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Hands-off Policy on the Exchange Rate

Since the late 1990s, India's exchange rate policy has been one of minimising the volatility and at the same time maintaining a healthy level of foreign exchange reserves to guard against risks. The Reserve Bank of India's interventions in the market have been by and large guided by these twin concerns. Since August 2009, however, the RBI appears to have followed a hands-off policy and has hardly intervened in the market. What has guided this new approach and what are the implications for the real value of the rupee? And under what circumstances is this policy likely to change?

Hands-off Policy on the Exchange Rate

EPW Research Foundation

can be summed up as: (i) a careful monitoring and management of exchange rates without a fixed target or a pre-announced target or a band; and (ii) a policy to build a higher level of foreign exchange reserves which takes into account not only anticipated current account deficits but also

Since the late 1990s, India’s exchange rate policy has been one of minimising the volatility and at the same time maintaining a healthy level of foreign exchange reserves to guard against risks. The Reserve Bank of India’s interventions in the market have been by and large guided by these twin concerns. Since August 2009, however, the RBI appears to have followed a hands-off policy and has hardly intervened in the market. What has guided this new approach and what are the implications for the real value of the rupee? And under what circumstances is this policy likely to change?

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

1 Exchange Rate Management

A
n important plank of India’s external sector management is its cali- brated exchange rate policy, along with management of the capital account and foreign exchange reserves. In this regard, while the objectives and policies on reserves and capital account management are explicit and transparent, the exchange rate management and policy are mostly guided by certain broad principles and therefore continue to appear somewhat ambiguous. The complexity in its nuances is debated from time to time, but perceptions are varied. What has been generally observed is that the Reserve Bank of India (RBI) has been intervening in both the spot and forward markets admittedly to prevent undue fluctuations or excessive volatility in rates. Thus, the exchange rate management seems to have served the purpose of ensuring that the external value of the rupee is realistic and credible.

In the last year or so, a striking feature has been that the RBI has practically stopped operating in the foreign exchange market. While its intervention in the spot market is virtually nil from December 2009 onwards, a hands-off policy seems to have begun from August 2009. The RBI’s intervention in the forward market also seems to have become lacklustre, limited to some meagre forward purchases during the same period. The first question is whether there is any change in the stance of policy. Second, has this approach caused any outcomes different from the desired objectives of containing volatility in exchange rates and in the management of foreign exchange reserves? We attempt to address these questions based on the recent evidence available.

1.1 Nuances in Policy Stance

The broad principles that guided exchange rate management during the tenure of RBI Governor Bimal Jalan during 1998 to 2003

september 18, 2010

“liquidity at risk” arising from unanticipated capital movements.

These nuances in policy mostly continued through Y V Reddy’s period of governorship. Duvurri Subbarao acknowledged this stance in his first October 2008 statement indicative of a status quo in the nuances of exchange rate policy, but in his later statements he maintained a silence insofar as the exchange rate policy was concerned. He however broke this silence in his April 2010 policy statement thus:

Our exchange rate policy is not guided by a fixed or pre-announced target or band. Our policy has been to retain the flexibility to intervene in the market to manage excessive volatility and disruptions to the macroeconomic situation. Recent experience has underscored the issue of large and often volatile capital flows influencing exchange rate movements against the grain of economic fundamentals and current account balances. There is, therefore, a need to be vigilant against the build-up of sharp and volatile exchange rate movements and its potentially harmful impact on the real economy.

Overall, one can surmise that despite the hands-off strategy for some time now, the stance on exchange rate management has not changed.

1.2 Different Views

A number of suggestions have been made from time to time calling for a shift in RBI’s exchange rate policy. One strong recommendation made by former RBI Deputy Governor S S Tarapore in 1997 in his first report on convertibility, which he has been reiterating from time to time, is that the RBI should attempt to follow a policy of maintaining a real effective exchange rate (REER).

Another view that found support among some prominent economists from both India and from abroad is that the rupee should be allowed to appreciate freely in line with market trends. According to this view, there is no strong case for RBI’s further intervention as reserves are already very high. RBI’s purchases create substantial

vol XLV No 38

MONEY MARKET REVIEW

additional domestic liquidity, which may An exactly opposite view con-Graph A: Monthly Movement in ECB+FIIs Flows and Net Foreign Currency Purchases or Sales

be destabilising in the long run. There is sistently pressed by many econ-

Amount in $ million

also no evidence, in their opinion, that unconstrained appreciation or volatility would affect growth prospects. All indications are that improvements in productivity and profitability in Indian business have been deep enough for exporters to withstand the kind of appreciation we have seen.

Table 1:Monthly Movement in ECB+FII Flows, RBI Net Foreign Currency Purchases(+)/Sales(-) Fedai Indicative Rates and REER (Amount in $ million)

Month/ ECB+FIIs Net Foreign Fedai Indices of REER

15000

omists and trade associations is that RBI should intervene more 10000 aggressively in the market to

5000

further reduce the degree of appreciation. The main argument 0 in favour of this view is that -5000 India must maintain its global

-10000

“competitiveness”, particularly

-15000

in relation to China which has a fixed exchange rate peg with the -20000

Net Foreign Currency Purchases (+)/Sales (–) ECB+FIIs

Graph B: Monthly Average Fedai Indicative Rates and Net Foreign

Year (Net of Currency Indicative ((6-Currency 1/07 5/07 9/07 1/08 5/08 9/08 1/09 5/09 9/09 1/10 5/10

US dollar and whose currency has

Equity Purchases Rates in Rs/$ Trade Based +Debt) (+)/ Sales (-) (Monthly Weights) Base: been depreciating along with it.

