per

    (1) (250.00) (1) (250.00) [91.42] [9.41]haps contributed to the sharp depreciation July 30 2,000.00 153 9,661.00 25 2,000.00 0.00 91.30 9.56 in rupee-dollar rates from Rs 39.37 to Rs (1) (36.55) (1) (36.55) [91.31] [9.55] 55,923.00

    42.13 during January-May 2008. Net sales 2009 July 1 1,000.00 56 3,650.00 8 1,000.00 0.00 96.34 3.81 46,491.00

    of foreign exchange of the order of $11.55

    (0) (0.00) (0) (0.00) [96.36] [3.79]

    billion during June and July 2008 seemed

    July 15 1,000.00 79 4,965.00 16 1,000.00 0.00 96.45 3.69 45,500.00 to have helped the rupee to remain stable (2) (259.42) (2) (259.42) [96.46] [3.68]

    at around Rs 42.80/90 till August 2008. July 29 1,000.00 46 3,070.00 24 1,000.00 0.00 96.35 3.80 44,464.00

    (0) (0.00) (0) (0.00) [96.40] [3.74]

    Since then, the persistent policy of augment-

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

    august 22, 2009 vol XLIV No 34

    MONEY MARKET REVIEW

    53

    51

    49

    47

    45

    43

    41

    39

    Graph D: Spot Quotations for the Dollar in the Domestic Inter-Bank Market

    (Monthly Averages) (Jan 2001 to June 2009) (Daily) Working Days July 2009

    In sum, except during early 2008 when RBI interventions seemed to have hastened the process of depreciation by and large, the interventions were counteracting market trends – purchases when market supply is large and sales when market supply dips, thus avoiding gyrations in rupee-dollar rates. Currently, there has been augmentation of supplies through both ECB and FIIs and RBI seems to have started purchasing foreign currency from the market, preventing any quick appreciation of rupee. But, when the RBI starts attempting to exit from the policy of excessive monetary accommodation, this is going to pose a dilemma and it may perforce be compelled to allow the rupee to appreciate in the near future. To what extent and at what pace this may happen will however be determined by the need for maintaining incentives for exports which are really in bad shape, and the overall liquidity conditions.

    The above analysis makes it clear that, though not explicitly stated, there does not seem to be any change in the approach to exchange rate policy or management in recent months.

    2 Money, Gilt-Edged and Forex Markets

    The two major events affecting market expectations during the month were the presentation of the Union Budget on 6 July and announcement of the first quarter Review of Monetary Policy on 27 July. The higher fiscal deficit and the enlarged borrowing programme of the union government were causes for depressing market sentiments. There were signals domestically and from abroad that the early recovery prospects of the economy were bright, excepting the agriculture and export sectors, which were adversely affected. The return of capital flows helped boost market sentiments and the rupee became more stable after touching lows in previous

    Economic & Political Weekly

    EPW
    August 22, 2009

    months. The very high borrowing pro

    gramme led the government to front-load

    its primary issuances and the pattern of

    borrowing and market preferences were

    in favour of relatively short-term invest

    ments, particularly treasury bills. Money

    market activity, in general, remained sub

    dued, perhaps because the liquid funds

    found their way into the credit, bonds and

    securities markets. The rates however

    remained flat, but marginal pressures are

    seen building up during the course of July.

    In spite of the larger outflow through

    government auctions, the financial system

    did not face any liquidity shortage as the

    volume in the repo market was much larger

    in comparison to June.

    The gilt edged segment saw a large

    number of issues in the primary market,

    reflecting the front-loading strategy of the

    government, bearing in mind the need for

    conducting a large borrowing programme

    in the remaining part of the financial year

    without market disruptions and ensuring

    credit flow to the commercial sector. The

    forex market saw the rupee-dollar rates

    touching Rs 49 and, in comparison to June,

    the rupee was slightly weaker in July. The

    strengthened position of the dollar vis-à-vis

    other currencies and low FII investments

    in the first half of the month were some of

    the reasons for the rupee weakening.

