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ULIPs and Mutual Funds: The Unidentical Twins

The expansion in the life insurance sector in the post-deregulation period has seen a disproportionate growth of unit-linked insurance plans. However, ULIPs have little value in promoting long-term savings. Moreover, if the insurance and pension sectors are to support infrastructure investments and the development of the corporate bond market, then life funds, rather than short-term investment products, should be the preferred instruments. Given that insurance companies and mutual funds operate under different regulatory regimes with separate prudential norms, the Financial Stability and Development Council should constitute a joint forum between the Securities and Exchange Board of India and the Insurance Regulatory and Development Authority that will focus upon orderly development of MFs and ULIPs.

ULIPs and Mutual Funds: The Unidentical Twins

EPW Research Foundation

rather than short-term investment products, should be perceived as the right instruments. We address this issue from the angle of regulation and future strategy for development of related products.

1.1 Mutual Funds vs Life Insurance

The expansion in the life insurance sector in the post-deregulation period has seen a disproportionate growth of unit-linked insurance plans. However, ULIPs have little value in promoting long-term savings. Moreover, if the insurance and pension sectors are to support infrastructure investments and the development of the corporate bond market, then life funds, rather than short-term investment products, should be the preferred instruments. Given that insurance companies and mutual funds operate under different regulatory regimes with separate prudential norms, the Financial Stability and Development Council should constitute a joint forum between the Securities and Exchange Board of India and the Insurance Regulatory and Development Authority that will focus upon orderly development of MFs and ULIPs.

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

1 Introduction

A
fter a long period of a state monopoly, the life (and non-life) insurance sector was opened up to private participation with the enactment of the Insurance Regulatory and Development Authority (IRDA) Act in 1999. Even though the participation by foreign joint venture partners through the foreign direct investment (FDI) route is limited to 26% of the paid-up capital under the current regulations, foreign players have entered the Indian insurance market via this route. There are 24 life insurance companies in India, including the Life Insurance Corporation (LIC), the only institution in the public sector. The remaining 23 are private life insurers.

The presence of new players in the market has no doubt resulted in enhanced product innovation, better services and value-added benefits. A significant component of expansion in the life sector has been the enormous growth in unit-linked insurance plans (ULIPs). Though public sector institutions require time to adapt themselves to the competitive environment and the associated contemporary structural changes, the post-deregulation period has seen greater diversification in the product offerings of the LIC, with added emphasis on marketing and distribution strategies.

The somewhat disproportionate growth of ULIPs as life insurance products is an area of concern. Experts are of the view that ULIPs are mainly investment products and carry relatively higher risk for the return offered. First, they have little value in promoting long-term savings and in providing a social safety net as part of inclusive public policy that has been gaining ground in recent discussions. Second, if the insurance and pension sectors are to support infrastructure investments in the medium term and the development of the corporate bond market, then life funds,

june 18, 2011

A mutual fund is essentially a capital market investment product that gives a return based on the amount of risk an investor takes. The investment is exposed to the risk in the capital markets, and there is no guarantee that even the invested amount will be totally safe or preserved, leave alone the return on the investment. This product is therefore suitable for people with a risk appetite and who are capable of taking such risks in accordance with their preferences.

Life insurance, on the contrary, is in principle a hedge against risk – and not principally an investment option. So it would be wrong to compare life insurance with any other financial product. In life insurance the object of insurance is human life. It includes insurance that pays benefits on a person’s death, living a certain number of years, incapacity, injury, or incurring a disease. Life insurance is essentially a protection product that offers security to the family or survivors, in the form of compensation for the loss of life of the insured, in case of occurrence of the contingency. The insurance company is contractually bound to meet its obligation to the beneficiaries in case something happens to the insured.

Unlike regular life insurance policies, the ULIPs are hybrid products which combine life insurance cover with an investment product. Experts and financial advisors generally opine that life insurance and investment options should not be clubbed. It would be preferable to take a term cover or whole life cover for insurance purposes which would provide a higher life cover for a lower premium. On similar lines, it is advisable to invest in regular mutual funds if the investor is interested in returns corresponding to his risk profile. It is not purported here to promote a particular package, but the point is that the investor should be made fully aware of the nature of all these products as part of financial literacy/financial inclusion.

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1.2 The Regulatory Status

The Committee on Financial Sector Assessment (CFSA) headed by Rakesh Mohan observed in 2009 that the regulatory policy with regard to the insurance sector had taken a cautious and calibrated approach in sequencing various elements of the reform process, which aims not only at a level playing field, but also took into account the structural constraints in the insurance sector.

A significant component of the growth in the life insurance industry has been the savings-linked insurance products in the last few years. This shift has also occurred on account of the unbundling of the products, whereby the policyholders are given the option to exercise their choice on the investment component based on their risk appetite. During the initial phase of growth of the insurance sector, ULIPs were seen as somewhat analogous to equity-linked savings schemes (ELSS) and similar mutual fund schemes. ULIPs are issued by insurance companies (regulated by the IRDA), whereas mutual fund schemes are issued by mutual funds (regulated by the Securities and Exchange Board of India (SEBI)). Insurance companies and mutual funds operate under different regulatory regimes with separate prudential norms. New guidelines issued by the IRDA in 2006 (further amended in 2010) have stopped ULIPs from being positioned as a short-term investment product. In order to ensure that these two different savings instruments with short- and long-term investment objectives are positioned appropriately to reflect their respective positions, steps were being taken towards interregulatory cooperation on an ongoing

1200000

CFSA felt that better inter

regulatory cooperation would 1050000 assume further importance to

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effectively address regulatory

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arbitrage issues.