Average) 2008-09=100)

Currency Purchases or Sales

Yet another view originates

Jan-07 927.18 2,830.00 44.33 ~

15000

Net Foreign Currency Purchases (+)/Sales (–) Fedai Rates in Rs/$ (monthly average)
35

Feb-07 5,028.34 11,862.00 44.16 ~ from the fact that the present

37

10000

Mar-07 5,177.55 2,307.00 44.03 ~ policy of controlled volatility

Net foreign currency in $ Million

Apr-07 4,023.90 2,055.00 42.15 107.22 has provided at times virtually

5000

Rupees per dollar

May-07 4,692.30 4,426.00 40.78 111.17

risk-less gain to market partici

0

Jun-07 3,076.80 3,192.00 40.77 110.58

pants since the rupee has been

-5000

Jul-07 8,889.47 11,428.00 40.41 110.39

expected to appreciate consist

Aug-07 -248.15 1,815.00 40.82 109.44

-10000

ently over a horizon and there

Sep-07 6,845.28 11,867.00 40.34 110.39

-15000

Oct-07 9,288.36 12,544.00 39.51 111.16 fore, the volatility tolerance

Nov-07 674.99 7,827.00 39.44 109.36

Dec-07 4,477.06 2,731.00 39.00 109.94

Jan-08 -859.44 13,625.00 39.37 109.51

Feb-08 1,910.81 3,884.00 39.73 108.33

Mar-08 4,226.60 2,809.00 40.36 106.35

Apr-08 1,005.62 4,325.00 40.02 107.57

May-08 -6.75 148.00 42.13 103.88

Jun-08 -1,135.25 -5,229.00 42.81 103.71

Jul-08 2,913.51 -6,320.00 42.84 103.35

Aug-08 1,615.07 1,210.00 42.94 106.50

Sep-08 1,576.95 -3,784.00 45.56 102.44

Oct-08 -3,140.07 -18,666.00 42.49 97.71

Nov-08 2,103.28 -3,101.00 49.00 97.98

Dec-08 2,258.08 -318.00 48.63 95.59

Jan-09 483.88 -29.00 48.83 94.81

Feb-09 -321.90 230.00 49.26 95.03

Mar-09 -346.01 -3,388.00 51.23 91.47

Apr-09 2,089.13 -2,487.00 50.06 94.26

May-09 4,071.60 -1,437.00 48.53 97.01

Jun-09 2,977.94 1,044.00 47.77 96.77

Jul-09 4,741.90 -55.00 48.48 96.27

Aug-09 2,034.10 181.00 48.33 97.16

Sep-09 5,772.10 80.00 48.46 96.92

Oct-09 6,013.80 75.00 46.89 99.50

Nov-09 3,683.90 -36.00 46.59 101.29

Dec-09 3,442.26 0.00 46.61 102.45

Jan-10 3,168.74 0.00 46.08 105.23

Feb-10 3,138.34 0.00 46.36 105.91

Mar-10 6,464.74 0.00 45.45 109.73

-20000 level should be widened. The RBI 55
1/07of late has in fact been allowing 5/07 9/07 1/08 5/08 9/08 1/09 5/09 9/09 1/10 5/10
the rates to move in a much wider band hands-off period since about August 2009,
compared to a few years ago. with practically no intervention in the
foreign exchange market.
1.3 The Evidence How did the exchange rate and reserves
Three major factors seem to have influenced moved during the three phases? Table 2
the rate movements during the period. provides some important statistical para-
First the foreign institutional investment meters. The important observations are:
(FII) flows, second the external commercial (i) During the first phase, the net inflows
borrowing (ECB) flows, and third the RBI through ECB and FII channels amounted
interventions. The relevant data are pro to $59.13 billion which was substantially
vided in Table 1 and illustrated in Graphs more than matched by RBI’s net purchases
A and B. Depending upon the intervention of $99.68 billion. The net increase in
policy of RBI, the entire period can be foreign currency assets with RBI including
divided into three phases: (i) January on account of valuation changes was as
2007 to May 2008 when the RBI pur high as $131.8 billion. Despite net purchases
chased foreign currency heavily from the by RBI, rupee in nominal terms appreci
market to arrest appreciation of rupee in ated by 0.6% but in real terms depreciated
the face of high capital inflows; (ii) June by 3.12%.
2008 to July 2009, when the RBI under (ii) During the second phase, the net capital
took heavy sales of foreign exchange to flows through ECB and FII channels depleted
accommodate the needs that arose fol to $19.89 billion and the net sales of foreign
lowing the financial crisis; and (iii) the currency by RBI amounting to $42.33 billion

Table 2: Foreign Exchange Market: Some Statistical Parameters (Amount in $ million)

Apr-10 5,601.02 0.00 44.50 113.97 Period ECB+FIIs Cumulative Net Variations in Fedai Daily Average Rates in Rs/$ Nominal % Change in (Cumulative Foreign Currency Net Foreign Average Standard Coefficient Appreciation (+)/ REER ((6

May-10 -808.70 0.00 45.81 114.00

Net Flow) Purchases (+)/ Currency Assets Deviation of Variation Depreciation (-) Currency Trade

Jun-10 4,215.29 0.00 46.57 113.34

Sales (-) with RBI of Rupees per Based Weights)Jul-10 6,449.90 0.00 46.84 - Dollar (in %) Base: 2008-09=100)

Aug-10 -0.00 46.53 -Jan 07 to May 08 59,130 99,675 1,31,794 41.00 1.67 4.07 0.06@ -3.12@

1: Rise in indices indicates appreciation of rupee and vice versa.