    2.1 Money Market

    The daily average volume in call and notice money markets witnessed a sharp fall in July. The reported volume was Rs 6,313 crore vis-à-vis Rs 8,647 crore in June. However, the weighted average call rate was in the range of 3.13% to 3.27% – similar to the month of June. The mean value of the call rate was 3.08% with a standard deviation of 0.66 (Table 3, p 27). The notice money market saw nearly a 70% fall in daily average volume, July reporting Rs 1,391 crore vis-à-vis Rs 4,653 crore reported in June. The volatility in the market had increased – the standard deviation during July was 0.98 compared to 0.48 in June. The trends exhibited in the CBLO and repo markets were similar (Table 4, p 27). There was a slowdown in the beginning of the month, but a gradual pickup was seen in the later part of the month. There was a substantial fall in repo transactions outside the RBI from Rs 1,85,570

    vol XLIV No 34

    crore in June to Rs 66,937 crore in July. The subdued activity in the money market is reflective of the deployment of liquid flows into the credit, bond and securities markets (Table 2, p 26 and Graph C, p 27).

    2.2 Forex Market

    Among Asian currencies, the rupee was referred to as the third worst performing currency in the month of July. The factors that led to poor performance of the rupee were the growing uncertainty in the global market scenario which depressed investor confidence, instances of dollar strengthening against other foreign currencies, the announcement of the budget and the fear about restoration of fiscal consolidation in time, and increased dollar demand from the importers. FII inflow for the first two weeks of the month was relatively less. Stock indices and exchange rates moved in tandem. The quarterly and monthly estimates of gross domestic product and the index of industrial production in India were favourable for a pickup in investment demand. The RBI reference rate touched its upper bound on 13 July quoting at Rs 49.40/$ and a lower bound of Rs 47.79/$ on 2 July. An appreciation of rupee against the dollar by about 1.1% occurred immediately after 14 July, when the news about Asian countries doing well hit the market (Graph D). Overall, the rupee remained range-bound during the month, depreciating slightly in the first half and stabilising during the latter part of the month.

    The forward premia of one month, three month and six month continued their downward trend in July, as in the previous month. The six-month annualised forward premia declined from 2.72% at end-June to 2.57% at end-July (Graph E, p 31).

    The rupee-dollar futures volumes have grown substantially during July as the month recorded a 23% rise in its daily average turnover. The average daily turnover on exchange-traded currency futures improved from Rs 6,516 crore in June to Rs 8,035 crore in July. Similarly, the total turnover on currency exchanges has jumped by 30% over the previous month.

    3 Primary Market

    The Primary market activity showed a substantial increase during the month of July across all segments, viz, the central

