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Will the Reserve Bank Reverse Its Stance?

Is the mid-year monetary review by the Reserve Bank of India going to see a pause in the rate hike, implying that policy rates have now peaked? This note tracks the past experience with policy rate movements and identifies the inflection points for rate changes and the nature and intensity of changes in response to inflation and growth behaviour. An attempt is also made to ask what the RBI's stance should be, given the policy dilemma and risks associated with different policy options.

MONEY MARKET REVIEW

response to inflation and growth behaviour.

Will the Reserve Bank Reverse
In conclusion, an attempt is made to ask

what the stance of the RBI should be, given

Its Stance?
the policy dilemma and risks associated

with different policy options.

1.1 Inflation Persistence and

EPW Research Foundation

Is the mid-year monetary review by the Reserve Bank of India going to see a pause in the rate hike, implying that policy rates have now peaked? This note tracks the past experience with policy rate movements and identifies the inflection points for rate changes and the nature and intensity of changes in response to inflation and growth behaviour. An attempt is also made to ask what the RBI’s stance should be, given the policy dilemma and risks associated with different policy options.

1 Introduction

A
key question on which Indian financial markets are expecting a direction from the central bank in its forthcoming mid-year monetary policy review on October 25 is whether the policy will see a reversal from the current hawkish anti-inflationary stance. In fact, a reversal in stance would not actually mean any reduction in policy rates, but only a pause in the rate hike which would, first, send a signal that the policy rate has peaked, and that it is time to allow the lagged impact of past rate hikes to work themselves out. Second, a pause at this time would signify that economic activity at the current level would be sustained to yield a growth rate of at least 8%, which is perceived as the non-inflationary potential growth rate in the current environment.

The aim apparently is to bring inflation down to some moderate level of 7% by the turn of the current fiscal, if not to the desirable and comfortable level of around 5% that can at best remain only a long-term goal. A related question is how long the pause or the lull in rate hikes will continue before a rate cut becomes a possibility.

The answers to the above questions would be pegged to two related further questions. The first is whether inflation at a high or near double-digit level has peaked and will there now be a downward movement henceforth? Second, will the continuance of rate hikes mean a significant threat to growth impulses which could substantially thwart growth projections, bringing it significantly below the potential of 8%?

This note addresses

Policy Rate Outlook

Table 1 and Graph A (p 136), present the inflation trends during different phases of the policy cycle of easing and tightening since early 2001. In the current tightening phase which began in early 2010, inflation rates measured by both the wholesale price index (WPI) and the consumer price index (CPI) remained persistently high. WPI inflation even at the minimum level was 8.2% and touched a maximum of 10.9% with an average of 9.6%. CPI inflation, similarly, at the minimum ruled at 8.3%, the maximum touching as much as 14.9% with an average of 10.5%. In the earlier easing phase, WPI inflation was relatively more volatile on account of both global and domestic factors, averaging at 4% but ranging between (-)0.4% and 10.7%. CPI inflation ruled at an elevated average level of 11%, which again ranged widely between 8% and 16.2%.

Graph A also shows the inflection points of directional change in the policy cycle. It is observed that irrespective of whether it was an easing or tightening phase, the inflections occurred at points when the WPI inflation rate peaked. The current phase of tightening started just before April 2010 when inflation rate peaked at 10.9%. Since then there have been a series of rate hikes but there is no relenting in the inflation rate which has not fallen significantly enough or shown any signs of touching a new low. Since September 2010 onwards, the rate of inflation has persisted at above 9%.

Yet another aspect is that the central bank allows a lull period of “pause” in every cycle, before the direction of rate change

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

Economic & Political Weekly

EPW
octoBER 22, 2011

these questions by using simple analysis to track the past experience and identify the inflection points for rate changes and the nature and intensity of rate changes in

vol xlvi no 43

Table 1: Trends in Monthly Y-o-Y Inflation during Different Policy Phases – WPI and CPI

CPI WPI
Average Min Max Average Min Max
Phase I (Apr 01 to Aug 04) 3.9 2.2 5.2 4.4 1.4 8.5
Phase II (Sept 04 to Sept 08) 5.9 3.3 9.8 6.0 3.2 11.1
Phase III (Oct 08 to Jan 10) 11.0 8.0 16.2 4.0 (-) 0.4 10.7
Phase IV (Feb 10 to ….) 10.5 8.3 14.9 9.6 8.2 10.9
Source: www.eaindustry.nic.in, www.epwrfits.in, compiled by EPWRF.
135

MONEY MARKET REVIEW

18 14 10 6 2 -2

Graph A: Movement in WPI, CPI, IIP and Quarterly GDP

4/018/0112/014/028/0212/024/038/0312/034/048/0412/044/058/0512/054/068/0612/064/078/0712/074/088/0812/084/098/0912/094/108/1012/104/118/11 I II WPI CPI IIP Quarterly GDP Phase I Phase II Phase III Phase IV

202 15 10 5 0 -5-10

Graph B: Intensity of Easing/Tightening

Basis points

450 400
350 Reverse repo rate
250 Repo rate 175
150 CRR
50
0
-50
-50
-150 -100
-250 -200
-250
-350 -325 -300
-450 Ph I Phase I Ph II Phase II Ph III Phase III

is actually reversed. Such lull periods last several months. Table 2 (p 137) shows the rate changes date-wise in different phases of the policy cycle and also the time intervals before the next rate change. In the earlier easing phase, the low repo rate of 4.75% and reverse repo rate of 3.5% were allowed to pause for 332 days from 21 April 2009 to 19 March 2010, before a rate hike of 25 bps was exercised. This was a time when it was felt that the economy was overheating and that the inflation rate was peaking.