June 08 to July 09 19,888 -42,330 -41,709 47.37 2.78 5.88 -11.70 -7.17

2: Base year 2008-09 is a moving one, which gets updated every year. REER: Real Effective Exchange Rate Aug 09 to Aug 10 49,175^ 300 -4,599 46.53 1.07 2.30 3.78# 11.56#

~ Not available at the current base rate -Not available @: From April 2007 to May 2008. # : From August 2009 to June 2010. ^ : From August 2009 to July 2010. Source: www.rbi.org.in Source: www.rbi.org.in

EPW

september 18, 2010 vol XLV No 38

more than matched the depletion in capital flows. There was almost an equivalent depletion in net foreign currency assets with RBI by $41.71 billion. The rupee in nominal terms steeply depreciated by 11.7% and in real terms, by a lower 7.17%.

(iii) During the third phase, the buoyancy in net capital inflows resumed with a cumulative inflow of as much as $49.18 billion. There were hardly any currency operations by the RBI and the net foreign currency assets further depleted by $4.60 billion. What is more significant to note is that the rupee has appreciated by 3.8% in nominal terms and by a much higher 11.6% in real terms, amplified by the inflation differentials.

(iv) Another significant observation is that volatility in terms of standard deviation and coefficient of variation was minimal during the hands-off period; it was the highest during the period of net sales of foreign currency by RBI and moderately high during the period of net purchases.

1.4 Implications

There are broadly three sets of issues. First, the high real appreciation in rupee can be viewed as harmful for the export sector. Hence, there will be pressure to depreciate the rupee. The widening current account deficit so far has been financed by the net capital flows and that way, the inflows have been absorbed by the market without causing volatility in the rupee value. But, what is significant to note is that the rupee in nominal terms stands at depreciated levels compared to the precrisis period. The real appreciation currently is more due to high inflation differentials and when the inflation is contained to moderate levels in the coming months and the prospects of deflationary tendencies in advanced markets receding with recovery, the real appreciation in rupee can be expected to get reversed quickly. Since the foreign exchange market is showing extraordinary stability, the RBI is naturally not inclined to end its hands-off strategy.

Second, any heavy purchases of foreign currency in the current context might again lead to the dilemma of managing excess liquidity. But a related question is whether the current level of reserves can be considered to be adequate and whether

Third, any expectation of continued appreciation in rupee, which is currently the case, may cause speculative build-up in the asset markets. This is already evident in stock and real estate markets.

All these factors have to be weighed carefully before a balance is struck.

2 Money, Forex and Debt Markets

Ever since the RBI hiked the policy rates in the first quarter review of monetary policy announced on 27 July, the market has been ripe with the expectation of further rate hikes, given the unrelenting inflation pressure particularly of non-food articles. This greatly influenced financial market sentiments during August. The tight liquidity conditions that prevailed due to the outflow of huge funds to meet 3G and broad band auctions got somewhat eased in August. The easing of liquidity was reflected in a lower injection of funds through RBI’s liquidity adjustment facility (LAF) window. This has caused all the segments of money market to witness some softening of rates, particularly towards the end of the month.

In the government securities market, central and state governments continued vigorously to raise funds. The market felt that there was oversupply of securities, given the sluggish deposit growth and pick-up in credit demand. Yields have firmed up particularly at the short end, while the secondary market volumes showed some further contraction.

The US dollar strengthened against most global currencies while the rupee depreciated marginally during the month. In the currency futures segment, the turnover fell in both the exchanges as in the previous month. In the corporate bonds market, the mobilisation of resources through issuance of bonds remained subdued compared to the previous month.

Promising a major fillip to the success of infrastructure bonds, the government has decided to exempt these bonds from getting

Table 3: Money Market Activity (Volume and Rates)

credit ratings – which are mandatory for all the other types of bond issuances.

2.1 Money Market

The short-term rates though continuing to rule high, softened a bit compared to the previous month reflecting the easing of liquidity conditions in the system. The weighted average call rates moved in the range of 3.66% and 5.84% during August slightly lower than the range of 4.43% and 5.88% of July. From the beginning of the month, the rates showed somewhat of an easing trend and during the first week of the month they ranged between 4.22% and 5.84%. The rates showed a similar behaviour and stayed range-bound during the second and third weeks. In the last week of the month the rates ruled relatively low and touched 3.66% on 24 August, the rates last seen in May. The month ended with call money weighted average rates ruling at 4.39% on 27 August compared to 4.43% in July. Similarly, the notice money rates also observed an easing trend and stayed in a range of 3.57% and 5.76% in August. The monthly weighted average rate of collateralised borrowing and lending obligations (CBLO) stood at 5.02% compared to 5.26% in the previous month. The weighted average rates of the market repo also eased to 5.12% from 5.39% during the review period.

The volumes in money market saw a massive reduction during the month over the previous month. The daily average turnover of call money transactions declined by 20% to Rs 6,705 crore in

Table 4: RBI’s Market Operations (in Rs crore)

Month/Year OMO (Net Purchase(+)/ LAF (Average Daily
Sale(-)) Injection (+)/Absorption(-))
January-10 -8 -76,949
February-10 -4 -80,674
March-10 -2 -44,404
April-10 10 -54,009
May-10 0 -34,749
June-10 -2 43,123
July-10 -16 48,740
August-10 -11 1,207

Source: RBI’s Weekly Statistical Supplement.

Instruments August 2010 July 2010
Daily Average Monthly Range of Weighted Daily Average Monthly Weighted Range of Weighted
Volume (Rs Crore) Weighted Average Daily Volume Average Rate (%) Average Daily Rate
Average Rate (%) Rate (%) (Rs Crore) (%)
Call Money 6,705 5.35 3.66-5.84 8,387 5.54 4.43-5.88
Notice Money 1,886 5.13 3.57-5.76 2,306 5.39 3.50-6.00
Term Money @ 75 - 5.10-7.55 112 - 4.40-7.60
CBLO 44,217 5.02 4.09-5.72 28,832 5.26 4.15-5.56

it provides enough room for the RBI to Market Repo 15,030 5.12 2.00-5.71 11,621 5.39 350-5.89 @ Range of rates during the month.

intervene when necessary. Source: www.rbi.org.in. and www.ccilindia.com.

