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Quenching the Inflation Fire

The current surge in inflation is not receiving the urgent attention that is needed from the government. Alongside a rise in wholesale price inflation, uncertainty and risk have increased. Consumer price inflation is also ruling at an unacceptably high level. The explanations that are offered are many, but it is clear that both supply and demand factors are at work behind the acceleration in inflation. Increase in inflation variability, which is indicative of uncertainty associated with the inflation rate, would place a higher premium on inflation risk, which would, in turn, be reflected in the next upturn in the interest rate cycle. One way of mitigating the inflation risk premium and generating interest in long maturities is to issue a series of inflation indexed bonds with an assured real return in the range of 2 to 3%.

inflation away is made further easier

Quenching the Inflation Fire

because of multiple inflation rates and divergent trends. If there is a spike in inflation it could be called only seasonal or EPW Research Foundation temporary or even a statistical phenome-

The current surge in inflation is not receiving the urgent attention that is needed from the government. Alongside a rise in wholesale price inflation, uncertainty and risk have increased. Consumer price inflation is also ruling at an unacceptably high level. The explanations that are offered are many, but it is clear that both supply and demand factors are at work behind the acceleration in inflation. Increase in inflation variability, which is indicative of uncertainty associated with the inflation rate, would place a higher premium on inflation risk, which would, in turn, be reflected in the next upturn in the interest rate cycle. One way of mitigating the inflation risk premium and generating interest in long maturities is to issue a series of inflation indexed bonds with an assured real return in the range of 2 to 3%.

Team led by K Kanagasabapathy and supported by V P Prasanth, Rema K Nair, R Krishnaswamy, Anita B Shetty, Shruti J Pandey, Vishakha G Tilak and Sharan P Shetty.

I
nflation is heating up in India by any measure or standard and once it gallops and gains further speed, reining it in would be increasingly difficult, as it will start feeding on itself. While emerging market economies including India encouraged excessively accommodative policies as a crisis mitigating measure, India should now quickly wake up to quench the inflation fire that is building up. Indian authorities who talked tough on inflation till mid-September 2008 have now moved into a phase of inertia, perhaps because there are no elections around the corner. But if the government does not want to face the next elections amidst runaway inflation, it better start acting now.

Former Reserve Bank of India (RBI) Deputy Governor Rakesh Mohan, alluding to multiple inflation measures in India, quipped when the wholesale price inflation and the consumer price inflation were running in the range of 3% to 6% that India was also apparently following a policy of targeting inflation in the

non, if the spike is caused by food prices then it is a supply side issue, if it is due to a rise in commodity or oil prices it is an external shock, and so on. The fact is that any number of explanations are not going to reduce the distress of the people, particularly the poor who are reeling under the pressure of rising prices of day to day consumption and whose limited wealth vapours into thin air.

Graph A (p 20) shows the trends in annual inflation rate on a monthly basis from April 1995 and up to October/ November 2009, measured by the two major indices WPI and CPI. While the indices generally move in tandem, there were periods when the CPI inflation remained way above the WPI, because of pressure exerted by food inflation, as is the case since mid-2008. The mean and variability of these two inflation rates are summarised in Table 1, for three different periods, viz, 1995-96 to 2000-01 (period one); 2001-02 to 2005-06 (period two); and from 2006-07 till October/November 2009 (current period).

Table 1: Inflation Variability – WPI and CPI

band of 3 percentage Period Wholesale Price Index Consumer Price Index Mean Standard Coefficient Mean Standard Coefficient

points. Now, this band is

Monthly Rate Deviation of Variation Monthly Rate Deviation of Variation

more than 10 percentage 1995-96-2000-01 5.6 2.1 0.4 7.8 4.1 0.5

points thanks to rising 2002-2005-06 4.7 1.7 0.4 4.1 0.8 0.2

food inflation. While 2006-07-2009-10

inflation according to the (upto October) 5.2 3.4 0.6 7.9 1.9 0.2 Source: Office of the Economic Adviser (www.eaindustry.nic.in), Compilation by EPWRF.

Wholesale Price Index

(WPI) will gather speed, inflation according to the Consumer Price Index (CPI) is persistent at a very high level and not relenting. Inflation expectations are on the rise and no credible commitment seems to be in place to address the issue. Against this backdrop, an attempt is made here to scan annual inflation trends in the current period and to suggest introduction of inflation indexed bonds as a step to ward off fear about rising inflation expectations before it gets too late.

1 Inflation Trends and Variability

It has become rather fashionable for official spokespersons to brush aside the seriousness of current inflation trends. Explaining

december 19, 2009

In the case of WPI, the mean inflation rate came down from 5.6% to 4.7% between the first and second periods, but in the current period it has risen to 5.2%. The more worrisome feature, however, is that the variability as measured by the standard deviation (SD) and coefficient of variation (CV) has increased significantly in the current period, compared to the second period, from 1.7 to 3.4 and from

0.4 to 0.6 respectively. This is a clear sign that the risk and uncertainty associated with the WPI inflation rate have increased substantially, and anchoring inflation expectations has been rendered relatively more difficult.