    MONEY MARKET REVIEW

    government, state governments, corpo also exhibited larger volumes. The corpo actively participating. The bid cover ratio
    rates, banks and government undertakings. rate bonds market also performed better and also the issuance volume generally
    Treasury bill issuances of all maturities with corporates and central undertakings depicted a preference for shorter maturities
    Appendix Table: Secondary Market Operations in Government Papers: NDS and NDS-OM Deals (Amount in rupees crore)
    Descriptions Week Ending July 2009: Yield to Maturity on Actual Trading Total for the Month
    31 24 17 10 3 of July 2009
    AMT YTM CY AMT YTM CY AMT YTM CY AMT YTM CY AMT YTM CY AMT YTM CY
    1 Treasury Bills
    A 91-Day Bills 1081.66 3.17 2053.50 3.13 3531.04 3.18 4982.18 3.02 3379.13 3.20 15027.51 3.12
    B 182-Day Bills 313.00 3.34 368.35 3.35 285.00 3.25 110.00 3.28 95.00 3.00 1171.35 3.29
    C 364-Day Bills 398.15 3.56 499.33 3.51 621.10 3.37 399.83 3.43 800.00 3.72 2718.41 3.54
    2 GOI Dated Securities
    A Regular (Per Cent: Year)
    5.87 , 2010 310.00 3.67 5.82 445.00 3.62 5.81 115.00 3.66 5.81 315.00 3.66 5.81 903.00 3.67 5.81 2088.00 3.66 5.81
    6.20 , 2010 UTI SB - - - - - - - - - 225.00 3.85 6.12 - - - 225.00 3.85 6.12
    7.55 , 2010 97.00 3.97 7.35 70.00 3.83 7.34 585.79 3.92 7.34 545.00 4.10 7.34 720.00 4.10 7.34 2017.79 4.03 7.34
    11.30 , 2010 130.00 4.00 10.55 - - - 50.00 4.05 10.54 - - - - - - 180.00 4.01 10.55
    12.25 , 2010 - - - - - - 215.00 4.10 11.39 100.00 4.07 11.37 35.00 4.29 11.37 350.00 4.11 11.38
    12.29 , 2010 480.00 3.66 11.80 20.00 3.60 11.78 - - - - - - 110.00 3.88 11.74 610.00 3.70 11.79
    6.57 , 2011 160.00 4.86 6.41 420.00 4.84 6.40 130.00 4.91 6.41 95.00 5.04 6.42 - 805.00 4.88 6.41
    9.30 , 2011 - - - - - - - - - 50.00 5.00 8.60 - - - 50.00 5.00 8.60
    9.36 , 2011 - - - - - - 100.00 4.95 8.65 285.00 5.20 8.68 - - - 385.00 5.14 8.68
    9.39 , 2011 660.00 5.14 8.72 70.00 4.94 8.68 225.00 4.98 8.68 - - - 731.00 5.26 8.72 1686.00 5.16 8.71
    10.95 , 2011 - - - 25.00 4.89 9.90 100.00 4.93 9.90 130.00 5.00 9.91 20.00 5.48 9.97 275.00 5.00 9.91
    11.50 , 2011 - - - 55.00 5.20 10.12 40.00 5.15 10.25 - - - - - - 95.00 5.18 10.17
    12.00 , 2011 - - - 25.00 5.30 10.53 575.00 5.15 10.49 - - - - - - 600.00 5.15 10.49
    12.32 , 2011 100.00 4.92 11.14 175.00 5.00 11.15 - - - - - - - - - 275.00 4.97 11.15
    6.85 , 2012 - - - - - - 35.00 5.66 6.65 - - - 0.09 6.24 6.75 35.09 5.66 6.65
    7.00 , 2012 OMC SB 10.00 6.38 6.88 50.00 6.37 6.88 - - - - - - - - - 60.00 6.37 6.88
    7.40 , 2012 140.00 5.80 7.11 785.00 5.95 7.17 1270.00 5.61 7.08 920.00 5.68 7.09 375.00 5.72 7.09 3490.00 5.73 7.10
    9.40 , 2012 - - - 26.25 5.93 8.56 - - - - - - - - - 26.25 5.93 8.56
    10.25 , 2012 - - - - - - - - - - - - 50.00 5.90 9.19 50.00 5.90 9.19
    7.27 , 2013 550.00 6.42 7.06 520.43 6.40 7.05 787.00 6.29 7.02 944.50 6.28 7.02 865.00 6.23 7.01 3666.93 6.31 7.03
    12.40 , 2013 - - - - - - 60.00 6.50 10.25 - - - 30.00 6.23 10.15 90.00 6.41 10.22
    6.07 , 2014 6967.71 6.62 6.21 8545.00 6.55 6.19 5312.37 6.43 6.16 15727.13 6.39 6.15 17645.99 6.39 6.15 54198.20 6.45 6.17
    6.72 , 2014 - - - 205.00 6.59 6.69 65.00 6.47 6.65 - - - - - - 270.00 6.56 6.68
    7.37 , 2014 50.00 6.74 7.19 - - - 260.00 6.52 7.13 125.00 6.50 7.12 276.20 6.53 7.13 711.20 6.53 7.13
    7.56 , 2014 635.00 6.71 7.29 505.00 6.77 7.28 350.00 6.56 7.24 270.00 6.50 7.22 835.00 6.51 7.23 2595.00 6.62 7.25
    6.49 , 2015 4358.78 6.73 6.57 3600.95 6.67 6.55 6078.48 6.55 6.51 7345.00 6.50 6.50 4591.00 6.48 6.49 25974.21 6.57 6.52
    7.59 , 2016 991.67 6.88 7.32 560.00 6.84 7.30 1412.00 6.78 7.27 1625.00 6.80 7.28 3949.00 6.74 7.26 8537.67 6.78 7.28