EPW

MONEY MARKET REVIEW

Table 5: Foreign Exchange Market: Select Indicators streng then against other
Month Rs/$ Reference Rate (Last Friday Appreciation (+)/ FII Flows Depreciation (-) ($ Million) Net Purchases by RBI BSE Sensex US Dollar (Month-end Index world currencies. After
Dec-09Jan-10Feb-10 of the Month) 46.73 46.37 46.37 of Rs/$ (in %)-0.53 0.78 0.00 1,873 1,849 946 ($ Million) (+) 525 (+) 525 (+) 525 Closing) 17,465 16,358 16,430 78.22 79.65 80.44 continuously showing a poor performance from the beginning of this
Mar-10 45.34 2.27 6,465 (+) 370 17,528 81.29 financial year, the US dol
Apr-10 44.44 2.03 2,783 (+) 370 17,559 81.99 lar index strengthened by

May-10 46.54 -4.51 -1,505 (+) 370 16,945 86.58

a notable 150 basis points

Jun-10 46.54 0.00 2,424 (+) 260 17,701 86.28

during the month, fol

Jul-10 46.46 0.17 5,285 (+) 260 17,868 81.65

lowing the appreciation

Aug-10 46.86 -0.85 3,163 Not available 17,971 83.25 Source: RBI (www.rbi.org.in), BSE (www.bseindia.com), SEBI (www.sebi.gov.in), Imf.org.in,

of dollar.

www.futures.tradingcharts.com

August. Similarly, the notice money and term money volumes witnessed a decline of 19% and 33%, respectively during a period of one month. However, the turnover of the major collateralised instrument, CBLO and market repo displayed a growing trend and gained 53% and 29%, respectively, during the month (Table 3, p 72).

The volume of outstanding certificates of deposit (CDs) dipped by about Rs 2,900 crore during a period of one fortnight and the total outstanding amount stood at Rs 3,24,810 crore on 30 July. Contrary to this, the volume of outstanding commercial papers (CPs) added around Rs 5,000 crore during the same period and the outstanding CPs stood at Rs 1,12,704 crore on 31 July. The interest rate on CDs hardened since the banks were compelled to raise deposit rates to reverse the sluggish growth of deposits. The discount rates on CPs also firmed up as the demand for commercial paper issues went up after the introduc-

In the domestic market, the rupee depreciated marginally against the dollar and other currencies but lost substantially against the Japanese yen during August. As in the past two months the FIIs invested heavily both in equity and debt markets in August also and the net investment during the month stood at Rs 14,700 crore or $3.2 billion on top of Rs 25,000 crore or $5.3 billion of the previous month. Still, the performance of local equity markets remained lacklustre during the month and dampened the sentiments in the forex market.

The rupee started the month with a gain of 27 paise to touch Rs 46.19 against the US dollar on 2 August aided by inflows and strong stock market performance. Thereafter, the rupee was flat against the dollar till 5 August amid the demand for dollars by importers but on 6 August the rupee touched Rs 46.02 per dollar boosted by an unhindered flow of funds into the domestic stock markets. Again, the rupee started to depreciate continuously for four days in a row and weakened by 95 paise against the dollar, on fears that the current account deficit might widen following the rise in crude oil prices. On 13 August the domestic currency recorded a massive gain of 36 paise per dollar as recovery in the stock market heightened sentiments. On 14 August the rupee again fell tracking the euro’s fall as concerns about weaker euro zone economies sparked a bout of risk aversion, triggering dollar demand from domestic importers. Thereafter, the rupee was stable till 20 August. From 23 August onwards the rupee paired its earlier gains and continued to depreciate till 27 August except on 26 August as the RBI raised concerns about inflation which led to strengthening of expectations that the central bank might raise the borrowing cost again for a fifth time this year. The rupee touched its lowest level on 25 August at Rs 46.93 per dollar and ended the month at Rs 46.89 per dollar on 27 August. Overall, the rupee depreciated by 0.85% during the month over

Table 6: Turnover in the Foreign Exchange Market* (Amount in $ billion)

Month Merchant Interbank Spote Forward Total Turnover
Jan-10 213.2 -(2.3) 653.4 (8.3) 466.2 (10.6) 400.4 (0.0) 866.6 (5.5)
Feb-10 221.8 (4.0) 641.2 -(1.9) 458.8 -(1.6) 404.1 (0.9) 862.9 -(0.4)
Mar-10 258.9 (16.8) 739.8 (15.4) 512.5 (11.7) 486.3 (20.3) 998.7 (15.7)

tion of the new base rate system. Apr-10 233.6 -(9.8) 689.0 -(6.9) 489.7 -(4.5) 433.0 -(11.0) 922.6 -(7.6)

The easing of liquidity conditions in the May-10 320.9 (37.3) 839.9 (21.9) 595.8 (21.7) 565.0 (30.5) 1,160.8 (25.8)

system was reflected in the RBI’s LAF win-Jun-10 281.2 -(12.4) 803.4 -(4.3) 547.1 -(8.2) 537.6 -(4.9) 1,084.7 -(6.6)

dow as the average daily injection of funds stood at a meagre Rs 1,200 crore during the month as against Rs 49,000 crore infused during the last month. The RBI’s open market operations window continued to remain dormant with a meagre net sales figure of Rs 11 crore (Table 4, p 72).