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MONEY MARKET REVIEW

Graph A: Trend in Inflation Rate – WPI and CPI (1995-96-2009-10)
4/95 10/95 4/96 10/96 4/97 10/97 4/98 10/98 4/99 10/99 4/00 10/00 4/01 10/01 4/02 10/02 4/03 10/03 4/04 10/04 4/05 10/05 4/06 10/06 4/07 10/07 4/08 10/08 4/09 10/09 CPI WPI

22.5

20.0

17.5

15.0

12.5

10.0

7.5

5.0

2.5

0.0

-2.5

As far as the CPI inflation rate is concerned, the data shows a different kind of concern. The variability in CPI inflation rate was at its peak in period one, at SD and CV of 4.1 and 0.5 respectively, with mean inflation rate also high at 7.8%. The mean inflation rate as also its variability came down significantly in period two. The mean rate was 4.1% and the SD and CV were at 0.8 and 0.2, respectively. But, in the current period, while the variability in terms of SD (1.9) and CV (0.2) has not widened significantly, the mean inflation rate has surpassed the level in period one and touched 7.9%. This reflects the persistence of CPI inflation at a much higher level. This level is further rising, rather galloping in recent months, currently to around 11.5% at the margin. This could transform into a wage-price spiral.

The danger signs are clear: inflation risk and uncertainty have increased; and the inflation rate is also persistent at a higher level.

1.1 Supply versus Demand Debate

A common and handy explanation offered is that inflation is now a supply side phenomenon because it is caused by a rise in food prices. Alfred Marshall stated that supply and demand side work like a pair of scissors and it would be very difficult to make out which side exerts more or less pressure in a given time. While talking Increase in food inflation cannot be brushed aside as a supply side phenomenon and there are several demand side factors at work, besides the obvious factor of monetary growth.

First, the overall demand from the urban sector has gone up due to the general services sector growth combined with the implementation of the recommendations of the pay commission. A crucial fact is that services sector growth is goods-less growth of employment putting pressure on consumer prices. Second, rural demand has gone up due to the implementation of the employment guarantee programme besides the impact of higher government expenditure on other rural development programmes. The National Rural Employment Guarantee Scheme, launched in 2006, alone had an initial allocation of Rs 12,000 crore which has gone up to Rs 39,100 crore in 2009-10. Third, the credit flow to agriculture and allied activities has increased substantially over the past few years at an annual rate ranging from 20% to 40% since 2005-06. Fourth, while the overall growth of the economy remained high and buoyant but for the dip after the global crisis, capital formation was sustained at a high level throughout, signalling a persistent growth of investment demand. The Q2 2009-10 data shows revival in capital formation to 34.7% of GDP from

Table 2: Money Market Activity (Volume and Rates)

31.6% in Q1. This is also supported by the robust contribution maintained by core industries and capital goods sectors to the growth in index of industrial production in recent years. Since the investments have a lagged effect on supply of consumption goods but will immediately augment consumption demand, the pressure on consumer prices is understandable.

Besides all these factors, if international commodity and oil prices go up, inflation has the potential of getting imported with a devastating impact on the overall price level. The burden of CPI inflation is further exacerbated because of market integration through operation of commodity bourses – the price risks instead of getting localised get transmitted across centres. The high and persistent consumer price inflation deserves to be viewed more seriously by Indian policymakers. Policy measures both from supply and demand sides are relevant for addressing this issue.

1.2 Case for Inflation Indexed Bonds

Nominal interest rates are influenced by three factors, viz, the expected real return of investors, expected inflation rate and the inflation risk premium. The inflation risk premium depends upon the variability associated with the inflation rate. Increase in inflation variability, which is indicative of uncertainty associated with the inflation rate, would thus place a higher premium on inflation risk, which would, in turn, be reflected in the next upturn in the interest rate cycle. The overall increase in interest rates will not only be guided by the higher inflation expectations alone but also by the higher inflation risk premium. This phenomenon was very much evident during the early 1990s when government bond rates touched a peak of 14%. In the current period, the situation seems to be much worse, unless quick remedial

about targeting inflation based on some November 2009 October 2009
core measure after excluding food and Instruments Daily Average Volume (Rs crore ) Monthly Weighted Average Rate (%) Range of Weighted Daily Average Average Daily Rate@ (%) Volume (Rs crore) Monthly Weighted Range of Weighted Average Rate (%) Average Daily Rate@ (%)
energy inflation in the Indian context, Call Money 6,441 3.23 2.58-3.28 6,831 3.26 1.68-3.91
Y V Reddy, former governor of the RBI, Notice Money 1,081 3.21 2.30-3.25 1,170 3.20 2.44-3.30
said on several occasions that looking at Term Money 76 - 3.25-6.75 39 - 3.00-6.80
inflation without these components in the CBLO 51,816 2.83 1.16-3.15 57,735 2.63 0.03-3.90
Indian case has no meaning since they have substantial weights in the indices. Market Repo 21,626 2.86 @: Range of rates during the month. Source: www.rbi.org.in. and www.ccilindia.com. 0.50-3.14 22,961 2.78 1.74-3.54
Economic & Political Weekly december 19, 2009 vol XLIV No 51 21
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Graph B: Trends in Weighted Averages of Call Rates, Repo Rates and CBLO Rates – government since the

November 2009

measures are taken. The bond rates would lead also to lower demand for long maturities, making the refinancing of bonds difficult.