The CFSA observed that in 600000 the medium term, sustained

450000

growth in volumes of busi

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ness, coinciding with the ever

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increasing capital requirements could project inade-0

2002-03

quacies in regulation with calls for further deregulation. The biggest challenge in the sector would be to raise the quality of regulation to a much higher level to keep pace not only with the domestic financial sector development, but also to bridge the gap with international practices specific to the insurance sector. Preventive regulation would be able to take care of any adverse changes in the short run, but it could lead to inefficiencies in capital utilisation and competition in the long run. This needs to be addressed within the next decade.

It may be recalled that soon after this observation by the CFSA, a regulatory turf war broke out when SEBI moved and instructed that all life insurance companies issuing ULIPs should register with SEBI since the investment component of ULIPs was akin to mutual funds which came under its regulatory purview. SEBI also argued that though such products gave life cover, and such funds partly represented life funds, the life insurance component in such funds was relatively small and the cover offered was also smaller compared to regular life insurance products.

basis. Going forward, the Graph A: Assets under Management (Amount in Rs crore)

Mutual funds Unit-linked insurance plans Life funds Pension and general group fund

2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10

It was unfortunate that the government totally overrode the directions of the SEBI and unilaterally passed a presidential ordinance which was later promulgated as law, empowering the IRDA as the sole regulator of ULIPs. Practically demolishing the earlier time-tested arrangement that existed among the regulators along with participation from the government in the form of a high level committee for inter-regulatory coordination, a government level council was appointed – the Financial Stability and Development Council (FSDC) – to arbitrate on inter-regulatory turfs on products or any other issues, including on policy matters.

1.3 Trend in Growth of Assets under Management

The trend in the growth of assets under management (AUM) of mutual funds and life insurance funds of various types shows clearly that the growth in AUM of ULIPs was faster than that of life funds and is fast catching up with growth in mutual funds. From Rs 1.40 lakh crore in 2003-04, the AUM in mutual funds increased to Rs 6.14

Table 1: Asset under Management of Life Insurers (Amount in Rs crore)

Particulars/Year 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10
Unit Linked Insurance Plans
LIC 3,47,959 (34.76) 4,18,289 (20.21) 4,63,771 (10.87) 5,59,201 (20.58) 6,78,403 (21.32) 7,99,593 (17.86) 9,85,028 (23.19)
Private Sector 4,665 (98.37) 10,163 (117.84) 23,380 (130.05) 44,979 (92.39) 87,567 (94.68) 1,16,772 (33.35) 2,20,127 (88.51)
Total Industry (A) 3,52,625 (35.34) 4,28,452 (21.50) 4,87,151 (13.70) 6,04,180 (24.02) 7,65,969 (26.78) 9,16,365 (19.63) 12,05,155 (31.51)
% to total 52.67 53.11 52.86 54.59 54.76 55.20 5,7.98
Life Funds
LIC 3,04,437 (33.70) 3,61,429 (18.72) 3,89,448 (7.75) 4,53,440 (16.43) 5,22,985 (15.34) 6,06,487 (15.97) 6,99,475 (15.33)
Private Sector 2,872 (47.44) 4,791 (66.82) 7,741 (61.58) 12,115 (56.50) 18,645 (53.90) 23,163 (24.23) 33,137 (43.06)
Total Industry (B) 3,07,309 (33.82) 3,66,220 (19.17) 3,97,189 (8.46) 4,65,555 (17.21) 5,41,630 (16.34) 6,29,650 (16.25) 7,32,613 (16.35)
% to total 45.90 45.40 43.10 42.06 38.72 37.93 35.24
Pension and General Group Fund
LIC 9,244 -(69.69) 11,462 (23.99) 36,158 (215.46) 35,062 -(3.03) 87,744 (150.25) 1,07,135 (22.10) 1,30,885 (22.17)
Private Sector 308 (114.23) 562 (82.52) 1,107 (97.00) 2,001 (80.84) 3,518 (75.77) 6,817 (93.80) 10,038 (47.25)
Total Industry (C) 9,552 -(68.82) 12,024 (25.88) 37,264 (209.92) 37,064 -(0.54) 91,262 (146.23) 1,13,952 (24.86) 1,40,923 (23.67)
% to total 1.43 1.49 4.04 3.35 6.52 6.86 6.78
Grand Total (A+B+C) 6,69,485 8,06,696 9,21,604 11,06,799 13,98,861 16,59,967 20,78,691
Figure in brackets are year-on-year percentage growth.
Source: IRDA Annual Report, various issues, Compiled by EPWRF .
Economic & Political Weekly june 18, 2011 vol XLVI No 25 121
EPW

lakh crore in 2009-10. It is significant that during the crisis year of 2008-09, the AUM value of mutual funds dipped sharply to Rs 4.17 lakh crore from Rs 5.63 lakh crore in 2007-08. On the other hand, the AUM of ULIPs consistently showed an increase from Rs 3.52 lakh crore in 2003-04 to Rs 12.05 lakh crore in 2009-10. Even during the crisis year, the AUM value went up from Rs 7.66 lakh crore in 2007-08 to Rs 9.16 lakh crore in 2008-09 (Table 1 and Graph A, p 121).