What is the outlook for inflation in the near future for the rest of the financial year? The variation in the index of wholesale prices year on year is indicative of a larger demand side pressure as of September 2011, compared to the corresponding period in 2010. The index of primary food articles increased by a lower 9.2% in 2011 against 16.3% in 2010, while that of manufactured food products rose by a higher 8% against only 3.6%. While the primary articles as a whole showed a lower increase of 11.8% compared with 18.2%, the manufactured products recorded a larger increase of 7.7% against 5% during the same period. As per

recent indications from the

speeches of RBI Governor Duvurri Subbarao and Deputy Governor Subir Gokarn, it is not merely the

demand-side pressure but even with supply-side pressures monetary policy has a role to play. In the present circumstances, therefore, the question is whether the pause should begin now or should await one or two more rate hikes. The answer to this will depend upon two factors. One, whether the rate hike has peaked and, two, whether the economy shows strong signs of a slowdown.

350 Graph B shows the

300

intensity of policy easing and tightening in differ

25

ent phases. In the current phase, the repo and reverse repo rates have been revised upward by 300 bps and 350 bps, respectively,

Phase IV

Ph IV

much larger than the intensity with which rates were eased in the earlier phase. However, the cash reserve ratio (CRR) has been revised upward by 25 bps against the easing of 100 bps in the earlier phase. Apparently, enough has been done as far as the rate hike is concerned, and it is now time to allow a pause and leave the rate hikes already done to work themselves out. Inflation has no doubt not eased enough, but given the current environment, taking into account both supplyside and demand-side factors, inflation may ease to the targeted level of around 7.0%. In case the policy action proves to be inadequate and signs of a persistence of high inflation continue, then the option of increasing the CRR by another 50 to 75 bps in steps may be considered a better option.

1.2 Is There a Threat of Slowdown Due To Rate Hikes?

Graph A also shows the variations in index of industrial production year on year on a monthly basis and GDP on a quarterly basis. Despite some volatile trends, there are clear signs that economic activity has been slowing during the current tightening phase. GDP growth has slowed consistently from 9.4% for the quarter ending April-June 2010, to 7.7% for the quarter ending April-June 2011. Similarly, though fluctuating, growth in the Index of Industrial Production (IIP) touched lows of 3.8% and 4.1% in recent months, compared to 9.4% in March 2011. There are also signs of investment demand coming down though the export sector has been buoyant. According to CMIE data, quarterly investment proposals have reportedly fallen from Rs 7.2 lakh crore in the June 2010 quarter to only Rs 2.6 lakh crore in the September 2011 quarter.

1.3 Debt Management Issues

The RBI from the beginning of this fiscal was continually stressing the downside risks to fiscal consolidation. Due to additional borrowings announced for the current year, the interest rates on government securities have spiked after September. Tables 3 and 4 (p 137) present the trends in primary market auction results and secondary market yield trends for select maturities during the last month. The auction results show poor responses as evident from lowered bid cover ratios and increasing devolvement on primary dealers. Another rate hike and signs of further rate hikes would push yield rates to dizzy heights which would spill over into bond and credit markets exacerbating the process of the current slowdown in economic activity. Smooth conduct of the borrowing programme would also require some stability to yield rates.

1.4 Concluding Observations

Based on past experience the policy rate hikes seem to have peaked. The inflation rate has also peaked, but there is no let-up and inflation persists at a high level. There are nevertheless sure signs of a slowdown in economic and investment activity. At its present level, the economy may not be considered as overheated. Further rate hikes may do harm dampening economic activity and also disrupting bond and credit markets severely.

It would be preferable at this stage to give a pause to further rate hikes and allow the past hikes to work themselves out over the next several months. If inflation continues to persist, the instrument of CRR may be reactivated for a while.

octoBER 22, 2011 vol xlvi no 43

EPW
Economic & Political Weekly

MONEY MARKET REVIEW

No of Days (%) No of Days Repo Rate (%) No of Days

Phase I 30-Apr-01 8.00 27-Apr-01 9.00 19-May-01 6.75down economic activity. The RBI again

19-May-01 7.50 19 30-Apr-01 8.75 3 28-May-01 6.50 9increased the key policy repo rate by 25

3-Nov-01 5.75 168 7-Jun-01 8.50 38 5-Mar-02 6.00 281

29-Dec-01 5.50 56 28-Mar-02 8.00 294 27-Jun-02 5.75 114

1-Jun-02 5.00 154 12-Nov-02 7.50 229 30-Oct-02 5.50 125

16-Nov-02 4.75 168 7-Mar-03 7.10 115 3-Mar-03 5.00 124

25-Aug-03 4.50 282 19-Mar-03 7.00 12 25-Aug-03 4.50 175

18-Sep-04 4.75 390 31-Mar-04 6.00 378 27-Oct-04 4.75 429

bps to 8.25% in its mid-quarter review on 16 September. The discouraging IIP data and dismal corporate earnings shadowed the growth prospects while inflation-linked worries further thwarted investor senti-

Phase II 2-Oct-04 5.00 14 26-Oct-05 6.25 574 29-Apr-05 5.00 184ments. The continuous depreciation of the