One way of mitigating the inflation risk premium and generating interest in long

Table 3: RBI’s Market Operations (Amount in Rs crore)

Month/ Year OMO (Net Purchase(+)/ LAF (Average Daily Sale(-)) Injection (+)/Absorption(-))

April-09 20,292 -95,915

May-09 16,959 -1,29,997

June-09 6,451 -1,23,153

July-09 5,243 -1,26,740

August-09 12,073 -1,24,488

September-09 14,275 -1,24,812

October-09 1,082 -1,04,047

November-09 182 -1,04,506

Source: RBI’s Weekly Stastical Supplement.

maturities is to issue a series of inflation indexed bonds with an assured real return in the range of 2 to 3%. Such bonds properly structured would provide a complete hedge against inflation and protect the long-time savers and investors from the inflation risk. The borrowing calendar for the ensuing period of this current fiscal should add this feature without much loss of time. These bonds would carry several advantages. First, this is about the only way to guarantee a real return on financial investments. Second, it will signal the government’s commitment to containing inflation and add to credibility of policies, which could help contain inflation expectations. Third, it will add to the diversity of financial assets and particularly fulfil the need of long-term savers and investors such as insurance, pension funds and the like. Fourth, for policymakers, the trading prices of these bonds vis-à-vis other nominal bonds will provide a measure of objectively gauging inflation expectation. Last but not least, they could potentially help reduce the cost of borrowing for the inflation expectation once triggered gets anchored at a higher level and takes a long time to subside and be captured in bond prices.

0 0.5 1 1.5 2 2.5 3 3.5 31/10 2/11 4/11 6/11 8/11 10/11 12/11 14/11 16/11 18/11 20/11 22/11 24/11 26/11 Call Rates Repo Rates – Outside the RBI CBLO Rates

As of 2008, it is reported that government-issued inflationlinked bonds comprise over $1.5 trillion of the international debt mar

ket and the inflation-linked market consists primarily of sovereign bonds. The United Kingdom, Canada, Australia and the United States are the prominent issuers of inflation indexed bonds and perhaps India could be a forerunner among the emerging markets. Though a capital indexed bond was introduced in the late 1990s, in India it proved to be a half-hearted attempt since it did not provide full hedge against inflation. Therefore, the new index-linked issues should provide protection to both capital and interest against inflation to be successful.

1.3 Inflation Mandate as Relevant as Ever

Inflation targeting has faced adverse criticism after the recent crisis. But, this is about a very rigid and blind targeting framework, which was never the approach followed in India. But, several committees in the past, including those headed by M Narasimham and S S Tarapore recommended a framework requiring the central government to commit and mandate an acceptable inflation objective for public policy and, in parallel, provide monetary independence to the central bank to use its instruments at discretion and will. The central government’s

a hard-pursued objective of former RBI governor C Rangarajan who advocated this view on several occasions. The case for such an approach in India has not been diluted because of the current crisis.

2 Money, Forex and Debt Markets

The money market activity appeared restrained throughout November compared to the previous month. Liquidity conditions became relatively tighter. There were liquidity outflows from the banking system of the order of Rs 34,334 crore sourced mainly from currency, bank credit and government securities operations during November, when compared to an inflow of Rs 37,300 crore in October. While, the aggregate bank deposits continued to increase in November to an extent of Rs 33,000 crore and inflow via bankers’ cash balance amounted to nearly Rs 11,000 crore, deposit accretion was still moderate because of low deposit rates and savers’ preference shifting to contractual saving schemes and mutual funds. While the treasury bills market remained somewhat subdued consistent with lower money market activity, the government securities market in general was buoyant because of profit booking opportunities and gains in prices were noticed because of the expected delay in any tightening of policy rates. The forex market showed tendencies for rupee further strengthening partly due to a weakening of the US dollar index and partly due to buoyant share market activity fuelled by strong inflows of foregn institutional investment. Corporate bond market picked up momentum.

2.1 Money Market

The money market activity in general remained somewhat dull. The movement

power to issue directions to the central Table 4: Foreign Exchange Market – Select Indicators Rs/$ Appreciation(+)/ FII Flows Net Purchases Exchange Rate Depreciation (-) ($ Million) by RBI BSE Sensex (Closing) US Dollar Index*
bank should not cover the central bank’s use of monetary instruments for inflation NovemberOctober September August (Month End) 46.78 46.96 48.05 48.90 in %1.03 2.30 1.75 -1.50 1,330 3,428 4,263 945 ($ Million) Not available 16,926 (+) 464 15,896 (+) 539 17,127 (+) 619 15,667 74.93 76.47 76.86 78.22
control. Such a frame- July 48.20 -0.60 2,727 (+) 800 15,670 78.45
work will be well June 47.90 -1.20 1,059 (+) 745 14,494 80.43
within the other major May 47.30 5.80 3,577 (+) 131 14,625 79.43
objectives of financial April 50.20 1.45 1,790 (-) 1071 11,403 84.70