The share of ULIP-AUM in the total life insurance fund, both in the public sector (LIC) and the private sector have seen a significant pick up during the above period. This share increased from 53% in 2003-04 to 58% in 2009-10. Correspondingly, the share of traditional life funds and pension and group funds together declined from 47% to 42% (Table 2).

Table 2: Asset under Management: Mutual Funds and Life Insurance (Amount in Rs crore)

Year Mutual Life Insurance Funds
Funds Unit Linked Life Funds Pension and
Insurance Plans General
Group Fund
2003-04 1,39,616 3,52,625 3,07,309 9,552
(27.84) (35.34) (33.82) -(68.82)
2004-05 1,49,600 4,28,452 3,66,220 12,024
(7.15) (21.50) (19.17) (25.88)
2005-06 2,31,862 4,87,151 3,97,189 37,264
(54.99) (13.70) (8.46) (209.92)
2006-07 3,26,292 6,04,180 4,65,555 37,064
(40.73) (24.02) (17.21) -(0.54)
2007-08 5,62,820 7,65,969 5,41,630 91,262
(72.49) (26.78) (16.34) (146.23)
2008-09 4,17,300 9,16,365 6,29,650 1,13,952
-(25.86) (19.63) (16.25) (24.86)
2009-10 6,13,979 12,05,155 7,32,613 1,40,923
(47.13) (31.51) (16.35) (23.67)

Figure in brackets are y-o-y growth. Source: IRDA Annual Report, SEBI Bulletin (various issues).

It is indeed commendable that in a recent statement, D K Mehrotra, the acting chairman of LIC, conceded that this trend needs to be reversed. According to him, “the entire industry started selling insurance as an investment product and lost its focus” and LIC made a conscious shift towards selling traditional policies, and hoped to maintain the unit-linked plans-traditional policies ratio at 60:40 or 55:45.

1.4 Conclusion

There is an argument that the direction India’s life insurance industry has taken thus far amounts to a regulatory failure. This industry was opened up to foreign capital and provided with a relatively lenient regulatory framework so that it could bring insurance to India’s under-insured masses. Instead, it has ended up focusing its energies (and capital) on selling expensive and opaque mutual funds dressed up as insurance.

While the government has settled the issue relating to ULIPs unilaterally, it would be advisable for the FSDC to constitute a joint forum between the SEBI and the IRDA that will focus upon orderly development of mutual funds and ULIPs. An orderly development would mean a level playing field, apart from overseeing products, their pricing and costs to the lay investor. Policyholders’ protection by the IRDA and investor protection by the SEBI would demand this. FSDC is responsible for financial inclusion policies and also promoting appropriate financial literacy in the interest of financial sector development and stability.

2 Money, Forex and Debt Markets

A disappointing performance of the United States (US) economy, along with the emergence of the crisis in the euro-zone, and a falling trend in commodity prices raised concerns over faltering global economic growth. Renewed efforts by the Reserve Bank of India (RBI) to control inflation even at the cost of some slowdown in growth and the firm market expectations about the RBI continuing its anti-inflationary stance dictated the market sentiments. Faced with the unenviable task of checking inflation expectations, the central bank has already raised key policy rates thrice in the year 2011. Macroeconomic indicators suggest a slowdown in growth prospects. This is reflected by the downtrend in the index of industrial production (IIP) and manufacturing data in April. According to the Finance Minister Pranab Mukherjee, “growth in the current fiscal would suffer if inflation continues to remain high”.

The liquidity conditions in May remained tight due to the front-loading of the government borrowing programme. The system witnessed outflows of the order of Rs 58,000 crore through dated government securities auctions on top of treasury bills (TBs) auctions sucking Rs 25,000 crore. Expansion of bank credit also led to outflows of Rs 31,000 crore during the month; whereas deposit growth became sluggish after a spurt in April. Overall, the net liquidity outflow was of the order of Rs 89,000 crore during May. To manage the situation, banks borrowed

june 18, 2011

heavily from the Liquidity Adjustment Facility (LAF) repo window of the RBI, where the prevailing interest rate stood at 7.25%. The tight liquidity and increase in repo rate resulted in upsurge in the rates of shortterm money market instruments and the rates ruled above the 7.00% mark in May.

The forex market experienced a more volatile trend both due to domestic and global factors. Negative factors such as decline in growth, rising inflation and a weak share market led the rupee to fall against most global currencies. Global factors such as the weak dollar overseas, rising interest rates and movements in oil prices further kept the outlook of the rupee uncertain.

The accelerated tightening pace in the interest rates exerted relatively steep upward pressure on the shorter-end of the yield curve. The oil price movements also influenced firming up of yields in the fixed income securities market. However, rising interest rates have hit the debt fund raising plans of most domestic companies. During May, the number of private debt placements listed in trading platforms declined remarkably compared to April.