    7.46 , 2017 30.10 7.11 7.31 195.27 7.04 7.27 88.92 6.98 7.25 - - - 253.10 6.96 7.24 567.39 7.00 7.26
    7.49 , 2017 15.00 7.10 7.33 26.00 7.08 7.32 - - - - - - 2.00 7.10 7.32 43.00 7.09 7.32
    7.99 , 2017 45.81 7.12 7.59 30.00 7.06 7.57 - - - - - - 0.11 7.15 7.61 75.92 7.10 7.58
    8.07 , 2017 76.00 7.08 7.64 50.07 6.95 7.58 30.00 7.29 7.73 75.50 7.11 7.65 290.90 7.01 7.60 522.47 7.04 7.62
    8.24 , 2018 120.00 7.12 7.69 260.00 7.00 7.63 40.00 7.09 7.67 - - - 1216.00 7.64 7.81 1636.00 7.49 7.77
    6.05 , 2019 65.00 7.05 6.50 - - - 10.00 6.97 6.46 593.80 6.99 6.47 1809.30 6.92 6.44 2478.10 6.94 6.45
    6.90 , 2019 8137.10 6.92 6.91 7617.15 6.87 6.89 16186.87 6.80 6.85 497.38 6.88 6.89 - - - 32438.50 6.85 6.88
    6.35 , 2020 210.00 7.17 6.75 530.50 7.06 6.70 350.50 7.10 6.72 2397.00 6.96 6.65 5353.00 6.79 6.56 8841.00 6.87 6.61
    7.94 , 2021 11361.41 7.24 7.53 13057.00 7.23 7.52 14386.82 7.20 7.50 11870.10 7.23 7.54 24131.14 7.19 7.50 74806.47 7.21 7.51
    8.08 , 2022 70.00 7.46 7.69 55.00 7.46 7.69 - - - - - - 50.00 7.41 7.66 175.00 7.44 7.68
    8.13 , 2022 - - - - - - 85.00 7.44 7.69 - - - - - - 85.00 7.44 7.69
    8.20 , 2022 771.00 7.42 7.71 508.65 7.40 7.70 2020.50 7.34 7.67 1420.00 7.35 7.67 4242.60 7.30 7.64 8962.75 7.33 7.66
    8.35 , 2022 - - - - - - - - - - - - 95.19 7.33 7.71 95.19 7.33 7.71
    6.65 , 2023 FERT BONDS - - - - - - 30.00 7.84 7.37 50.00 7.85 7.38 30.00 7.85 7.38 110.00 7.85 7.38
    8.20 , 2023 OMC SB 56.79 7.88 7.98 746.62 7.91 8.00 12.00 7.89 7.99 - - - - - - 815.41 7.91 8.00
    7.35 , 2024 150.00 7.43 7.40 26.38 7.41 7.39 1190.56 7.39 7.38 416.38 7.42 7.40 1345.55 7.35 7.35 3128.87 7.38 7.37
    8.03 , 2024 FCI SB - - - - - - - - - - - - 40.05 7.91 7.94 40.05 7.91 7.94
    8.03 , 2024 FCI BONDS - - - - - - - - - - - - 30.00 7.87 7.92 30.00 7.87 7.92
    7.95 , 2026 FERT SB 10.89 7.89 7.91 15.94 7.90 7.92 - - - 0.96 7.90 7.91 0.15 8.25 8.17 27.94 7.90 7.91
    7.95 , 2026 FERT BONDS - - - - - 30.00 7.95 7.95 - - - 30.00 7.95 7.95
    8.00 , 2026 OMC SB 32.77 7.89 7.92 85.99 7.85 7.89 567.33 7.91 7.94 405.53 7.90 7.93 989.45 7.87 7.91 2081.07 7.89 7.92
    8.23 , 2027 FCI SB 0.10 7.83 7.93 - - - 3.00 8.21 8.21 39.64 7.91 7.99 64.60 7.90 7.98 107.34 7.91 7.99
    8.24 , 2027 1735.67 7.70 7.84 722.50 7.67 7.82 2159.50 7.73 7.86 2106.25 7.77 7.89 2792.57 7.69 7.83 9516.49 7.72 7.85
    8.26 , 2027 - - - 25.00 7.84 7.94 70.00 7.84 7.94 - - - - - - 95.00 7.84 7.94
    8.28 , 2032 25.00 7.83 7.91 - - - - - - - - - 5.00 7.72 7.82 30.00 7.82 7.90
    7.35 , 2034 - - - 115.00 7.40 7.39 - - - 240.00 7.38 7.37 - - - 355.00 7.38 7.37
    7.50 , 2034 90.60 7.81 7.76 141.08 7.82 7.77 1052.57 7.92 7.86 395.54 7.81 7.76 123.53 7.75 7.71 1803.32 7.87 7.82
    7.40 , 2035 411.94 7.78 7.75 746.55 7.81 7.75 219.09 7.78 7.73 122.35 7.90 7.83 553.65 7.85 7.79 2053.58 7.82 7.76
    8.33 , 2036 9.00 7.81 7.88 0.60 7.80 7.87 14.68 7.78 7.85 - - - 8.40 7.72 8.81 32.68 7.78 8.10
    6.83 , 2039 16.50 7.72 7.61 15.50 7.90 7.77 65.00 7.92 7.79 25.00 7.81 7.69 - - - 122.00 7.87 7.75
    Sub-total 39107.79 6.86 7.13 41108.33 6.87 7.03 56446.20 6.83 7.14 49394.76 6.71 6.87 74621.56 6.82 7.03 260678.64 6.81 7.04
    B RBI’s OMO: Sales 354.00 - - 311.00 - - 749.00 - - 889 - - 289 - - 2592.00 - -
    Purchase 352.00 - - 3899.00 - - 749.00 - - 2554 - - 281 - - 7835.00 - -
    Sub-total 706.00 - - 4210.00 - - 1498.00 - - 3443.00 - - 570.00 - - 10427.00 - -
    (A+B) 39813.79 6.86 7.13 45318.33 6.87 7.03 57944.20 6.83 7.14 52837.76 6.71 6.87 75191.56 6.77 6.98 271105.64 6.81 7.04
    3 Market Repo 12988.17 10924.34 16421.15 11790.92 14812.70 66937.28
    4 State Govt Securities 2276.87 7.70 8.09 809.15 7.41 8.17 726.53 7.65 7.97 1268.08 7.68 8.04 879.36 7.62 7.97 5959.99 7.64 8.06
    Grand total (1 to 4) 56871.64 59973.00 79529.02 71388.77 95157.75 362920.18