*: The analytical value of US dollar index was suggested by K V Ramaswamy, IGIDR, Mumbai. Source: RBI (www.rbi.org.in), BSE (www.bseindia.com), SEBI(www.sebi.gov.in), www.futures. growth. This was also tradingcharts.com

stability and sustained

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in the Domestic Inter-Bank Market

Graph C: Spot Quotations and Annualised Forward Premia for the US Dollar

0 10 20 30 40 50 60 -1 0 1 2 3 4 5 6 Premia in percentageSpot 1-month Monthly Averages (Apr 2007 to October 2009) (Daily) Working Days Nov 2009 6-month

in call rates was range-bound around the reverse repo rate. The monthly weighted average collateralised borrowing and lending obligations (CBLO) and market repo rates showed marginal firming up respectively by 20bps from 2.63% to 2.83% and by 8bps from 2.78% to 2.86% reflecting tightness in liquidity conditions. The daily average volume of call money transactions was less by about 6% in November compared to the previous month, the volume showing a decrease from Rs 6,831 crore to Rs 6,441 crore. The daily average notice money volume also came down from Rs 1,170 crore to Rs 1,081 crore. The major collateralised instruments, viz, the CBLO and market repo volumes also showed similar trends. The CBLO and market repo volumes decreased from Rs 57,735 crore to Rs 51,816 crore and from Rs 22,961 crore to Rs 21,626 crore, respectively. The term money volume, though negligible, showed a jump from Rs 39 crore to Rs 76 crore. The fall in money market activity was also reflected in the reduced secondary market trade in treasury bills (Table 2, p 21 and Graph B, p 22).

The outstanding certificates of deposit stood at Rs 2.26 lakh crore as on 9 October 2009, less by about Rs 975 crore compared to 24 September 2009. But, there was a significant increase in the volume of outstanding commercial paper by about Rs 3,700 crore between 15 September and 15 October 2009, reflecting improvement in demand from corporate sector.

The daily average volume of liquidity absorption in liquidity adjustment facility (LAF) auctions peaked in the second week to Rs 1.04 lakh crore

and in the third week it came down to Rs 91,000 crore. The daily average absorption witnessed a steady movement of around Rs 1.05 lakh crore in November as in October. The RBI’s OMO purchases while remained vigorous during April to September, deteriorated to Rs 1,082 crore in October and further to

Table 6: Details of Central Government Market Borrowings (Amount in Rs crore)

a meagre Rs 182 crore Date of Auction Nomenclature Notified Bid Cover Devolvement YTM at Cut-off of Loan Amount Ratio on Primary Price (in %)

in November signifying

Dealers

practically total with 06-Nov-09 7.32% 2014 N 3,000 3.14 nil 7.09% (Rs 100.93)
drawal of RBI’s support 6.35% 2020 N 4,000 2.68 nil 7.77% (Rs 90.14)
to primary auctions of 7.50% 2034 N 2,000 2.28 nil 8.35% (Rs 91.15)
government securities 13-Nov-09 7.02% 2016 N 3,000 2.75 nil 7.36% (Rs 98.20)
(Table 3, p 22). 6.90% 2019 N 4,000 2.51 nil 7.34% (Rs 96.96)
The recently intro 8.24% 2027 N 3,000 1.83 nil 8.28% (Rs 99.62)
duced interest rate 20-Nov-09 7.32% 2014 N 3,000 4.32 nil 6.90% (Rs 101.70)
futures segment of NSE has not seen any significant growth in its turno 6.35% 2020 N 7.50% 2034 N Total for November Total for October 4,000 3,000 29,000 30,000 3.06 2.27 2.77 2.16 nil nil nil 942 7.56% (Rs 91.55) 8.28% (Rs 91.84)

ver. In November, it gar-R: Re-issue, N: New issue. Source: RBI press releases.

nered only Rs 337 crore compared to Rs 394 crore in October and Rs 1,473 crore in September.

2.2 Forex Market

Most of the global currencies strengthened against the US dollar in November hoping that the US economy would continue with its easy money policy and stimulus packages. This was reflected in the fall in US dollar index by about 2% during the month, though this trend was partly reversed in

Table 5: Turnover in the Foreign Exchange Market (Amount in $ billion)

Month Merchant % Change Interbank % Change Spot % Change Forward % Change Total Turnover % Change

early December. The rupee also strengthened against the dollar during the month as in the previous month, mainly due to the buoyant domestic stock markets and the continued inflow of FIIs. It is generally observed that the fall in the dollar index triggered share prices internationally and the Indian share market also followed this cue. The FII investments stood around $1.3 billion in November, lower than the $3.4 billion in October but, the finance minister’s statement that the government will not put any curbs on foreign inflows raised the investor expectations.