2.1 Money Market

The ease in liquidity experienced in the beginning of April was not sustained in May due to increased government borrowing coupled with the hike in key policy rates by the RBI. This pushed up the rates of all short-term money market instruments. During the first week, ending 6 May 2011, the overnight money market rates ruled in a narrow range between 6.33% and 6.92% since the system experienced huge liquidity crunch in the first week itself. The situation somewhat eased in the later part of the week as it was also the second week of the reporting fortnight, and banks had already covered their reserve needs in advance. However, the rates moved northward again in the second week and crossed 7.00% levels, taking cues from increase in the repo and reverse repo rate by 50 basis points (bps) on 3 May. The rates continued to remain range-bound throughout the fortnight ending 20 May and ruled in an upper range of 6.41% and 7.41%. The rates also continued to harden till the last week of May on the back of emergence of fresh demand for funds from borrowing banks to fulfil their liquidity needs. They ended

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at 6.95% on 27 May, comparatively higher as against 6.62% on 29 April. The notice money rates also showed similar movements during the same review period. The collateralised instruments such as the collateralised borrowing and lending obligations (CBLO) and market repo rates also moved in tandem with overnight rates, exhibiting a huge rise. All the rates crossed the repo rate of the LAF during the month.

The call rates were less volatile compared with the other four short-term rates. This, along with rise in rates resulted in lower trading volumes in the overnight segment. The remaining short-term instruments also recorded a fall in their traded turnover except for the term money, which recorded a rise of 18% during the month. Call money recorded a 12% fall while notice money recorded a 5% drop. Among the collateralised instruments, CBLO and market repo registered a 32% and 2% slump respectively. Overall, all short-term

Table 3: Money Market Activity (Volume and Rates)

13.50% for the fortnight ending 15 May 2011.

According to the Fixed Income Money Market and Derivatives Association (FIMMDA), the average daily traded volume in CDs almost halved during May compared to April, while trade in CPs remained almost the same as in the

29/04 1/05 3/05

previous month.

The tight liquidity situation was reflected in the rise in the net injection through the LAF repo window of the RBI during May, after showing some temporary relief in April. During the first week of the month, the repo tendered amount averaged to Rs 22,500 crore and gradually increased in the second week and averaged to Rs 65,000 crore. However, the third week of the month saw a slightly lower tendered amount in the repo window, averaging to

5/05 7/05 9/05 11/05 13/05 15/05 17/05 19/05 21/05 23/05 25/05 27/05

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

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

Jan-2011 17,510 90,349

Feb-2011 2 79,677

Mar-2011 -14 87,950

Apr-2011 16 4,264

May-2011 1 53,666

Source: RBI’s Weekly Statistical Supplement.

of its worst performances and depreciated against the dollar during May, taking cues from lowered growth prospects of the domestic economy. The rupee remained

May 2011 April 2011
Instruments Daily Average Monthly Range of Daily Average Monthly Range of
Volume Weighted Weighted Average Volume Weighted Average Weighted Average
(Rs Crore) Average Rate (%) Daily Rate (%) (Rs Crore) Rate (%) Daily Rate (%)
Call Money 10,508 7.21 6.33-7.43 11,999 6.62 5.45-6.94
Notice Money 2,158 7.23 6.10-7.54 2,280 6.34 5.40-6.87
Term Money @ 127 6.30-10.35 107 7.00-9.25
CBLO 40,172 6.91 5.52-7.29 58,903 5.63 1.03-6.85
Market Repo 15,697 7.04 3.00-7.25 16,053 5.56 3.72-6.74

@: Range of rates during the month. Source: www.rbi.org.in. and www.ccilindia.com

instruments together recorded a 23% fall in the total volume during May over April (Table 3 and Graph B).

As per the latest RBI data, the volume of outstanding certificates of deposit (CDs) issued by scheduled commercial banks decreased by Rs 16,000 crore during the period of one fortnight and over the month it fell by Rs 13,000 crore. The outstanding amount at the end of the fortnight ending 6 May amounted to Rs 4,31,372 crore with the discount rates ranging between 7.85% and 10.05%. In contrast to this, the outstanding amount of commercial papers (CPs) increased by around Rs 21,000 crore during the period ending 15 May over 15 April; but over the period of one fortnight, the amount increased marginally by Rs 1,800 crore. The discount rates for these products continued to rule high for the past several months and the trend continued in May also, with the rates ranging between 7.01% and

Despite various efforts, there was no trading activity in the interest rate futures (IRF) segment of the National Stock Exchange (NSE).

2.2 Forex Market

In line with Asian currencies, the Indian rupee also witnessed one

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june 18, 2011 vol XLVI No 25

Graph B: Trends in Weighted Averages of Call Rates, Repo Rates and CBLO Rates – May 2011

Call rates Repo rates – Outside the RBI CBLO rates

Rs 52,000 crore. During the last week it peaked to Rs 75,000 crore.

During the month, the net borrowings by banks through the LAF window crossed Rs 85,000 crore on 26 May. Overall, during the month, the net injection by the RBI in its LAF window recorded a remarkable increase and crossed Rs 50,000 crore on a daily average basis, despite the RBI withdrawing second LAF operations on a daily basis and making it available only on reporting Fridays. The open market operations (OMO) window of the RBI continued to remain practically inactive (Table 4).

under pressure throughout the month despite rate hikes by the RBI in the beginning of May. Inflation concerns coupled with rising crude oil prices, dismal stock market behaviour, rising yields and portfolio outflows from the domestic market are the major reasons behind the overall weakness of the currency (Table 5).