The interest rate futures segment of the

Jul-10 253.4 -(9.9) 747.5 -(7.0) 492.4 -(10.0) 508.5 -(5.4) 1,000.9 -(7.7)

*: Includes trading in FCY/ INR and FCY/FCY. Figures in brackets are % change over the previous month. Source: Weekly Statistical Supplement, various Issues.

Table 7: Details of Central Government Market Borrowings (Amount in Rs crore)

Date of Auction Nomenclature of Loan Notified Amount Bid Cover Ratio Devolvement on YTM at Cut-off Price Primary Dealers

06-Aug-10 7.46% 2017 R 5,000 2.03 nil 7.93% (Rs 97.49)

8.13% 2022 R 5,000 2.4 nil 8.13% (Rs 100.01)

8.32% 2032 R 3,000 1.7 341.25 8.41% (Rs 99.10)

13-Aug-10 7.17% 2015 R 4,000 2.03 nil 7.71% (Rs 97.86)

NSE showed hardly any improvement and 7.80% 2020 R 5,000 2 nil 7.90% (Rs 99.32)

remained practically inactive with a negli-8.26% 2027 R 3,000 2.52 nil 8.39% (Rs 98.81) 20-Aug-10 7.46% 2017 R 4,000 2.41 nil 8.00% (Rs 97.16)

gible turnover of Rs 50 lakh during August.

8.13% 2022 R 5,000 2.03 nil 7.99% (Rs 101.07)

8.30% 2040 R 3,000 2.15 nil 8.40% (Rs 98.90)

2.2 Forex Market

27-Aug-10 7.17% 2015 R 5,000 1.76 nil 7.74% (Rs 97.72) The dollar recovered against most of the 7.80% 2020 R 4,000 2.05 1,387.35 8.03% (Rs 98.45)

global currencies despite the mounting con- 8.26% 2027 R 3,000 2.44 nil 8.38% (Rs 98.91)

cerns about the recovery in the US economy. Total for August 49,000 2.11 Total for July 50,000 2.33

The US dollar gained its position as a safe

R: Re-issue currency to invest in, which helped it to Source: RBI press releases.

Economic & Political Weekly

EPW
september 18, 2010 vol XLV No 38

the previous month-end and moved along transactions shed 7% during Graph C: Yield Curves for Dated Securities – Weighted Averages for August 2010

with local equity markets coupled with the month. Similarly, the spot 8.50

global recovery concerns; but, positive capi and forward markets turnover
tal inflows limited the loss (Table 5, p 73). also declined by 10% and 5.4%,
The firm liquidity conditions caused the respectively, during the same
continued hardening of forward premia. period (Table 6, p 73).
But they softened at the end of the month The trading in the currency
more because of the fall in rupee rather futures segment of both MCX-SX

7.50

3-months ago Previous month Current month

Yield (% per annum)

6.50

5.50

than easing of liquidity conditions. During and NSE continued to show a
the beginning of the month, there was huge 4.50 negative trend as in the earlier
paying interest among the three tenures 0 1two months and the aggregate 2 3 4 5 6 7 8 9 101112131415161718222425262930
in the forward market. The one-month turnover fell by 7% during August. from devolvement on primary dealers twice,
and two-month premia touched their high The combined average daily turnover the first time in the first auction for 8.32%
on 2 August and rose to 6.49% and 5.59%, decreased by 4.6% from Rs 24,244 crore 2032 security for Rs 341.25 crore when the
respectively but thereafter showed a con in July to Rs 23,441 crore in August. The notified amount was Rs 3,000 crore and
stant softening trend till the end of the average daily turnover in the MCX-SX and for the second time in the last auction for
month. The six-month premia, however, NSE stood at Rs 14,546 crore and Rs 9,698 the 10-year benchmark -7.80% 2020 worth
reflected a mixed trend and started the crore, respectively. Rs 1,387.35 crore against the notified
month with softening trend but shot up to amount of Rs 4,000 crore. The tapered
5.14% on 10 August while eased during the 2.3 Government Securities Market interest of investors could also be seen from
later part of the month like other tenures. The government borrowing programme for the falling bid cover ratio to 2.11 times of the
Among the three tenures, the one-month the first half 2010-11 is nearly complete. notified in August against 2.33 times of
premia ended lower at 4.99% on 27 August Windfall revenues due to auctions of 3G the last month (Table 7, p 73 and Graph C).
against 5.94% of 30 July. Similarly, the spectrum and broadband wireless services During the month, 12 central government
three-month and six-month premia also had not resulted in any cut in the borrow securities, all reissues, worth Rs 49,000
softened and ended at 5.12% and 4.69%, ing programme in the first half. Till the end crore were sold in four auctions held on
respectively, during the same period of August, out of Rs 2,87,000 crore, targeted 6 August, 13 August, 20 August and on
against 5.51% and 4.91% of the last month. for the first half, Rs 2,50,000 crore were 27 August. The notified amount for the first
The forex market turnover continued to raised. The investor interest in government auction was Rs 13,000 crore and for the
plunge in July also as in June and recorded securities suffered partly because of depre rest of the auctions Rs 12,000 crore each.
a fall of 7.7% during a period of one month. ciating prices and partly due to sluggish The aggregate notified amount for August
The turnover in the merchant segment growth in deposits combined with a pick-up was slightly lower at Rs 49,000 crore as
showed a fall of 9.9% while inter-bank in credit demand. This can be readily seen compared to Rs 50,000 crore in July.