The rupee-dollar exchange rate started on a weak note at Rs 47.04 on 3 November tracking a downswing in the domestic stock markets and signs of increased capital outflows. The rupee continued to fall for two consecutive days and stood at

Rs 47.13 on 5 November. The rupee recovered its early losses on 6 November and appreciated to Rs 46.82 following the dollar weakness against other major Asian currencies. The appreciation of the rupee against the dollar continued and moved in the range of 46.58 to 46.50 from 9 November to 12 November. The trend continued till 16 November and the rupee breached Rs 46.09, following huge dollar selling in the overseas market to take advantage of the arbitrage between the spot and nondeliverable forward markets. The appreci-

October 243.3 14.9 594.7 2.4 440.6 4.6 397.4 7.0 838.0 5.8 ation of the rupee was arrested in the

September 211.8 9.5 580.6 6.8 421.1 14.4 371.4 0.5 792.4 7.5 middle of the month. From 16 November

August 193.5 -7.5 543.8 -22.2 368.0 -16.3 369.4 -21.2 737.4 -18.8 to 24 November the rupee moved in the

July 209.2 -9.9 699.1 -1.0 439.4 -3.0 468.9 -3.3 908.3 -3.2 range of Rs 46.26 to Rs 46.60 against the June 232.1 8.3 705.9 4.5 453.0 10.2 485.0 1.4 938.0 5.4

dollar, backed by pressure exerted from

May 214.2 20.2 675.3 16.9 411.0 29.6 478.5 9.1 889.5 17.7

oil companies and mostly tracking the glo-

April 178.2 -577.4 -317.2 -438.5 -755.6

bal equity markets, which crashed due to

Includes trading in FCY/ INR and FCY/FCY. Source: Weekly Statistical Supplement, various Issues.. the Dubai debt crisis. Again, the rupee

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december 19, 2009 vol XLIV No 51

rose to Rs 46.27 per dollar on 26 November tracking strong GDP numbers and positive equity markets and closed the month at Rs 46.81 per dollar. On the whole, the rupee appreciated by around 1% in November against dollar mainly due to the weakness of dollar against the basket of some major currencies (Table 4, p 22).

The 1-month forward premia moved in a narrow range throughout the month. But, the 3-month and 6-month premia eased significantly during the month except on some occasions signalling expectations about the relative strengthening of the rupee. The 1-month premia for the month-end stood at 2.44% (2.43% in September-end), while 3-month and 6-month premia ended substantially lower at 2.22% (2.73%) and 2.35% (3.02%), respectively (Graph C, p 23).

Triggered by uncertainty over rate movements, there was a substantial growth in turnover of the foreign exchange market witnessed during October as in September. Merchant and interbank transactions in the foreign exchange market increased during October to $243 billion and $595 billion, a jump of 14.9% and 2.4%, respectively over the previous month. The spot and forward markets also witnessed the same trend, showing respectively a 4.6% and 7% rise, in their total market turnover. The escalation in each segment helped the foreign exchange market to continue its growth momentum and increase the total turnover by 5.8% in October over the previous month (Table 5, p 23).

The trading activity in the currency futures market witnessed a marginal growth of 8% during the month of November over October. But, the impressive growth recorded in October was somewhat restrained during the month following the diminishing value of the dollar against the euro. The average daily turnover in the MCX-SX and NSE stood at Rs 8,498 crore and Rs 7,878 crore respectively, amounting to a total of Rs 16,375 crore. The total number of contracts and notional value recorded in exchange traded currency futures segment also improved by 8% each in November over October. The MCX-SX continued to retain its position to top the currency futures segment during the month.

2.3 Dated Government Securities

In contrast to October, when primary issues of government securities met with

Table 7: Secondary Market Outright Trades in Government Papers – NDS and NDS-OM Deals (Amount in Rs crore)