23-Dec-06 5.25 812 24-Jan-06 6.50 90 26-Oct-05 5.25 180

1-Jan-07 5.50 9 8-Jun-06 6.75 135 24-Jan-06 5.50 90fundamentals led to adverse conditions
17-Feb-07 5.75 47 25-Jul-06 7.00 47 8-Jun-06 5.75 135across all the segments of financial markets.
31-Mar-07 6.00 42 31-Oct-06 7.25 98 25-Jul-06 6.00 47
14-Apr-07 6.25 14 31-Jan-07 7.50 92 8-Dec-08 5.00 867The liquidity in the system was generally
28-Apr-07 6.50 14 31-Mar-07 7.75 59 5-Jan-09 4.00 28tight during September following out
4-Aug-07 7.00 98 12-Jun-08 8.00 439 5-Mar-09 3.50 59 flows caused due to advance tax payments
10-Nov-07 7.50 98 25-Jun-08 8.50 13 21-Apr-09 3.25 47 by corporates. Still, the system experienced
26-Apr-08 7.75 168 30-Jul-08 9.00 35 19-Mar-10 3.50 332 some moderation in the overall tight
10-May-08 8.00 14 20-Oct-08 8.00 82 20-Apr-10 3.75 32 liquidity situation and it is likely to return
24-May-08 8.25 14 3-Nov-08 7.50 14 2-Jul-10 4.00 73 to its balance in the coming days. During
5-Jul-08 8.50 42 8-Dec-08 6.50 35 27-Jul-10 4.50 25

rupee coupled with bouts of weak macro

19-Jul-08 8.75 14 5-Jan-09 5.50 28 17-Aug-10 5.00 21

September, expanding bank credit caused

30-Aug-08 9.00 42 5-Mar-09 5.00 59 2-Nov-10 5.25 77 Rs 48,000 crore outflows followed by an

Phase III 11-Oct-08 6.50 42 21-Apr-09 4.75 47 25-Jan-11 5.50 84increase in bankers’ deposits with the RBI 25-Oct-08 6.00 14 19-Mar-10 5.00 332 17-Mar-11 5.75 51

which absorbed another Rs 40,000 crore

8-Nov-08 5.50 14 20-Apr-10 5.25 32 3-May-11 6.25 47

from the system. Aggressive market bor

17-Jan-09 5.00 70 2-Jul-10 5.50 73 16-Jun-11 6.50 44

rowing by the government also withdrew

13-Feb-10 5.50 392 27-Jul-10 5.75 25 26-Jul-11 7.00 40

another Rs 32,000 crore from the system.

Phase IV 27-Feb-10 5.75 14 17-Aug-10 6.00 21 16-Sep-11 7.25 52

24-Apr-10 6.00 56 2-Nov-10 6.25 77 However, a huge amount of Rs 60,000 crore

16-Sep-11 6.00 25-Jan-11 6.50 84

17-Mar-11 6.75 51
3-May-11 7.25 47
16-Jun-11 7.50 44
26-Jul-11 8.00 40
16-Sep-11 8.25 52

of inflows through variation in foreign currency assets supported the system to restore some balance. Aggregate deposits also showed signs of a pick-up growing by Rs 21,000 crore.

Thick line indicates end of phase. Source: RBI, Compiled by EPWRF. The money market rates further hardened following rising key interest rates and the
Table 3: Primary Market Data of Government Securities Date of Auction Nomenclature of Loan Notified Amount (in Rs Crore) Cut-off Price (in Rs) Cut-off Yield (in %) Devolvement on Primary Dealers Bid Cover Ratio Table 4: Secondary Market Yields of Frequently Traded Securities (%)
(in Rs Crore) Date/Maturity 2017 2018 2021 2022 2027 2040
09-Sep-11 7.80% 2021 R 5,000 96.71 8.30 nil 2.32 15-Sep-11 8.36 8.36 8.35 8.44 8.59 8.63
14-Oct-11 7.80% 2021 R 6,000 93.75 8.78 2,424 1.74 16-Sep-11 8.36 8.36 8.35 8.43 8.59 8.63
14-Oct-11 7.83% 2018 R 4,000 95.31 8.79 1,614 1.84 19-Sep-11 8.36 8.35 8.33 8.41 8.58 8.63
02-Sep-11 7.99% 2017 R 3,000 98.15 8.39 725 1.97 20-Sep-11 8.35 8.34 8.32 8.41 8.58 8.62
09-Sep-11 8.07% 2017 R 3,000 98.87 8.33 nil 1.74 21-Sep-11 8.32 8.35 8.33 8.41 8.58 8.61
07-Oct-11 8.07% 2017 R 3,000 97.61 8.64 nil 1.84 22-Sep-11 8.32 8.33 8.31 8.40 8.57 8.60
02-Sep-11 8.13% 2022 R 5,000 97.66 8.46 nil 2.07 23-Sep-11 8.33 8.33 8.30 8.38 8.55 8.59
07-Oct-11 8.08% 2022 R 6,000 95.68 8.70 nil 1.74 26-Sep-11 8.30 8.31 8.29 8.37 8.54 8.59
09-Sep-11 8.28% 2027 R 3,000 97.49 8.57 nil 2.98 27-Sep-11 8.31 8.33 8.32 8.39 8.55 8.59
07-Oct-11 8.28% 2027 R 3,000 95.00 8.87 193 1.98 28-Sep-11 8.31 8.33 8.33 8.39 8.55 8.59
14-Oct-11 8.26% 2027 R 3,000 94.21 8.95 nil 1.98 29-Sep-11 8.41 8.39 8.39 8.43 8.64 8.59
02-Sep-11 8.30% 2040 R 3,000 96.09 8.67 nil 2.17 03-Oct-11 8.46 8.51 8.51 8.54 8.71 8.72
07-Oct-11 8.30% 2040 R 3,000 93.59 8.92 706 1.84 04-Oct-11 8.49 8.53 8.53 8.58 8.72 8.71

R-Reissue Source: RBI website.