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

Descriptions August 2010 Previous Month Three Months Six Months
Last Week (27th) First Week (6th) Total for the Month (July 2010) Ago (May 2010) Ago (February 2010)
AMT YTM AMT YTM AMT YTM AMT YTM AMT YTM AMT YTM
GOI Dated Securities
6.57 , 2011 5.00 6.51 175.00 6.31 875.00 6.27 788.00 5.70 895.00 4.82 3,455.50 4.88
9.39 , 2011 50.00 6.51 230.00 6.35 634.42 6.40 3,112.00 5.48 2,871.55 5.10 1,222.44 5.21
7.40 , 2012 90.00 6.83 2,605.00 7.03 4,371.50 7.00 6,193.00 6.49 9,562.51 5.84 2,860.15 6.14
7.27 , 2013 570.00 7.22 2,265.00 7.21 4,259.82 7.23 4,716.18 6.87 6,649.50 6.52 2,141.75 6.89
7.32 , 2014 - - 420.00 7.40 840.00 7.47 460.72 7.21 3,885.84 6.98 2,298.93 7.21
7.17 , 2015 5,616.96 7.73 6,686.00 7.67 25,476.01 7.68 24,437.73 7.37 - - - -
7.38 , 2015 1,015.10 7.73 250.00 7.66 2,645.30 7.70 853.00 7.43 12,659.37 7.31 115.55 7.45
7.02 , 2016 215.00 7.91 2,035.00 7.84 3,698.08 7.85 4,273.59 7.61 48,400.66 7.46 31,056.76 7.58
7.46 , 2017 1,155.35 7.99 2,661.08 7.87 10,359.13 7.90 8,597.76 7.62 80.71 7.48 147.44 7.64
6.90 , 2019 90.00 8.04 15.14 8.03 130.14 8.02 153.93 7.76 384.50 7.76 6,915.68 7.86
6.35 , 2020 245.68 7.98 31.34 8.00 352.33 8.00 209.68 7.85 6,150.66 7.91 81,420.69 7.79
7.80 , 2020 15,796.07 8.02 28,838.25 7.85 98,687.42 7.88 1,53,975.62 7.63 1,10,475.55 7.50 - -
8.13 , 2022 19,305.51 8.00 785.90 8.11 59,726.77 7.99 105.00 8.00 - - 85.00 8.09
8.20 , 2022 230.00 8.16 489.00 8.14 1,564.03 8.14 25,375.46 7.96 1,19,949.17 7.75 113.00 8.12
8.24 , 2027 69.19 8.35 700.42 8.34 840.89 8.34 407.41 8.26 985.16 8.13 3,775.20 8.35
8.26 , 2027 1,364.53 8.30 1,028.63 8.34 4,529.47 8.34 2,546.26 8.22 7,427.81 8.08 - -
8.28 , 2032 1.70 8.29 9.50 8.31 112.30 8.37 1,164.76 8.26 6,419.82 8.20 355.57 8.32
8.32 2032 415.03 8.00 357.93 8.40 2,558.99 8.33 1,208.34 8.31 562.25 8.19 - -
8.30 2040 695.87 8.40 64.17 8.33 1,453.85 8.39 1,971.96 8.32 - - - -
Total (All Securities) 47,837.04 7.95 52,754.13 7.73 2,29,375.66 7.84 2,50,927.49 7.57 3,61,583.98 7.45 1,47,852.12 7.52
(-) 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.

september 18, 2010 vol XLV No 38

EPW
MONEY MARKET REVIEW

Auctioned securities are due to mature in 2015, 2017, 2020, 2022, 2027, 2032, and 2040. Barring securities maturing on 2032 and 2040, all other securities were auctioned twice in the month. The cut-off prices inched up for two securities maturing on 2022 and 2027 in the second auction with a consequent fall in yield.

A high inflation rate, slow government spending and advance tax outflows due in September, uncertainty about the supply of government securities in the second half of the year and combined tightness in conditions, all affected yields of government securities in both primary and secondary market segments.

In the secondary market, total traded volume tumbled by almost 9% to Rs 2,29,376 crore with monthly YTM of 7.84% against Rs 2,50,927 crore in July with YTM of 7.57%. Overall the yields have firmed up. Most traded securities were 7.80% 2020 and 8.13% 2022 with traded amount of Rs 98,687 crore and Rs 59,727 crore, respectively, contributing to 69% of traded volume. Other than these two securities, 7.17% 2015 – a five-year security – also traded for Rs 25,476 crore. Northward movement in yield tracking uncertainties in the market had continued across maturities in this month also, with exception of 8.13% 2022. Increase in yields was distinct for securities with short-term maturities and a moderate increase was seen in longer-term securities. The yield spread as a result narrowed for securities maturing between one to five years at 137 basis points in August from 184 basis points in July and the spread between 1 and 10-year also shrunk to 157 basis points from 208 basis points in July (Table 8, p 74 and Table 9).

State Development Loans (SDLs) were auctioned twice, on 3 August and on 24 August, raising a total amount of Rs 7,921 crore in August against Rs 8,319 core in July. As in the past, relatively lower supply and higher yields attracted investor interest in state loans. Yield to maturity and weighted average yield nevertheless increased to 8.36% and 8.37% respectively in August, against 8.17% and 8.14% in July. Yields in the second auction were higher compared to the first auction. The response was also better in the later auction than the earlier one. Overall, for the month, the bid cover ratio improved to 3.13 times in August from

Economic & Political Weekly

EPW
september 18, 2010

2.34 times in July. The only state which approached the market twice was Tamil Nadu, raising Rs 937 crore in each auction. The quantum of traded volume in secondary market for the SDLs decreased to Rs 2,339 crore with increased YTM of 8.21% against Rs 3,041 crore with YTM of 8.01% in July. The traded volume of the last week to the tune of Rs 1,167 crore was better than the first week’s Rs 746 crore (Table 10).