    (-) means no trading. YTM = Yield to maturity in per centage per annum. CY = Current yield in per cent per annum. SGL = (RBI’s) Subsidiary General Ledger. OMO = Open Market Operations. OMC SB= Oil Marketing Companies Special Bonds. NDS = Negotiated Dealing System. OM = Order Matching Segment. Securities with small-size transactions (Rs 25 crore or less) have been dropped from the above list but included in the respective totals.

    (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.

    august 22, 2009 vol XLIV No 34

    MONEY MARKET REVIEW

    Graph E: Annualised Forward Premia in Percentage for the Dollar in the dominated by 91-day bills Graph F: Yield Curves for Dated Securities – Weighted

    Domestic Inter-Bank Market and Weighted Averages of Call Rates for July 2009 Averages for the Second and Last Week of July 2009

    amounting to Rs 34,000

    3.00 3.05 3.10 3.15 3.20 3.25 3.30 0.00 0.50 1.00 1.50 2.00 2.50 3.00 3.50 6 month Weighted Averages of Call Rates (Right axis) 1 month – – – – – – – – – – – – – – –

    30/6 3/7 6/7 9/7 12/7 15/7 18/7 21/7 24/7

    which is usual when the market expects a rising interest rate scenario.

    3.1 Dated Government Securities

    The 16-year high fiscal deficit confronted by the government puts pressure on it to plan its ways of raising funds ahead of the pickup in economic activity, adopting a “front loading” strategy. In the month of June and July, government issued a total volume of Rs 82,000 crore in dated securities. The maturity of 2014 and 2015 dominated issues, sharing Rs 23,000 crore out of the total issue of Rs 33,000 crore. The bid-cover ratios were more than two times for these issues. One of the auctions, for 2021 maturity witnessed a devolvement on primary dealers. During the course of the month, fresh issues were cut off at higher yields indicating increasing pressure on interest rates. For instance, the cut-off yield for 6.07% 2014 on 31 July was 6.74% compared to 6.49%, two weeks earlier.

    State government borrowings amounted to Rs 12,300 crore by nine states with the state of Andhra Pradesh and Uttar Pradesh issuing bonds on two occasions. The yield from these securities ranged from 7.77% to 7.97% and recorded a bid-cover ratio of 3.3. The yield on securities issued by Andhra Pradesh was 7.93%, with a bid ratio of 2.76 at the first instance; the yield was 7.97 % and the bid ratio was 3.35 at the second instance. Uttar Pradesh state securities yielded 7.97% (highest yield) with bid-cover ratio of 2.39 at the first instance and a yield of 7.8% with a bid-cover ratio of 2.59 in the second instance.