2 Money, Forex and Debt Markets

The financial markets globally had continued with their traumatic behaviour in September, on the back of eurozone debt worries combined with disruptive global

Economic & Political Weekly

EPW
octoBER 22, 2011

economic recovery. The domestic markets also chased global developments with almost all the segments of markets turning apathetic. Market participants became increasingly anxious following a series of

vol xlvi no 43

05-Oct-11 8.55 8.55 8.60 8.74 8.71
07-Oct-11 8.62 8.69 8.86 8.92
10-Oct-11 8.68 8.68 8.72 8.76 8.89 8.96
11-Oct-11 9.30 8.73 8.74 8.76 8.91 8.95
12-Oct-11 8.67 8.70 8.73 8.74 8.80 8.93
13-Oct-11 8.71 8.71 8.73 8.75 8.90 8.92
14-Oct-11 8.74 8.79 8.78 8.78 8.95 8.96
Source: RBI and CCIL websites.
137

MONEY MARKET REVIEW

Table 5: Money Market Activity (Volume and Rates) maturities also moved in an upper range of
Instruments Call Money Notice Money Daily Average Volume (Rs Crore) 10,320 3,027 September 2011 Monthly Weighted Average Rate (%) 8.11 8.10 Range of Weighted Average Daily Rate (%) 7.48-8.28 7.25-8.29 Daily Average Volume (Rs Crore) 8,381 2,649 August 2011 Monthly Weighted Average Rate (%) 7.97 7.96 Range of Weighted Average Daily Rate (%) 7.02-8.00 6.70-8.02 7.67% and 14.50% in the second fortnight of August. According to the trading platform of the Fixed Income Money Market and Deriva-
Term Money @ 353 - 7.00-10.65 209 - 7.00-10.15 tives Association (FIMMDA), CDs and CPs
CBLO 43,408 7.95 6.56-8.24 38,634 7.86 5.77-8.00 recorded a notable 21% and 18% rise, respec-
Market Repo 13,714 8.03 5.25-8.27 14,450 7.94 5.00-8.04 tively, both in their total and average daily
@: Range of rates during the month.
Source: www.rbi.org.in. and www.ccilindia.com turnover during a period of one month.
Table 6: RBI’s Market Operations (Rs crore) while in the afte rmath of the rate hike by Moreover, rates in both the segments also
Month/Year OMO LAF (Average Daily he rates h ardened subst
(Net Purchase(+)/Sale(-)) Injection (+)/Absorption(-)) RBI, t antially and had seen substantial spikes.
Apr-2011 16 4,264 the sit uation go t worsened towards the After experiencing some normalcy in
May-2011 1 53,666 end o f Septemb er when ove rnight rates liquidity during August, the system again
Jun-2011 981 72,204 crosse d the repo rate of 8.25%. However, faced a severe cash crunch during Septem
Jul-2011 -6 37,683
Aug-2011 -6 36,948 expect ation of a probable pa use in rate ber, since advance tax payments by com
Sep-2011 5 52,194 hikes in the com ing days ke pt the term panies for the second quarter of 2011-12

Source: RBI’s Weekly Statistical Supplement.

crucial needs of funds by banks to meet their half yearly balance sheet requirements. The short-term money market rates remained more volatile and one-day rates crossed the prevailing repo rate of 8.25% on several occasions. The RBI’s liquidity adjustment facility (LAF) window also reflected bank borrowings in excess, touching levels of above Rs 1 lakh crore in September.

The troubled domestic fundamentals with increasingly complex euro-debt crisis crippled the rupee-dollar exchange rates to touch the lows seen in May 2009. The domestic currency depreciated by around 6% against the dollar in September. The government securities market also reeled under increasing pressure on interest rates following a policy rate hike combined with an added stress caused by the government’s announcement to borrow about Rs 53,000 crore in excess of the budgeted amount in the remaining part of the current fiscal. This led to a sudden spurt in yields towards the end of the month particularly in the 10-year benchmark government bonds. Despite this, the yield curve remained inverted due to short-term pressures. Looming uncertainties kept the corporate bond market activity also at bay.

2.1 Money Market

The liquidity crunch in the system and incessant hikes in key policy rates resulted in short-term money market rates heading to their peaks during September. Mixed perceptions about another aggressive stance by RBI in its mid-quarter review kept the short-term money market rates rangebound in the first two weeks of September rates stable during the month. Overall, in a period of one month, the weighted average call and notice money rates increased by 14 basis points each while collateralised instruments such as collateralised borrowing and lending obligations (CBLO) and market repo depicted rates hardening by 9 basis points each.

Due to immediate needs of funds by banks to meet their half-yearly needs and relative volatility in rate movements, money market reported a surge in trading activity. During the month, except the market repo segment, the remaining four short-term instruments together recorded a 15% rise in their traded volume over the previous month. Despite the huge volatility in rates, the market repo shed 5% of its average daily turnover during the same period (Table 5).

As per the latest available data from the RBI, the short-term certificates of deposit (CDs) market had seen a fall in issuances

during August compared to the previous month. The rates also softened notably and fell below the 10% mark and in the second fortnight rates ranged bet ween 8.79% and 9.82%. The total amount outstanding at the end of 26 August stood at Rs 4,05,685 crore. Contrary to CDs, the issuance of commercial papers (CPs) improved by Rs 15,000 crore in one month and the outstanding amount at the end of 31 August amounted to Rs 1,48,812 crore. The rate of interest on CPs across and half yearly requirements of banks put huge cash demands on the system. The liquidity in the system seemed endurable in the beginning of September with the repo tendered amount touching its low of Rs 3,745 crore on 8 September – the levels seen in May 2011. However, the situation tightened gradually thereafter, witnessing crucial needs of banks coupled with widening demand for credit. The injection of funds by the RBI remained above Rs 50,000 crore per day till the end of the month except for one or two occasions. Moreover, the RBI’s repo window exhibited bank borrowings crossing Rs 1 lakh crore on 16 September after a gap of three months reflecting the severe cash crunch in the system. Overall, the injection of funds by RBI in its repo window averaged Rs 52,000 crore higher than that injected in the previous month. The OMO window reported hardly any activity (Table 6).