The domestic currency started the month with a marginal appreciation against the dollar, at Rs 44.30 per dollar on 2 May. However, it then fell continuously for two days in a row on the back of huge rise in crude oil prices in international markets, increasing inflationary pressures. The rupee also responded negatively to the interest rate hikes by the central bank on 3 May and the lower projection of the country’s growth prospects in its Annual Policy statement. Thereafter, the behaviour of the rupee remained more volatile since the US dollar strengthened against most of the Asian currencies and the euro, fuelling

Table 5: Foreign Exchange Market: Select Indicators

Month Rs/$ Reference Appreciation (+)/ FII Flows BSE Sensex Dollar
Rate (Last Friday Depreciation (-) (Equity +Debt) (Month-end Index
of the Month) of Rs/$ (in %) in $ Million Closing) (Average)
Jan-2011 45.74 -2.03 1,198 18,328 73.19
Feb-2011 45.37 0.82 -721 17,823 72.22
Mar-2011 * 44.65 1.61 1,535 19,445 71.02
Apr-2011 44.38 0.61 1,616 19,136 69.75
May-2011 45.21 -1.84 -948 18,503 69.85

*: Data relates to Thursday, 31 March 2011. #:Nominal Major Currencies Dollar Index. Source: www.rbi.org.in, www.bseindia.com, www.sebi.gov.in, www.federalreserve.gov.

adverse pressure on the rupee, while turned bearish in response to the huge the rupee. In addition, the month-end intermittent portfolio investments into the reversals in portfolio investments. The payments of oil importers put further country’s equity market had some positive currency recovered by 15 paise on 19 and pressure. However, from 26 May onwards, impact. However, on 6 May, the rupee lost 20 May, reacting to the easing of crude oil the rupee limited its losses and marginally 21 paise against the dollar, but recouped prices and also their positive impact on the appreciated till the end of the month and in the next session and remained more or domestic markets. The rupee fell the most collectively added 35 paise against the less stable until 11 May, taking cues from on 23 May by 35 paise tracking huge sell-dollar. Overall, the rupee depreciated by easing oil prices overseas. The rupee again off in the local share market. Further, the 1.84% over April and ended at Rs 45.03 lost its shine on 12 May, extended its losses portfolio investors’ preference to withdraw per dollar on 31 May. continuously for four days and collectively funds from the domestic equity markets In spite of the huge fall in the rupee, the shed 39 paise till 18 May, as the stock market weighed heavily on the performance of forward premia across the three tenures Table 6: Details of Central Government Market Borrowing (Amount in Rs crore) softened remarkably during May compared

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

to April hinting towards a likely apprecia-

Primary Dealers Price (in %) (In Rupees)

06-May-11 7.59%2016 R 4,000 2.42 nil 8.40 96.78 tion of the rupee in the coming months,

8.13% 2022 R 5,000 2.67 nil 8.40 98.04influenced by broad weakness in the

8.26% 2027 R 3,000 2.42 nil 8.60 97.04

13-May-11 7.83% 2018 R 4,000 2.33 nil 8.40 97.05

7.80% 2021 R 5,000 1.71 nil 8.29 96.72

8.30% 2040 R 3,000 2.33 nil 8.64 96.39

20-May-11 7.59% 2016 R 4,000 1.90 631 8.49 96.46

8.08% 2022 R 5,000 2.18 nil 8.49 97.05

8.26% 2027 R 3,000 2.61 nil 8.64 96.71

dollar and a slight ease in crude oil prices. The premia in all the three tenures moved in a wide range during the month. The one-month premia touched its high of 7.86% on 2 May and low on 25 May while eased by 131 bps over April and closed at

27-May-11 7.80% 2021 R 5,000 1.99 nil 8.43 95.816.26% on 31 May. Similarly, the 3-month

8.30% 2040 R 3,000 2.41 nil 8.66 96.20 and 6-month premia softened by 144 bps Total for May 48,000 2.19 8.48 96.74

and 166 bps respectively, during the

Total for April 36,000 1.92 8.14

same period, and closed at 6.04% and

R: Reissue. Source: RBI press releases. 5.82% respectively.

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

Descriptions May 2011 Previous Month Three Months Ago Six Months Ago

Last Week (27) First Week (6) Total for the Month (April 2011) (February 2011) (November 2010) AMT YTM AMT YTM AMT YTM AMT YTM AMT YTM AMT YTM

1 Treasury Bills 6,683 4,156 19,135 17,843 12,827 11,947

A 91-Day Bills 3,722 8.01 2,758 7.75 11,929 7.89 12,653 7.09 8,911 6.93 6,846 6.62

B 182-Day Bills 804 8.10 240 7.77 2,245 7.95 2,526 7.19 1,599 7.30 2,720 7.08

C 364-Day Bills 2,158 8.18 1,158 8.08 4,962 8.14 2,665 7.37 2,317 7.47 2,381 7.02