2.4 Treasury Bills

There was a leap in total auctioned volume of treasury bills (TBs) in August at Rs 33,000 crore, over the total volume of July at only Rs 13,000 crore. This considerable shift in auctioned volume was contributed by 91-day TBs, with 250% higher auctioned volume in August at Rs 28,000 crore as compared to only Rs 8,000 crore in July. Total auctioned amount of rest of the TBs remained flat over the last month, that is Rs 3,000

crore for 182-day TBs and Rs 2,000 crore for 364-day TBs. The lower bid cover ratio across the maturities of TBs in August over July and increased cut-off and weighted average yields are partly due to oversupply of 91-day TBs. The strong preference of the government to borrow short term perhaps portends the possibility of the government reducing its overall medium- to long-term borrowings from their budgeted amounts for the fiscal year, taking advantage of 3G and broadband auction revenues to cut fiscal deficit (Table 11).

Total traded volume in secondary market for TBs tumbled by almost 30% to Rs 18,373 crore in August against Rs 26,139 crore in July. This fall in volume was across all maturities. Traded volume fell the most in 182-day TBs by 72% in August at Rs 1,955 crore with YTM of 6% against Rs 6,905 crore in

vol XLV No 38

July with YTM of 5.51%. Traded volume of 364-day TBs also plunged by 47% in August at Rs 2,918 crore with YTM of 6.25% against Rs 5,537 crore of July with YTM of 5.71%. The traded volume in 91-day TBs at Rs 13,500 crore in August remained almost flat, though the yield went up to 5.90% against 5.50% in July (Table 12, p 76).

2.5 Corporate Bonds Market

The primary issues in the corporate bonds market fell by 40% compared to the previous month and the total amount raised stood at Rs 7,342 crore in August with a green shoe option of Rs 250 crore. The mobilisation of funds declined over the corresponding month of the previous year also by 23%.

Banks/financial institutions (FIs), the major contributors, accounted for 53% of the total mobilisation through 10 issues raising an aggregate amount of Rs 4,201 crore. The bonds carried coupon rates

Table 9: Yield Spreads (Weighted Average): Central Government Securities – August 2010 (basis points (bps))

Yield August 2010 Previous Three Six Months Spread in bps Last Week First Week Entire Month Month Months Ago Ago

1 Year-5 Year 114 135 136.882 184 222 258

5 Year-10 Year 29 18 19.903356 24 20

10 Year-15 Year ---28 74

1 Year-10 Year 143 153 156.785356 208 242 281

Source: As in Table 5. Table 10: Details of State Government Borrowings (Amount in Rs crore)

Date of Auction Number of Total Bid Cover YTM at Weighted Participating Amount Ratio Cut-off Price Average States Accepted (in %) Yield (%)

03-Aug-10 5 4,138 2.85 8.29 8.33

24-Aug-10 5 3,783 3.44 8.43 8.41

Total for August 10 7,921 3.13 8.36 8.37

Total for July 11 8,319 2.34 8.17 8.14

Source: RBI press releases. Table 11: Auctions of Treasury Bills (Amount in Rs crore)

Date of Auction Bids Bid Cover Cut-off Weighted Cut-off Weighted Accepted Ratio Yield (%) Average Price (Rs) Average Yield (%) Price (Rs)

A: 91-Day Treasury Bills 04-Aug-10 7,000 2.22 5.98 5.86 98.53 98.56

11-Aug-10 7,000 1.84 6.15 6.03 98.49 98.52

18-Aug-10 7,000 1.89 6.27 6.23 98.46 98.47

25-Aug-10 7,000 2.61 6.19 6.19 98.48 98.48

Total for August 28,000 2.14 6.15 6.08 98.49 98.51

Total for July 8,000 3.61 5.56 5.51 98.63 98.65

B: 182-Day Treasury Bills 04-Aug-10 1,500 1.93 6.35 6.22 96.93 96.99

18-Aug-10 1,500 2.5 6.46 7.06 96.88 96.60

Total for August 3,000 2.22 6.41 6.64 96.91 96.80

Total for July 3,000 2.44 5.86 5.75 97.16 97.22

C: 364-Day Treasury Bills 11-Aug-10 1,000 3.37 6.42 6.4 93.98 94.00

25-Aug-10 1,000 2.45 6.54 6.42 93.88 93.98

Total for August 2,000 2.91 6.48 6.41 93.93 93.99

Total for July 2,000 4.26 5.99 5.93 94.36 94.42

Source: RBI's press releases.

varying between 7.50% and 10.40%, and 10% interest rates. Table 13: Details of Commercial Bond Issues during August 2010

Institutional Category No of Issues Volume in Range of Range of Maturity

comparatively higher than the previous Among the six issues, four

Rs Crore Coupon Rates in Years (Y) and

(in %) Months (m)

month’s rates of 7.29% and 8.79% for NBFCs favoured the NCDs

FIs/Banks 10 4,201 7.50-10.40 1y, 6m-15y

maturity periods ranging from 1 year to route to tap the market

NBFCs 6 2,491 8.20-10.00 3y-15y

15 years. EXIM Bank, Bank of Baroda, Yes while the remaining two

Corporates 3 650 8.75-11.69 3y-15y

Bank and NABARD tapped the bonds preferred to raise the money

Total for August 2010 19 7,342 7.50-11.69 1y-15y market twice during August while HDFC through bonds. LIC Hous-Total for July 2010 18 12,515 6.85-11.50 1y-15y and National Housing Bank raised Rs 750 ing Finance entered the

Source: HSBC InvestDirect (India) Limited.

crore and Rs 250 crore, respectively, in market three times during the month The secondary market transactions in single issues during the same month. through issuance of bonds and NCDs for an commercial bonds decreased notably dur-

The non-banking financial corpora-aggregate amount of Rs 1,505 crore with ing the month partly due to the reduced tions’ (NBFCs) participation showed con-coupon rates ranging from 8.2%-8.9% for participation from FIIs. According to the siderable improvement during the month 2-10 years maturity. data published by SEBI, the aggregate and they contributed around 32% of the State and central undertakings stayed turnover as well as the average daily turntotal mobilisation compared to 15% of the away from the corporate bonds market over in the corporate bonds reported by previous month. They raised Rs 2,491 during the month. Three corporates mobi-BSE, NSE and FIMMDA fell by 21% and 17%, crore from six issues in August. Indiabulls lised Rs 650 crore, through issuance of respectively over a period of one month. raised the highest amount of Rs 650 crore NCDs by offering rates in the range of 8.75% The average daily turnover declined to as in the previous month by issuing NCDs and 11.69% for 3 to 15 years maturities Rs 2,400 crore from Rs 2,899 crore for two years and five years offering 8.90% (Table 13). recorded in the previous month.