Table 7: Foreign Exchange Market: Select Indicators

Month Rs/$ Reference Appreciation (+)/ FII Flows BSE Sensex Dollar Index Rate (Last Friday Depreciation (-) (Equity +Debt) (Month-end (Average)# of the Month) of Rs/$ (in %) in $ Million Closing)

Apr-2011 44.38 0.61 1,616 19,136 69.75

May-2011 45.21 -1.84 -948 18,503 69.85

Jun-2011 44.72* 1.10 4,883 18,846 69.76

Jul-2011 44.16 1.27 2,399 18,197 69.34

Aug-2011 46.05 -4.12 -7,903 16,677 69.19

Sep-2011 48.93 -5.87 -1,866 16,454 71.18

*: Data relates to last day of the month. #:Nominal Major Currencies Dollar Index. Source: www.rbi.org.in, www.bseindia.com, www.sebi.gov.in, www.federalreserve.gov.

Table 8: Average Daily Turnover in the Foreign Exchange Market* ($ billion)

Month Merchant Interbank Spot Forward Total

Apr-2011 14.1 (10.8) 40.1 (14.7) 27.7 (20.1) 26.5 (7.6) 54.2 (13.6) May-2011 13.5(-16.7) 48.3 (-6.3) 28.9 (-9.7) 33.0 (-8.0) 61.9 (-8.8) Jun-2011 12.7 (-5.8) 48.1 (-0.5) 27.4 (-5.2) 33.4 (1.47) 60.8 (-1.7)

Jul-2011 14.0 (9.53) 45.1 (-6.3) 28.5 (4.04) 30.5 (-8.8) 59.0 (-3.0)

Aug-2011 17.0(21.59) 46.6(3.35) 30.3(6.22) 33.3(9.01) 63.5(7.66) *: Includes trading in FCY/ INR and FCY/FCY. Figures in brackets are percentage change over the previous month. Source: RBI’s Weekly Statistical Supplement, various issues.

octoBER 22, 2011 vol xlvi no 43

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Economic & Political Weekly

MONEY MARKET REVIEW

The trading activity in the two months old 91-day TBs interest rate futures (IRFs) in NSE came to a standstill from 9 September onwards while the segment recorded a meagre Rs 19.3 crore turnover in five trading days till 8 September. The open interest at the end of the period also remained negligible.

2.2 Forex Market

Uncertainty and stagnant recovery with significant downside risks to the US economy and intensifying eurozone sovereign debt crisis rattled the global markets. This tendency got exacerbated with some key officials in policy circles threatening that the world economy was entering into a seriously “dangerous” phase. However, US President Barack Obama’s unveiling of a $447 billion plan for creating jobs coupled with the efforts by global central banks and European lawmakers to deal with the eurozone’s fiscal problems and rescue them from a fallout resulted in some return of risk appetite in the financial markets.

The fears of a Greek default lowered the value of the euro and it depreciated by 5.5% against the dollar. The Japanese yen appreciated against the dollar with worries over global growth boosted safe haven demand for the Japanese currency. The dollar rose sharply against most of the major

Table 9: Details of Central Government Market Borrowing (Amount in Rs crore)

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

02-Sep-11 7.99% 2017 R 3,000 1.97 725.25 8.39 98.15

8.13% 2022 R 5,000 2.07 nil 8.46 97.66

8.30% 2040 R 3,000 2.17 nil 8.67 96.09

09-Sep-11 8.07% 2017 R 3,000 1.74 nil 8.33 98.87

Asian currencies also on account of increased demand for dollar liquidity. There was a sharp upsurge in the dollar index posting a 3.91 percentage points rise over end August.

In the domestic market, the downward pressure on Indian rupee was sustained and the currency posted one of its worst monthly declines during September and depreciated by 5.9% against the dollar. The RBI is also reported to have intervened in the market to arrest the rupee’s slide but was unable to make any drastic impact. Sustained dollar demand from importers, a slowdown in capital inflows with relative volatility in the stock market weighed heavily on the performance of the rupee (Table 7, p 138).

The rupee began the month on a positive note adding 12 paise against the dollar on 2 September, tracking an improved outlook of portfolio inflows with relatively better stock market behaviour. Despite huge

7.80% 2021 R 5,000 2.32 nil 8.3 96.71capital inflows, the rupee fell continuously

8.28% 2027 R 3,000 2.98 nil 8.57 97.49 except on 7 September and lost nearly 2% Total (1 to 12 August) 22,000 2.21 8.44 97.44

of its value against the greenback till

Total for August 2011 46,000 2.23 8.39 97.54

15 September. Following strong dollar over-

R: Reissue. Source: RBI press releases. seas and sustained dollar demand from

Table 10: Secondary Market Outright Trades in Government Papers – NDS and NDS-OM Deals (Amount in Rs crore)

Descriptions September 2011 Previous Month Three Months Ago Six Months Ago Last Week (30) First Week (2) Total for the Month (August 2011) (June 2011) (March 2011) AMT YTM AMT YTM AMT YTM AMT YTM AMT YTM AMT YTM