    3.2 Treasury Bills

    The total issuance under treasury bills of all maturities aggregated Rs 40,000 crore in July against Rs 22,000 crore in June,

    Economic & Political Weekly

    EPW
    August 22, 2009

    8

    crore. The preference to issue short-term securities may be due to the large issuance of government bonds and investor resistance to long-term bonds

    Yield (% per annum) 5 5.5 6 6.5 7 7.5 Week ending 31 July Week ending 3 July

    in the current context of interest rates bottoming out. This preference is evident from the very

    27/7 30/7

    high bid-cover ratio of

    more than three times in all issues. The

    cut-off yields picked up during the course

    of the month from 3.11% to 3.23%.

    The issues of 182-day bills amounted to

    Rs 3,000 crore and cut-off yield ranged

    from 3.41% to 3.43% and the 364-day bills

    were issued for an equivalent amount at

    cut-off yields of 3.69% and 3.81%. The cut

    off yields in the treasury bill auctions

    showed some softening in July compared

    to the previous month, thanks to the huge

    demand for these short-term instruments

    (Tables 5, 6 and 7, p 28).

    3.3 Corporate Bonds

    Corporate bonds amounting Rs 10,430

    crore were issued in July. These accrued

    from 28 issues. The issues from corporates

    and the central undertakings dominated the

    issuance market equally with respective

    shares of 31% (Rs 3,530 crore) and 33%

    (Rs 3,325 crore). FIs’/Banks’ share was

    16.7% while that of non-bank finance com

    panies (NBFCs) was 17.4%. A larger volume

    of Rs 2,000 crore came from the Indian Oil

    Corporation with triple A rated bonds

    maturing in three years with a coupon of

    7%. Rural Electrification Corp also issued

    bonds worth Rs 2,000 crore. The Life Insur

    ance Corporation of India issued bonds of

    Rs 1,100 crore topping under NBFCs. These

    bonds carried a coupon of 7.45% in three

    years maturity. In the banks segment, the

    participating banks issued lower and upper

    tier-II bonds and perpetual bonds, with

    maturities spanning 10 years and carrying

    coupons from 8.54% to 9.15%. Two issues

    had provisions for step-up by 50 basis

    points if call was not exercised at maturity.

    Overall, the corporate bond segment

    performed better in comparison to June

    with issues of Rs 10,430 crore, which is

    reflective of an improving investment

    vol XLIV No 34

    123456789 1011121314151718192325262730

    Years to Maturity

    climate consequent to expectations of better growth prospects.

    4 Secondary Market

    The total volume traded in Treasury Bills fell by about 6% to Rs 18,917 crore in July vis-à-vis Rs 20,104 crore in June. The total turnover in the secondary market amounted to Rs 3,62,920 crore in July showing a decline of 11% from the previous month. OMO of the RBI remained relatively more active and recorded a volume of Rs 10,427 crore against Rs 6,860 crore in June. The instruments that were traded popularly were 7.94% 2021, five-year benchmark security of 6.07% 2014 and 10-year benchmark security of 6.90% 2019. The total volume in government of India dated securities traded showed a marginal increase and amounted to Rs 2,60,678 crore. Importantly, the yield rates marginally picked up by 15 basis points from 6.67% to 6.81%. The yield curve showed, by and large, a steady shift across maturities (Graph F).

    A drastic decrease in the volume of trade in the repo market was observed. The transactions amounted to Rs 66,937 crore in July in comparison to Rs 1,85,570 crore in June. The fall in the trading volume reflected the subdued volumes in the money market in general.

    Operations of the RBI under LAF exhibited a trend of higher absorption compared to the last month, confirming the enormous surplus liquidity remaining in the system. These funds are perhaps kept under LAF, expecting a pickup in the credit demand in the coming months. The net outstanding amount at weekends through the month remained around Rs 1,40,000 crore, the daily average of bids remaining generally above Rs 12,80,00 crore.

    The daily average turnover in the bonds segment of trades in NSE showed an increase from Rs 348 crore in June to Rs 503 crore in July.

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