Descriptions November 2009 Previous Month Three Months Six Months
Last Week (27th) First Week (6th) Total for the Month (October) Ago (August) Ago (May)
AMT YTM AMT YTM AMT YTM AMT YTM AMT YTM AMT YTM
1 Treasury Bills 3,639.24 2,332.28 12,661.77 20,328.86 11,477.00 31,08,0.57
A 91-Day Bills 2,670.00 3.26 920.63 3.18 7,628.75 3.23 16,187.65 3.08 7,473 3.25 23,027 3.08
B 182-Day Bills 570.00 3.56 475.65 3.51 2,431.08 3.57 2,070.62 3.33 2,075 3.43 2,629 3.29
C 364-Day Bills 399.24 3.72 936.00 3.88 2,601.94 3.87 2,070.59 3.33 1,929 3.73 5,425 3.49
2 GOI Dated Securities
A Regular (Per Cent:Year)
2009 - - - - - - - - - - 7,694 3.09
2010 5 620.00 3.74 410.00 3.79 2,655.15 3.91 5,800.00 4.01 4,778 4.29 7,187 4.14
2011 8 2,085.00 5.38 1,325.00 5.85 6,369.88 5.46 2,303.83 5.83 6,481 5.53 3,583 4.89
2012 5 655.00 6.20 845.00 6.55 5,595.40 6.32 5,263.33 6.58 1,985 6.19 2,719 5.84
2013 2 255.00 6.69 310.00 6.90 1,066.65 6.78 918.56 6.97 2,184 6.74 10,299 5.95
2014 4 1,025.00 6.92 620.00 7.11 4,505.00 7.04 4,713.02 7.24 32,155 6.86 45,422 6.09
2015 2 3,253.66 7.17 1,488.00 7.41 10,470.17 7.28 18,076.14 7.29 10,710 7.02 469 5.79
2016 3 8,520.25 7.16 4,451.10 7.32 28,028.62 7.25 30,210.40 7.31 16,674 7.16 13,475 6.79
2017 4 661.40 7.50 590.00 7.62 2,338.84 7.56 789.92 7.55 819 7.25 4,952 6.59
2018 2 60.00 7.61 - - 110.05 7.64 342.34 7.71 160 7.26 777 6.46
2019 3 21,490.66 7.18 15,620.00 7.27 70,383.66 7.25 73,677.92 7.29 25,817 7.2 1,10,630 6.31
2020 1 27,068.00 7.49 8,252.01 7.74 70,465.23 7.58 31,145.87 7.75 11,596 7.47 12,696 6.81
2021 2 165.00 7.72 35.00 7.86 333.29 7.77 592.10 7.58 6,908 7.63 1,424 6.75
2022 4 82.13 7.88 5.00 8.07 107.13 7.91 192.05 8.05 291 7.68 8,809 7.19
2023 4 402.25 8.23 - - 1,083.23 8.28 14.48 8.18 574 8.02 479 6.86
2024 4 137.28 8.01 3.25 8.26 287.77 8.12 1,763.30 8.24 45 7.86 3,447 7.60
2025 1 - - - - 0.90 8.23 10.02 8.25 1 7.96 5,278 7.60
2026 1 - - 10.00 8.33 15.30 8.33 476.66 8.25 307 7.94 7,916 7.78
2027 3 520.41 8.10 168.88 8.20 2,141.84 8.18 2,364.81 8.25 4,545 7.98 7,517 7.39
2028 1 - - - - 2.66 8.13 - - 3 7.92 24 7.13
2032 4 67.75 8.26 103.53 8.34 284.53 8.30 2,880.40 8.38 395 8 2,063 7.27
2034 1 1,509.25 8.22 25.00 8.31 1,807.01 8.23 53.50 8.13 283 7.99 7,144 6.88
2035 1 5.75 8.15 - - 7.08 8.16 45.84 8.28 954 7.99 603 7.74
2036 1 5.00 8.18 - - 9.00 8.28 154.65 8.29 70 8.01 1,425 7.48
2039 1 - - 20.00 8.29 20.00 8.29 - - - - 4,453 7.35
Sub-total 68,588.79 7.24 34,281.78 7.29 2,08,088.37 7.27 1,81,789.14 7.27 1,27,736 6.97 2,70,485 6.33
3 State Govt Securities 1,307.43 7.91 862.41 7.96 4,187.36 7.95 2,497.04 8.00 4,175 7.85 9,750 7.10
Grand total (1 to 3) 73,535.46 37,476.47 2,24,937.50 2,04,615.04 1,43,387.54 3,11,315.34

(-) means no trading. YTM = Yield to maturity in per cent per annum. NDS = Negotiated Dealing System. OM = Order Matching Segment. (1) Yields are weighted yields, weighted by the amounts of each transaction. Source: Compiled by EPWRF; base data from RBI, CCIL.

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MONEY MARKET REVIEW

more investor resistance due to continu-Increased demand Graph D: Yield Curves for Dated Securities – Weighted Averages for November 2009

ous supply of securities and the disap-for dated securities in

8.5

pointment of market players on HTM limit the primary market is

Previous month 3-month ago Current month

hike, November saw a considerable leap. reflected also in the Prices of government securities have gone higher trading vol-7.5 up in auctions held during the month, umes of the second

yield has dampened and interest in these ary market in Novem

securities has regained. This is partly due ber over October. The to the delay in any hike in policy rates, and total traded volume

partly due to high liquidity and low increased to Rs 2.08 demand for bank credit from industry. lakh crore from Rs 1.82

Yield (% per annum)

6.5

5.5

The incremental credit-deposit ratio was lakh crore, i e, by more 4.5 at a level of about 34%. Waning supply of than 14%. The two government securities and government most traded securities

3.5 0123456789 10 11 12 13 14 15 16 17 18 19 23 25 26 27 30

disinvestment plans also made govern-during the month ment securities an attractive investment were 6.90% 2019 and 6.35% 2020 with November yields still depicted a general option. While yields started showing eas-monthly trade of around Rs 70,314 crore tendency of firmness. ing, profit-booking tendencies enhanced and Rs 70,465 crore, respectively. Trading Punjab, Rajasthan and Tamil Nadu as reflected in a preference for trading in volume for the 6.35% 2020 security has issued state development loans twice, in long-term government securities. The bid-gone up by almost two times during both the auctions held during the month. to-cover ratio of government securities in the month to Rs 70,465 crore from The other participating states were Bihar, the auctions held during November also Rs 31,146 crore in October. Increased Chhattisgarh and Uttar Pradesh in the improved and primary dealers did not preference for long-term securities is first auction and Karnataka, Kerala, take any devolvement. duly reflected in the reduced spread Nagaland and West Bengal in the second

During November, central government between 10 and 15 year maturity to 87 auction. Trades in state government secuauctioned securities worth Rs 29,000 crore basis points during Nov ember from 95 rities nearly doubled to Rs 4,187 crore against Rs 30,000 crore in the earlier basis points last month (Table 7 (p 24), from Rs 2,497 crore in October. The month. It can be seen from the data on Tables 8 and 9).