1 Treasury Bills 5,335 3,524 27,761 15,476 22,595 23,024

A 91-Day Bills 4,800 8.32 2,488 8.30 21,065 8.31 10,429 8.17 18,798 8.07 14,098 7.04

B 182-Day Bills 499 8.33 1,023 8.37 2,787 8.35 2,514 8.32 1,639 8.15 3,889 7.20

C 364-Day Bills 36 8.38 13 8.30 3,909 8.34 2,533 8.28 2,159 8.13 5,037 7.38

2 GOI Dated Securities 37,979 8.36 33,919 8.36 2,45,522 8.35 2,87,935 8.31 2,49,571 8.33 1,58,390 8.05

Year of (No of Maturity Securities)

2011 21 8.58 1,733 8.29 1,307 7.43

2012 (2) 536 8.38 42 8.20 1,003 8.32 783 8.27 1,415 8.06 2,264 7.55

2013 (4) 75 8.26 225 8.40 822 8.27 490 8.23 180 8.14 819 7.65

2014 (6) 127 8.24 5 8.20 266 8.26 212 8.15 301 8.23 206 7.90

2015 (7) 155 8.50 236 8.32 1,067 8.32 456 8.22 2,059 8.37 7,664 7.92

2016 (3) 67 8.31 241 8.38 997 8.33 3,623 8.25 4,057 8.37 46 8.01

2017 (4) 194 8.31 167 8.38 5,405 8.33 2,535 8.29 3,142 8.37 9,091 7.93

2018 (4) 3,746 8.35 1,154 8.35 12,051 8.34 18,507 8.30 13,445 8.37 69 8.12

2019 (3) 25 8.34 0 8.07 1 8.30 203 8.07

2020 (2) 430 8.98 480 8.90 1,590 8.97 1,920 8.87 2,630 8.08 5,524 7.96

2021 (2) 25,889 8.33 25,348 8.33 1,74,377 8.32 1,85,767 8.28 1,42,798 8.29 82 8.10

2022 (4) 6,020 8.40 5,501 8.44 42,386 8.41 66,939 8.37 73,835 8.39 1,21,222 8.07

2023 (1) 1 8.65 4 8.18 7 8.20

2027 (2) 608 8.57 349 8.58 4,218 8.57 4,271 8.56 2,590 8.57 7,198 8.36

2028 (1) 1 8.51 4 8.38 0 9.62 11 8.39

2032 (3) 17 8.56 18 8.56 231 8.58 1,120 8.58 1,119 8.59 517 8.37

2034 (1) 0 8.65 4 8.51 3 8.39 0 8.30 53 8.37

2035 (1) 2 8.92 5 8.33 68 8.38

2040 (1) 114 8.59 154 8.66 1,076 8.63 1,284 8.64 256 8.64 1,414 8.40

3 State Govt Securities 409 8.63 89 8.59 2,042 8.62 2,328 8.57 2,587 8.58 4,983 8.34

Grand total (1 to 3) 43,724 37,533 2,75,325 3,05,738 2,74,753 1,86,396

(-) 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) Trading in 2024-26 and 2036-39 securities were negligible. Source: Compiled by EPWRF; base data from RBI, CCIL.

Economic & Political Weekly

EPW
octoBER 22, 2011 vol xlvi no 43

MONEY MARKET REVIEW

importers, the rupee recovered most of its losses and appreciated by 38 paise against the dollar on 16 September even as the RBI hiked key policy rates again. The RBI however relaxed overseas borrowing rules, paving the way for a brightened outlook for capital inflows. However, the euphoria was short-lived as the domestic currency continued its poor show and fell below the 48-mark on 20 September as the eurozone problems escalated, causing a reversal of portfolio inflows. The rupee recovered again on 21 September, as the RBI intervened in the market to restrict the rupee slide. However, with crude oil prices ruling above $117 per barrel overseas, downward revisions of growth estimates by the IMF, short squeeze in dollars in the market amid heavy dollar demand from importers along with a weakness in local stocks, altogether fuelled adverse pressure on the rupee and the currency threatened to cross the psychological Rs 50-mark on 23 September. The rupee limited its losses from 26 September due to some positive news from Europe aiding demand for emerging-market assets. The rupee’s movement remained mixed towards the end of the month as domestic trends spooked a negative outlook for the rupee while global fundamentals turned positive giving some respite. Overall, in a period of one month, the rupee lost 291 paise and ended at Rs 48.93 per dollar as on 29 September.

After showing a significant fall in August, the forward premia across three maturities displayed a hardening trend during the month predicting a further depreciation of the rupee in the coming days. However, the premia of three different maturities remained relatively volatile and hence they moved upwards in the beginning of the month but softened considerably on 19 September and again inched up in the last week of the month. On the whole, premia across three tenures recorded a 80 to 360 basis points rise over the previous month. Overall, the one-month premia ended at 5.64% (2.09% on 30 August) while the remaining 3-month and 6-month premia closed at 5.15% (2.91%) and 3.71% (2.89%), respectively, as on 29 September.

Despite uncertain global developments, with the spurt in exports and imports the total and average daily turnover in the foreign exchange market increased by 2.5% and 7.7%, respectively during August over July. During August, forward and spot transactions reported a more than 30% rise in their average daily trading while merchant business increased by 21.6%. Interbank trades registered a minuscule rise of 3.3% during the same review period (Table 8, p 138).

Imposition of transaction charges for reported a 28% fall both in total and average daily terms. The collective daily turnover across three exchanges trading in currency derivatives products fell below Rs 50,000 crore during the month and amounted to Rs 48,885 crore. The hedging activity in options trading as well as in futures trading fell by 28% and 31% in turnover, respectively.