2 GOI Dated Securities 36,310 8.42 29,549 8.29 1,27,796 8.36 1,00,608 8.09 1,33,542 8.17 1,39,919 7.99

Year of (No of Maturity Securities) 2011 2 90 8.23 50 7.99 315 7.96 1,353 7.58 737 7.40 216 6.88

2012 4 595 8.17 340 8.02 1,105 8.11 3,453 7.73 1,396 7.54 1,578 7.21

2013 3 55 8.17 295 8.19 371 7.79 800 7.73 801 7.30

2014 5 1 8.49 300 8.25 311 8.25 796 7.98 376 7.90 521 7.45

2015 3 656 8.44 665 8.32 1,650 8.37 2,285 8.02 13,870 8.10 13,250 7.80

2016 2 1,625 8.48 1,206 8.37 4,106 8.43 2,845 8.17 129 8.16 415 7.84

2017 4 146 8.29 405 8.38 4,114 8.01 12,635 8.12 35,362 7.93

2018 5 2,572 8.48 1,253 8.35 8,988 8.42 3,941 8.00 30 8.19 53 8.10

2019 1 0 8.66 0 8.04 0 8.18 16 7.91 70 8.20 27 7.97

2020 3 515 7.84 1,020 7.81 1,870 7.87 1,759 7.98 4,827 8.11 23,236 8.02

2021 2 11,404 8.37 11,915 8.21 49,678 8.28 24,634 8.03 18 8.20 6 8.09

2022 3 18,248 8.47 11,905 8.38 55,138 8.43 51,697 8.16 89,712 8.17 55,481 8.04

2023 1 2 8.20 6 8.38 1 8.38

2027 1 466 8.63 616 8.56 2,740 8.61 1,927 8.41 7,183 8.51 6,108 8.39

2028 4 8.31 5 8.55 6 8.52

2032 3 18 8.61 87 8.54 333 8.61 8 8.37 53 8.50 39 8.42

2034 1 5 8.36 7 8.40 2 8.46 2 8.50 2 8.28

2035 1 5 8.39 3 8.35 11 8.34 105 8.37 18 8.56 0 8.73

2036 1 10 8.55 10 8.55 1 8.14

2040 1 60 8.69 29 8.53 833 8.60 1,297 8.46 1,600 8.57 2,817 8.47

3 State Govt Securities 869 8.67 1,047 8.47 2,708 8.58 1,785 8.30 3,177 8.47 2,449 8.33

Grand total (1 to 3) 43,862 34,753 1,49,639 1,20,236 1,49,545 1,54,314

(-) 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. (2) Trades were negligible in maturities of 2023 to 2026 in the recent period. Source: Compiled by EPWRF; base data from RBI, CCIL.