Table 12: Secondary Market Outright Trades in Government Papers – NDS and NDS-OM Deals (Amount in Rs crore)

Descriptions August 2010 Previous Month Three Months Six Months
Last Week (27th) First Week (6th) Total for the Month (July 2010) Ago (May 2010) Ago (February 2010)
AMT YTM AMT YTM AMT YTM AMT YTM AMT YTM AMT YTM
1 Treasury Bills 3,669.94 5.93 4,782.76 18,372.72 26,139.26 33,103.04 25,903.40
A 91-Day Bills 163 5.79 3,443.85 5.68 13,500.25 5.9 13,697.18 5.5 21,595.37 4.33 18,910.53 3.78
B 182-Day Bills 469.2 6.26 525 6 1,954.83 6.03 6,904.65 5.51 4,925.19 4.55 2,292.33 4.16
C 364-Day Bills 469.2 6.26 813.91 6.13 2,917.64 6.25 5,537.43 5.71 6,582.48 4.77 4,700.54 3.98
2 GOI Dated Securities 47,837.04 7.95 52,754.13 7.73 2,29,375.66 7.84 2,50,927.49 7.57 3,61,583.98 7.45 1,47,852.12 7.52
Year of (No of
Maturity Securities)
2010 - - - - - - 345.00 5.53 8,379.46 5.98 1,987.55 4.22
2011 7 465.00 6.59 430.25 6.32 3,369.67 6.31 5,047.57 5.54 4,985.10 5.09 5,528.84 4.96
2012 5 367.74 6.91 4,205.80 7.04 6,480.61 7.01 6,952.23 6.47 12,776.45 5.87 5,415.45 6.21
2013 3 580.00 7.22 2,505.06 7.20 4,539.88 7.23 4,821.41 6.88 7,375.52 6.52 2,281.97 6.89
2014 6 170.00 7.48 1,450.00 7.39 2,415.13 7.43 1,290.80 7.11 7,360.04 6.97 3,044.38 7.24
2015 5 6,632.06 7.73 6,966.26 7.67 28,191.58 7.68 26,850.90 7.38 15,641.53 7.31 2,992.48 7.54
2016 2 240.00 7.91 2,035.00 7.84 3,723.28 7.85 4,475.99 7.61 48,547.68 7.46 31,433.44 7.58
2017 4 1,155.45 7.99 2,716.80 7.87 10,415.43 7.89 8,767.96 7.62 767.12 7.53 297.14 7.68
2018 4 0.35 7.95 31.00 8.01 49.66 7.99 115.34 7.80 47.56 7.64 28.52 7.88
2019 2 90.60 8.04 15.14 8.03 130.74 8.01 159.93 7.75 411.70 7.77 7,150.37 7.86
2020 3 16,041.75 8.02 28,869.77 7.85 99,039.92 7.88 1,54,935.30 7.62 1,16,896.20 7.51 81,772.04 7.77
2021 1 - - 15.00 8.09 15.00 8.09 331.61 7.99 41.00 7.90 57.97 8.12
2022 2 19,535.51 8.00 1,274.90 8.12 61,290.80 7.99 25,520.46 7.96 1,19,969.17 7.75 364.42 8.12
2023 - - - - - - 85.08 8.17 1,677.19 8.22 225.69 8.16
2024 1 0.01 8.23 - - 0.05 8.20 3,237.18 8.27 12.00 8.17 827.24 8.48
2025 - - - - - - 1.61 7.90 20.00 8.25 0.15 8.24
2026 - - - - - - 98.60 8.19 848.59 8.14 87.25 8.17
2027 2 1,433.72 8.30 1,729.05 8.34 5,370.36 8.34 2,953.68 8.23 84,66.08 8.09 3,776.40 8.35
2028 - - - - 0.50 8.16 46.40 8.09 3.10 8.12
2032 3 416.73 8.00 387.43 8.39 2,708.29 8.33 2,663.25 8.27 7,060.07 8.20 492.07 8.32
2034 1 12.25 8.22 12.50 8.21 113.60 8.24 168.00 8.13 179.22 8.15 50.00 8.42
2035 - - - - - - 1.00 8.04 6.45 8.16 14.90 8.17
2036 1 - - 3.00 8.32 4.30 8.32 128.13 8.29 65.95 8.21 20.50 8.35
2039 1 - - 43.00 8.27 63.50 8.23 4.00 8.07 3.50 8.32 0.27 8.29
2040 1 695.87 8.40 64.17 8.33 1,453.85 8.39 1,971.95 8.32
3 State Govt Securities 1,167.24 8.11 745.75 8.33 2,338.57 8.21 3,040.98 8.01 5,731.80 8.08 6,785.97 8.11
Grand total (1 to 3) 53,306.42 58,282.64 2,50,086.95 2,80,107.73 4,00,418.82 1,80,541.49

(-) 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.

september 18, 2010 vol XLV No 38

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