Table 9: Yield Spreads (Weighted Average): Central Government Securities –

first auction and last auction of the month, As a result of the shift November 2009 (bps)
showing that the same securities, 7.32% 2014, 6.35% 2020 and 7.50% 2034, fetched in yields generally southward, the yield curve for Yield Spread in bps 1 Year - 5 Year Current Month Last Week First Week Entire Month 318 331 313 Previous Month 323 Three Months Ago 257 Six Months Ago 195
higher prices in the later auction. The ‘bid- November also shifted 5 Year - 10 Year 26 16 21 5 34 23
to-cover ratio’ in the month of November downward though mar 10 Year - 15 Year 83 99 87 95 66 129
at 2.77 was higher compared to 2.16 in ginally. But, compared to 1 Year - 10 Year 344 348 334 328 291 217
October (Table 6, p 23). three months ago, the Source: As in Table 5.

Table 8: Predominantly Traded Government Securities (Amount in Rs crore)

Descriptions November 2009 Previous Month Three Months Six Months
Last Week (27th) First Week (6th) Total for the Month (October) Ago (August) Ago (May)
AMT YTM AMT YTM AMT YTM AMT YTM AMT YTM AMT YTM
GOI Dated Securities
7.55 , 2010 380.00 3.97 160.00 4.33 1,485.15 4.34 1,290.00 4.39 1,716.26 4.53 313.00 4.00
12.29 , 2010 210.00 3.39 - - 360.00 3.36 1,295.00 3.41 900.00 3.97 150.00 4.06
9.39 , 2011 380.00 5.43 970.00 5.85 2,585.00 5.63 1,183.73 5.84 4,761.12 5.55 1,481 4.88
7.40 , 2012 560.00 6.20 845.00 6.55 5,305.00 6.31 5,032.33 6.57 445.11 6.11 2,243 5.86
7.27 , 2013 230.00 6.68 310.00 6.90 1,031.35 6.78 828.30 6.96 2,059.20 6.73 10,063 5.94
6.07 , 2014 175.00 6.96 75.00 7.33 415.00 7.13 239.39 7.26 30,961.96 6.86 11,858 6.03
7.32 , 2014 690.00 6.90 545.00 7.08 3,540.00 7.01 4,005.13 7.23
6.49 , 2015 3,193.66 7.17 1,488.00 7.41 10,045.17 7.28 18,071.11 7.29 10,613.80 7.02 - -
7.02 , 2016 8,480.25 7.16 4,441.10 7.32 27,837.58 7.25 30,102.80 7.31 13,782.36 7.16 - -
6.90 , 2019 21,490.66 7.18 15,615.00 7.27 70,313.66 7.25 73,620.74 7.29 25,683.74 7.20 0 6.51
6.35 , 2020 27,068.00 7.49 8,252.01 7.74 70,465.23 7.58 31,145.87 7.75 11,595.57 7.47 12,490 6.81
7.35 , 2024 105.00 7.94 - - 177.52 8.03 1,495.65 8.25 41.82 7.85
8.24 , 2027 485.01 8.10 143.88 8.20 1,986.44 8.18 2,319.81 8.25 4,545.06 7.98 7,517 7.39
8.28 , 2032 3.50 8.23 102.50 8.34 149.25 8.32 2,830.40 8.38 233.53 7.95 310.70 7.33
Total (All Securities) 68,588.79 7.24 34,281.78 7.29 2,08,088.37 7.27 1,81,789.14 7.27 1,27,735.59 6.97 2,70,485 6.33

(-) Means no trading. YTM = Yield to maturity in percentage per annum.

(1) Yields are weighted yields, weighted by the amounts of each transaction. Source: As in Table 5.

EPW

december 19, 2009 vol XLIV No 51

traded prices have increased during the month bringing the weighted yield to 7.24% in the last week from 7.29% in the first week of the month. Yields softened in the case of state development loans also (Table 10).

2.4 Treasury Bills

The total primary issue of treasury bills of all maturities during the month significantly came down from Rs 39,000 crore to Rs 30,000 crore mainly because of lower issuance in 91-day segment by Rs 8,000 crore to Rs 22,000 from Rs 30,000 crore in October. Issue of 182-day treasury bills was less by Rs 1,000 crore and the issue of 364-day treasury bills remained constant at Rs 4,000 crore. Despite increase in the bid-to-cover ratio to 3.46 from 3.28, price of 91-day bills remained constant throughout the month, the cut-off yield remaining at 3.28% in all the four auctions. This yield was higher compared to the previous month’s 3.23%. The weighted average yield also increased from 3.22% to 3.26%. In the case of 182-days treasury bills, the cut-off price rose to Rs 98.15 in November from Rs 98.06 in October, and weighted average price has also gone up to Rs 98.17 from Rs 98.08. The cut-off yield thus eased to 3.78% from 3.97% of October. Weighted average yield also dipped to 3.74% from 3.92%.