june 18, 2011 vol XLVI No 25

MONEY MARKET REVIEW

After recording huge growth in the daily turnov er, while options trading government borrowing. At the rate of
overall turnover during March, the forex recorded a fa ll of 6% over April. However, Rs 12,000 crore per auction, the total pri
market continued to record double-digit the recent pe riod has seen options trading mary issuance amounted to Rs 48,000
rise in its average daily turnover during gaining pace in the currency derivatives crore against Rs 36,000 crore in April.
April also. The highest rise was recorded segment, and the exchanges that are trad- The auctions had a smooth sail, with the
by spot transactions at 18.7%, followed by ing in these products are also increasing exception of one security, namely, 7.59%
inter-bank (16.1%) during a period of one their total ma rket share. The United Stock 2016 issued on 20 May which faced a
month. The sustained rise in India’s trading Exchange (U SE) registered strong growth, devolvement on primary dealers worth
activity during April supported the forex where the dai ly average trading is hovering Rs 631 crore. Overall, the average cut-off
turnover since domestic exports and imports around Rs 6, 500 crore in May, showing a yield had gone up to 8.48% in May against
increased by 34% and 14% respectively, on 55% increase compared to April. However, 8.14% during April with improvement in
a year-on-year basis. a similar jum p is not seen in the case of the bid cover ratio to 2.19 times from 1.92
The total as well as the average daily NSE and the Multi-Commodity Exchange times. Five securities – 7.59% 2016, 8.26%
traded turnover in the currency deriva(MCX-SX). De spite trading only in futures, 2027, 7.83% 2017, 7.80% 2021 and 8.30%
tives market in May recorded a 40% and the MCX-SX maintained an increase in its 2040 – which were issued twice during
6% jump respectively, compared to April. trading activ ity, while the NSE turnover the month, witnessed firming up of yield
The recently introduced currency options, decreased by 4% on a daily average basis. rates over the month (Table 6, p 124).
growing awareness about these derivative Still, the NSE dominated in total market A higher supply of government securities
products, higher volatility in forex markets share and co rnered 44% of the total cur during the month as well as increased
and increased popularity among smaller rency derivat ives turnover while the con notified amounts of TBs in primary auctions
companies to hedge foreign exchange tribution of M CX-SX remained at 36% and led to stubborn yield rates. The banking
exposure are some of the reasons behind USE at 21%. A mong the products traded on system was also in deficit mode. The
the increasing daily average volumes on the exchange s, trade in USD-INR contracts expectation of further policy rate hikes
the bourses. contributed to 95% of the total futures following continued inflationary pressure
During May, the futures trading registrading, whil e EURO-INR, JPY-INR and GBP also contributed to the overall hardening
tered a high growth of 49% in its average INR still rema ined lacklustre. of yields, particularly at short maturities.
Table 8: Yield Spreads (Weighted Average) – Central Government Securities – The turnover of central government
May 2011 (basis points (bps)) Yield May 2011 Previous Three Six Months Spread in bps Last Week First Week Entire Month Month Months Ago Ago 2.3 Government Securities Market securities in the secondary market increased by 27% to Rs 1,27,796 crore in May with
1 Year-5 Year 31 35 32 44 62 63 5 Year-10 Year -11 -16 -15 -14 4 25 10 Year -15 Year – – 42 – 22 46 1 Year-10 Year 20 19 17 30 66 88 Source: As in Table 8. The RBI came out with four auctions of the central government securities during the month of May, front-loading overall increase in yield rate to 8.36%. The share of top five securities, 7.80% 2021, 8.13% 2022, 8.08% 2022, 7.83% 2018 and 7.59% 2016, in the total traded volume of
Table 9: Predominantly Traded Government Securities (Amount in Rs crore)
Descriptions May 2011 Previous Month Three Months Ago Six Months Ago
Last Week (27) First Week (6) Total for the Month (April 2011) (February 2011) (November 2010)
AMT YTM AMT YTM AMT YTM AMT YTM AMT YTM AMT YTM
GOI Dated Securities
9.39 , 2011 90 8.23 265 7.95 1,180 7.58 251 7.34 161 6.90
7.40 , 2012 540 8.16 340 8.02 1,040 8.10 2,665 7.77 738 7.49 1,128 7.25
7.27 , 2013 55 8.17 295 8.19 370 7.79 800 7.73 788 7.30
7.32 , 2014 200 8.30 200 8.30 350 8.00 36 7.48
7.17 , 2015 656 8.44 665 8.32 1,649 8.37 2,278 8.02 13,408 8.10 12,949 7.81
7.02 , 2016 10 8.37 33 7.94 125 8.16 415 7.84
7.59 , 2016 1,625 8.48 1,206 8.37 4,096 8.43 2,812 8.17 3 8.18 0 8.17
7.46 , 2017 0 8.26 1 8.22 190 8.02 174 8.08 1,901 7.92
7.49 , 2017 34 8.36 262 8.43 2,413 7.99 5,117 8.12 0 8.20
7.99 , 2017 110 8.27 141 8.29 1,479 8.03 7,336 8.12 33,411 7.92
7.83 , 2018 2,572 8.48 1,212 8.35 8,901 8.42 3,930 8.00
7.80 , 2020 515 7.84 1,015 7.80 1,860 7.86 892 8.02 4,287 8.12 23,175 8.02
7.80 , 2021 11,402 8.37 11,915 8.21 49,676 8.28 24,634 8.03 4,287 8.12
8.08 , 2022 13,197 8.47 4,306 8.38 24,889 8.45 28,681 8.18 39,453 8.18 16,944 8.06
8.13 , 2022 5,052 8.45 7,599 8.38 30,168 8.42 22,978 8.13 50,184 8.16 38,394 8.04
8.20 , 2022 80 8.47 37 8.11 75 8.16 142 8.09
8.26 , 2027 466 8.63 616 8.56 2,740 8.61 1,914 8.41 7,124 8.51 6,073 8.39
8.28 , 2032 18 8.61 2 8.59 248 8.64 4 8.36 46 8.51 15 8.46
8.30 , 2040 60 8.69 29 8.53 833 8.60 1,297 8.46 1,600 8.57 2,817 8.47
Total (All Securities) 36,310 8.42 29,549 8.29 1,27,796 8.36 1,00,608 8.09 1,33,542 8.17 1,39,919 7.99

(-) 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 8.

Economic Political Weekly

EPW
june 18, 2011 vol XLVI No 25

government securities was a whopping Secondary market turnover in SDLs 92%. The 10-year security 7.80% 2021 was jumped by more than 50% to Rs 2,708 traded worth Rs 49,676 crore followed by crore during May, against Rs 1,785 crore 8.13% 2022 and 8.08% 2022 with traded in April. The traded yield also hardened amounts of Rs 30,168 crore and Rs 24,889 over the month to 8.58% from 8.30% in the crore respectively. The yield spread between previous month. securities with maturity of one-year to five-year and one-year to 10-year nar-2.4 Treasury Bills rowed down to 32 bps and 17 bps, respec-Four auctions of TBs for an aggregate tively, from 44 bps and 30 bps in the previ-amount of Rs 42,000 crore were held in May ous month, driven mainly by hardening as compared to Rs 30,000 crore in April, of short-term yield rates (Table 7, p 124, owing to rise in auctioned amounts devi-Tables 8 and 9, p 125). ating from the original calendar. A sudden