All the products traded in the futures segment reported a fall in turnover with USD-INR contracts reporting a 27% decline while the turnover of the remaining three products nearly halved from the previous month. Continuing its dominance, the USD-INR contracts accounted for 95% of the total futures turnover. Among the exchanges trading in currency derivatives products, the NSE dominated with a 42% market share while the MCX-SX contributed 38% towards total currency derivatives turnover. After completing one year of operations, the United Stock Exchange (USE) trading is gaining pace and it cornered a 20% market share in September.

2.3 Central Government Securities

During the month, only two auctions were conducted, the last two of the first half of

currency derivatives trad-Table 12: Yield Spreads (Weighted Average) – Central Government Securities

(September 2011)

ing by the exchanges from

Yield September 2011 Previous Three Six Months August continued to confine Spread in bps Last Week First Week Entire Month Month Months Ago Ago

1 Year - 5 Year -7 18 0 -2 31 46

the trading activity to the

5 Year - 10 Year 2 -5 -1 3 -8 9

currency derivatives mar

10 Year - 15 Year 32

ket. In September, the cur

1 Year - 10 Year -5 13 -1 1 23 55 rency derivatives segment Source: As in Table 10.

Table 11: Predominantly Traded Government Securities (Amount in Rs crore)

Descriptions September 2011 Previous Month Three Months Ago Six Months Ago

Last Week (30) First Week (2) Total for the Month (August 2011) (June 2011) (March 2011) AMT YTM AMT YTM AMT YTM AMT YTM AMT YTM AMT YTM

GOI Dated Securities

7.40 2012 51 8.37 10 8.18 364 8.28 505 8.26 1,230 8.07 1,025 7.51

7.27 2013 75 8.26 155 8.27 750 8.23 460 8.22 180 8.14 810 7.65

7.17 2015 105 8.29 211 8.26 991 8.28 438 8.22 1,989 8.37 7,600 7.91

7.59 2016 65 8.31 216 8.33 970 8.31 3,588 8.25 3,917 8.37 20 7.99

7.49 2017 15 8.32 76 8.30 95 8.43 567 8.34 3,872 7.93

  • 7.99 2017 5 8.42 112 8.40 2,477 8.36 2,575 8.38 5,164 7.94
  • 8.07 2017 189 8.31 40 8.34 2,802 8.32 2,348 8.28
  • 7.83 2018 3,746 8.35 1,154 8.35 12,041 8.34 18,502 8.30 13,410 8.38

  • 7.80 2021 25,889 8.33 25,347 8.33 1,74,374 8.32 1,85,762 8.28 1,42,798 8.29
  • 8.08 2022 1,068 8.41 1,776 8.42 9,931 8.40 26,559 8.38 23,962 8.40 63,339 8.08
  • 8.13 2022 4,948 8.40 3,725 8.44 32,390 8.41 40,380 8.37 49,872 8.39 57,345 8.06

    8.20 2022 60 8.57 1 8.30 537 8.12

    8.26 2027 40 8.55 59 8.58 562 8.57 897 8.60 2,550 8.57 7,127 8.36

    8.28 2027 568 8.57 290 8.58 3,656 8.57 3,363 8.55 1,108 8.59 194 8.39

    8.28 2032 10 8.55 18 8.56 218 8.58 1,119 8.58

    8.30 2040 114 8.59 154 8.66 1,076 8.63 1,284 8.64 256 8.64 1,414 8.40

    Total (All Securities) 37,979 8.36 33,919 8.36 2,45,522 8.35 2,87,935 8.31 2,49,571 8.33 1,58,390 8.05

    (-) 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 10.