For longest maturity 364-day treasury bills, interest of investors went up with higher bid-cover ratio of 3.36 as compared

to October’s 2.86. Cut-off

Table 10: Details of State Government Borrowings (Amount in Rs crore)

and weighted average

Date of Auction Number of Notified Bid Cover YTM at Cut-off Weighted Participating Amount Ratio Price (in %) Average yields have also gone up States Yield (%)

to 4.53% and 4.49%,

10-Nov-09 6 4,306 3.18 8.20 8.15

respectively, from the

24-Nov-09 76,716 2.41 8.07 8.05

October figures of 4.45%

Total for November 13 11,022 2.21 8.12 8.09

and 4.42% Rs 95.65 and

Total for October 21 14,016 2.21 8.22 8.15 Source: RBI press releases. Rs 95.68, correspondingly. The investor has

Table 11: Auctions of Treasury Bills (Amount in Rs crore)

shown more interest in

Date of Auction Notified Bid Cover Cut-off Weighted Cut-off Weighted Amount Ratio Yield (%) Average Price (Rs) Average364-day treasury bills Yield (%) Price (Rs)

(Table 11).

A: 91-Day Treasury Bills 6-Nov-09 7,000 3.06 3.28 3.23 99.19 99.20 Total traded volume

13-Nov-09 5,000 4.43 3.28 3.28 99.19 99.19 in the secondary market

20-Nov-09 5,000 3.64 3.28 3.28 99.19 99.19 of treasury bills during

27-Nov-09 5,000 2.88 3.28 3.28 99.19 99.19 November drastically

Total for November 22,000 3.46 3.28 3.26 99.19 99.19 declined to Rs 12,662

Total for October 30,000 3.28 3.23 3.22 99.20 99.20 crore from Rs 20,329

B: 182-Day Treasury Bills

crore in October. This

13-Nov-09 2,000 4.53 3.82 3.80 98.13 98.14

reflects the overall

27-Nov-09 2,000 2.65 3.74 3.68 98.17 98.20

restrained activity in the

Total for November 4,000 3.59 3.78 3.74 98.15 98.17

short-term money mar-

Total for October 5,000 3.72 3.97 3.92 98.06 98.08

ket. Volume of traded

C: 364-Day Treasury Bills 6-Nov-09 2,000 2.45 4.53 4.49 95.68 95.71 treasury bills plummeted

20-Nov-09 2,000 4.28 4.45 4.42 95.75 95.78 mainly because the 91-day

Total for November 4,000 3.36 4.49 4.46 95.72 95.75 treasury bills traded

Total for October 4,000 2.86 4.57 4.53 95.65 95.68 came down to Rs 7,628

Source: RBI's press releases.

crore from Rs 16,188 crore in the previous

Table 12: Details of Commercial Bond Issues

Institutional Category No of Issues Volume in Range of Range of month. Trades in 182-day Rs Crore Coupon Rates Maturity in Years treasury bills increased

FIs/Banks 12 3,915 5.55-9.65 1.1-15

to Rs 2,431 crore from the

NBFCs 16 2,850 6.00-9.85 2-10

previous month’s trade

State Undertakings 1 650 8.60 10

of Rs 2,071 crore. Traded

Central Undertakings 4 2,685 7.75-8.60 3-10

volume in 364-day Treas-

Corporates 8 1,350 7.00-11.40 2-10

ury Bills also increased

Total for November 41 11,450 5.55-11.4 1.1-15

to Rs 2,602 crore from

Total for October 12 8,125 6.90-9.86 1.10-16 Source: Various media sources. Rs 2,071 crore in October.

december 19, 2009

2.5 Corporate Bond Market

The corporate bond market activity witnessed a remarkable improvement in the month of November compared to October. The total volume of primary issues jumped by 41% to Rs 11,450 crore during the month compared to Rs 8,125 crore in October and Rs 5,200 crore in November 2008. During the month, the number of issues also increased tremendously as there were 41 issues comprising 12 from financial institutions (FIs)/banks, 16 from nonbanking financial corporations (NBFCs). The issues by FIs/banks, NBFCs, state undertakings, central undertakings and corporates constituted 34%, 25%, 6%, 23% and 12% of total issues, respectively. In November there were 2 floating rate bonds (FRB) issued by Power Finance Corp and Nuclear Power Corp India offering 1-year g-sec yield. During the month, there were 18 issues of NCDs and NBFCs and corporates preferred to raise money through this route as the RBI in its Second Quarter Review of Monetary Policy 2009-10

announced that it may frame regulations on issuance of NCDs with maturity of less than one year, as they fall under the definition of “money market instruments” of chapter IIID of the Reserve Bank of India (Amendment) Act, 2006. The availability of the greenshoe option also rose from Rs 200 crore in October to Rs 2,785 crore in November. For instance, the Rural Electrification Corp offered Rs 1,000 crore as greenshoe and the same company raised Rs 1,000 crore via bonds (Table 12).

Similarly, the aggregate secondary market trading in corporate bonds as reported by SEBI increased by 5% to Rs 31,013 crore in November from Rs 29,533 crore in October. But, the daily average volume in the bond segment reported by BSE, NSE and FIMM-DA during the month declined to Rs 1,551 crore compared to Rs 1,554 crore over the previous month.

An important development has been that the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE) have issued guidelines outlining the procedure for settlement of corporate bonds through the National Securities Clearing Corporation Limited (NSCCL) and the Indian Clearing Corporation Limited (ICCL). This is expected to give a further boost to the growth of corporate bond market.

vol XLIV No 51

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