During the month, there were three and sharp rise in auctioned amounts was issuances of state development loans seen in the case of 91-day TBs, which (SDLs) for Rs 9,100 crore. The first issue increased by 60% to Rs 32,000 crore from on 5 May witnessed participation from Rs 20,000 crore in April. As a result, the West Bengal alone, mopping up Rs 2,000 month saw a sharp rise in cut-off yields over crore. This issue received the highest bid the last month across maturities. The RBI cover ratio of 3.02 times in May. Then, on took the decision to increase notified 10 May, five state governments raised amounts of TBs auctions for tiding over the Rs 3,100 crore. Four states accessed the mismatches in the government’s cash posimarket during the third issue, which was tion in the short term. For 91-day TBs the conducted on 25 May, after a gap of 14 days, hike in the notified amount was Rs 3,000 for Rs 4,000 crore. As compared to the crore for each auction to Rs 8,000 crore. As previous month, May had higher accepted per the earlier calendar, this amount was amounts with surge in bid cover ratio and Rs 5,000 crore. In the case of 182- and cut-off and weighted average yield rates 364-day TBs also, the auctioned amounts (Table 10). were raised by Rs 1,000 crore each for the

month as a whole. Uptick in

Date of Auction Number of Total Bid Cover YTM at Weightedthe cut-off yield rates was Participating Amount Ratio Cut-Off Average

seen for auctions since early

States Accepted Price (%) Yield (%)

05-May-11 1 2,000 3.31 8.6 8.6 May, across maturities, in

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

10-May-11 5 3,100 2.97 8.65 8.64 the wake of higher notified
25-May-11 4 4,000 2.92 8.67 8.66 amounts combined with
Total for May 10 9,100 3.02 8.65 8.64 hikes in policy rate on 3 May.
Table 11: Auctions of Treasury Bills (Amount in Rs crore) Date of Auction Bids Bid Cover Cut-off Weighted Cut-off Accepted Ratio Yield (%) Average Price (Rs) Total for April 8 8,423 2.98 8.4 Source: RBI press releases. Weighted Average8.38 It may be recalled that in the recent past, the RBI has also been mopping up liquidity through cash man-
A: 91-Day Treasury Bills 04-May-11 11-May-11 8,000 8,000 1.86 2.67 7.89 8.06 Yield (%) 7.85 8.02 98.07 98.03 Price (Rs) 98.0898.04 agement bills (Table 11). Contrary to heightened primary market activity, the
18-May-11 8,000 2.7 8.1 8.1 98.02 98.02 traded volume in the sec
25-May-11 8,000 1.98 8.14 8.14 98.01 98.01 ondary market for TBs saw
Total for May 32,000 2.3 8.05 8.03 98.03 98.04 only a marginal rise over the
Total for April 20,000 2.51 7.36 7.32 98.2 98.21 month to Rs 19,135 crore
B: 182-Day Treasury Bills 11-May-11 3,000 25-May-11 3,000 2.73 2.44 8.2 8.29 8.18 8.25 96.07 96.04 96.0896.05 against Rs 17,843 crore in April. While trade in 91-day
Total for May 6,000 2.58 8.25 8.21 96.06 96.07 TBs and 182-day TBs record-
Total for April 5,000 2.95 7.63 7.59 96.34 96.35 ed a fall in turnover over the
C: 364-Day Treasury Bills previous month to Rs 11,929
04-May-11 18-May-11 Total for May Total for April 3,000 3,000 6,000 5,000 2.25 3.24 2.74 3.25 8.2 8.29 8.25 7.67 8.17 8.28 8.22 7.65 92.44 92.36 92.4 92.89 92.4792.37 92.42 92.91 crore from Rs 12,753 crore and to Rs 2,245 crore from Rs 2,526 crore respectively,
Source: RBI's press releases. the trade in 364-day bills
126 june 18, 2011

nearly doubled to Rs 4,962 crore from Rs 2,665 crore thanks to higher yields. The overall pressure on short-term rates in the system was reflected in the steep rise in traded yields of TBs. The yields overall rose by around 80 bps and the 364-day TB yield crossed the psychological level of 8%, closer to the 10-year yield, narrowing the spread.

2.5 Corporate Bonds Market

The number of private placement issues of corporate bonds listed in the trading platform of the NSE fell during the month in comparison with April. However, the amount raised by the institutions saw a tremendous jump in May, three times more than that recorded in April. The coupon rates had obviously seen upward movement, in tandem with government securities yields, and ranged between 9.27% and 11.50% during the month compared to 9.18% and 10.40% of April. The lower coupon rate was offered by the Indian Railway Finance Corporation (IRFC) for 10-year maturing bonds, while the highest coupon rate was offered by Tata Steel for perpetual maturity bond. It was observed that HDFC issued bonds seven times during May and the coupon rates ranged between 9.40% and 9.95% for the maturity period ranging between one and 15 years. In addition, the same institution offered higher rates for one-year bonds than for the longer maturity papers, signalling an inversion in the bond yield curve. This is not surprising, given that in the government securities market, shorter maturity bonds and TBs have seen yield pressures. Moreover, this met with the investor needs for short duration investments (Table 12).

Table 12: Private Placement of Corporate Bonds in NSE

Month No of Issues Amount Rs crore

Apr-2011 31 4,203
May-2011 25 13,170
Total 56 17,373

Source: NSE.

According to the data published by the SEBI, the average daily turnover in the secondary market for corporate bonds reported by the Bombay Stock Exchange, the NSE and the FIMMDA together declined by about 36% in comparison with the previous month. The aggregate turnover also declined by a significant 16%. The turnover in BSE, NSE and FIMMDA declined by 14.5%, 30.9% and 14.5% respectively, in comparison with the previous month.

vol XLVI No 25

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