    octoBER 22, 2011 vol xlvi no 43

    EPW
    Economic & Political Weekly

    MONEY MARKET REVIEW

    of about Rs 53,000 crore. Table 13: Details of State Government Borrowings (Amount in Rs crore) 2.4 Treasury Bills
    Combined with liquidity Date of Auction Number of Total Bid Cover YTM at Weighted Participating Amount Ratio Cut-Off Average Issuance amount of the 91-day and 364
    outflow due to half yearly States Accepted Price (%) Yield (%) day TBs remained the same over the period
    income tax payments by 06-Sep-11 5 4,450 1.66 8.63 8.62 at Rs 28,000 crore and Rs 6,000 crore,
    corporates, the sentiment in 13-Sep-11 1 1,500 2.12 8.65 8.64 20-Sep-11 4 2,800 1.55 8.66 8.64 respectively, whereas for the 364-day TBs
    the government securities 27-Sep-11 1 300 2.25 8.66 8.64 it fell by 59% to Rs 5,742 crore. Yield rates
    market remained dampenedTotal for September 11 9,050 1.72 8.64 8.63 firmed up across maturities, but more so
    throughout the month. Since Total for August 14 12,363 1.97 8.57 8.55 in the case of 91-day and 364-day TBs. The
    most banks were also hold-Source: RBI press releases. cut-off yield of 91-day and 364-day bills
    ing government securities in Table 14: Auctions of Treasury Bills (Amount in Rs crore) Date of Auction Bids Bid Cover Cut-off Weighted Cut-off Weighted had gone up by 7 bps each to 8.41% and
    excess of the SLR, the first Accepted Ratio Yield (%) Average Price (Rs) Average 8.40%, respectively. Strengthening of yields
    two auctions for the second Yield (%) Price (Rs) was seen in the second half of the month,
    half held on 7 and 14 Octo-A: 91-Day Treasury Bills 07-Sep-11 7,000 2.71 8.39 8.35 97.95 97.96 after the policy rate hike and liquidity out
    ber resulted in devolvement 14-Sep-11 7,000 2.85 8.39 8.39 97.95 97.95 flows due to advance tax payments.
    on primary dealers. 21-Sep-11 7,000 2.50 8.44 8.44 97.94 97.94 The turnover of TBs across maturities
    The secondary market 28-Sep-11 7,000 2.73 8.44 8.44 97.94 97.94 increased by a whopping 79% to Rs 27,761
    turnover of government Total for September 2011 28,000 2.70 8.41 8.40 97.95 97.95 crore over the period, but the highest increase
    securities fell by 15% to Total for August 2011 28,000 2.64 8.35 8.33 97.96 97.97 B: 182-Day Treasury Bills was of 91-day TBs, the turnover doubling to
    Rs 2,45,522 crore over the 14-Sep-11 3,000 2.94 8.40 8.38 95.98 95.99 Rs 21,065 crore with a yield rate of 8.31%.
    period with overall firmed 28-Sep-11 3,000 2.44 8.47 8.44 95.95 95.96 Yields of 182-day and 364-day TBs were at
    up yield at 8.35%. Yields Total for September 2011 6,000 2.69 8.43 8.41 95.97 95.98 8.35% and 8.34%, respectively, even higher
    across the maturity strength-Total for August 2011 6,000 2.24 8.42 8.40 95.97 95.98 than the yield of the 10-year benchmark
    ened during the month. C: 364-Day Treasury Bills4.42 8.34 8.33 92.32 92.33 government security at 8.32% during the
    Both one year and 10 year 07-Sep-11 2,742 21-Sep-11 3,000 2.64 8.46 8.44 92.22 92.24 month. Overall, the market activity shifted in
    maturity yields were high Total for September 2011 5,742 3.49 8.40 8.39 92.27 92.28 favour of short-term securities (Table 14).
    at 8.32%. The spread of one Total for August 2011 14,000 2.42 8.33 8.30 98.89 98.90
    and five year maturities Source: RBI’s Press Releases. 2.5 Corporate Bond Market
    became in fact negative. Table 15: Details of Private Placement in Corporate Bonds in NSE With tightening of credit market conditions,
    Securities maturing on Institutional Category No of Volume in Range of Range of Maturity Issues Rs Crore Coupon Rates private placement issues on NSE plunged
    2028 and 2034 saw the highest surge in the yields over the period by 13 bps (in %) NBFCs 3 461 9.38-9.45 1-10 years Central Undertakings 3 5,868 9.60-10.15 5-15 years Total for September 2011 6 6,329 9.38-10.15 1-15 Years over the month by 86% to Rs 6,329 crore. Only six issues were made during the month and that too were from the first
    each. Most traded securities Total for August 2011 20 44,948 9.10-14.56 1-16 Years fortnight of the month. Coupon rates
    Source: www.nseindia.com contributed to almost 95% offered for these issues ranged between
    the borrowing calendar for the FY 2011-12 of the total traded volume: 7.80% 2021, 9.38% and 10.15%. In September, yields
    for Rs 22,000 crore in aggregate, with a 8.13% 2022, 7.83% 2018, 8.08% 2022 and seemed to have softened. Central under
    lower bid cover of 2.21 times and higher 8.28% 2027 were the top traded securities. takings including the rural Electrification
    cut-off yield of 8.44%. In the first auction, While the turnover of the 10-year bench Corporation and Power Finance Corpora
    a 7.99% 2017 security saw devolvement of mark 7.80% 2021 alone contributed 75% to tion of India raised the major portion
    Rs 725 crore on primary dealers. The end total turnover at Rs 1,74,374 crore followed worth Rs 5,868 crore while the Develop
    of the borrowing of the first half in the by 8.13% 2022, 7.83% 2018 (Table 10, p 139 ment Finance Corporation and Tourism
    early period of September witnessed some and Tables 11 and 12, p 140). Finance Corporation raised Rs 461 crore in
    softening of primary yields, expecting Eleven states raised Rs 9,050 crore dur the aggregate. One public issue was also
    perhaps some pause in the policy rate hike ing the month with the overall yield mov offered by Religare Finvest during the
    (Table 9, p 139). Subsequent auctions had ing up to 8.64% while the bid cover dwin month for Rs 80 crore. Two maturities of
    to await the announcement of the new caldled to 1.72 times. Two auctions out of three and five years, of non-convertible
    endar for the second half, towards the end four were conducted only for one state debentures were offered at interest rates
    of the month. each, namely, Punjab and West Bengal. of 12% and 12.50%, respectively (Table 15).
    The RBI, following the elevated level of These two auctions received better response According to the data published by SEBI,
    inflation at 9.78%, came out with another with above two times bid cover, while the total turnover in the secondary market
    round of policy rate hikes by 25 bps on 16 the rest of the auctions where more than of corporate bonds, reported by BSE, NSE and
    September. In such a situation, government one state participated realised a lower FIMMDA dropped by about 16% in the month
    borrowing for the second half was expected bid cover. In the secondary market, the of September to Rs 44,882 crore, compared
    to be higher, based on fiscal trends, which in traded amount in the month slipped by to the previous month. All trading platforms
    fact turned out to be true when the govern12% to Rs 2,042 crore with higher yield at recorded a fall in turnover, BSE recording
    ment announced an additional borrowing 8.62% (Table 13). the sharpest fall by 37% to Rs 3,600 crore.
    Economic & Political Weekly octoBER 22, 2011 vol xlvi no 43 141
    EPW

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