Institution Development

Early during the reform process, the Reserve Bank promoted the Discount and Finance House of India and Securities Trading Corporation of India to promote the development of the money market and secondary market for government securities. The Reserve Bank has subsequently sold its majority shares to market participants and these institutions have since obtained Primary Dealership in Government Securities.

Since the inception in 1995, the number of Primary Dealers (PDs) in Government Securities has progressively increased from 6 to 18. The obligations cast upon PDs include an annual minimum bidding commitment for dated securities and Treasury Bills with a minimum success ratio and commitment to underwrite the gap between the subscribed/accepted amount in respect of dated securities and the notified amount, where there is a short-fall. The PDs are allowed access to call money as well as repos/reverse repo markets and to trade in all money market instruments. They have access to Subsidiary General Ledger (SGL) and current account facility with the Reserve Bank. The Reserve Bank also conducts exclusive Open Market Operations (OMO) in T-Bills through PDs. A second level satellite dealer system exits, with the main objective of retailing Government Securities. These satellite dealers are also given some liquidity support by the Reserve Bank. A few of these SDs have graduated as PDs.

It may be of interest to note that among the Primary Dealers, the newly licensed are, J.P. Morgan, ABN Amro, Deutsche Bank, and DSP-Merrill Lynch.

The Reserve Bank has also encouraged the setting up of mutual funds dealing exclusively in gilts, called gilt funds. Like PDs and SDs, these gilt funds are also provided with liquidity support, among other facilities.

Significant reforms in the non-Government debt market should also be recognised. National and local stock exchanges have been set up with facility for trading in corporate debt, and for that matter, even Government debt, through screen based systems. The securities and Exchange Board of India regulates the primary issuances in capital and non-Government debt markets and ensures sound trading practices through stock exchanges. Depositories have been set up to facilitate dematerialisation and quicker transfer mechanisms.

As is well known, a large participant base would result in lower cost of borrowing for the Government. In fact, retailing of Government Securities is high on the agenda of further reforms.

Banks are the major investors in the Government Securities markets. Traditionally, banks are required to maintain a part of their net demand and time liabilities in the form of liquid assets of which Government Securities have always formed the predominant share. Despite lowering the Statutory Liquidity Ratio (SLR) to the minimum of 25 per cent, banks are holding a much larger share of Government Stock as a portfolio choice. Other major investors in Government Stock are financial institutions, insurance companies, mutual funds, corporates, individuals, non-resident Indians and overseas corporate bodies. Foreign institutional investors are permitted to invest in Treasury Bills and dated Government Securities in both primary and secondary markets.

Often, the same participants are present in the non-Government debt market also, either as issuers or investors. For example, banks are issuers in the debt market for their Tier-II capital. On the other hand, they are investors in PSU bonds and corporate securities. Foreign Institutional Investors are relatively more active in non-Government debt segment as compared to the Government debt segment.

It will be useful to identify the progress in primary and secondary market. Credible systems have been established ensuring transparent mechanisms of issuance in the primary market and creating efficient mechanisms for trading and settlement in the secondary market for Government Securities.

Since 1992, after the market orientation of Government borrowing programme, and later after the abolition of automatic monetisation of fiscal deficit, the Reserve Bank has been resorting to primary market issues at greater frequency. Efforts are made to raise all issues directly from the market. Dated Securities are generally issued through auctions or tap sale. Primary Dealers are permitted to underwrite the entire notified amount of the auctions. Depending on prevailing market conditions, dated securities are sometimes privately placed with the RBI, and subsequently offloaded in the secondary market when conditions turn conducive. Issues have occasionally devolved on the RBI.

Until recently, Government dated securities were issued through yield based auctions. A beginning has been made during the current year with regard to consolidation of Government debt with a view to developing benchmark securities and development of a market for STRIPS. Most of the current primary issues are, therefore, reissuances of existing stock through reopening, and this has helped in consolidation of Government debt to some extent as also in creating a critical fungible mass for active trading and enhanced liquidity in the secondary market.

Treasury Bills are issued through auctions. The notified amounts with respect to T-Bills have been rationalised in the recent period. A calendar of T-Bills is announced in advance. Non-competitive bids from select participants are accepted outside the notified amount. Both discriminatory and uniform price auction methods are used, as appropriate to each of the T-Bills.

A large part of the issuance in the non-Government debt market is currently on private placement basis. Stringent entry and disclosure norms for public issues coupled with low cost of issuance, ease of structuring instruments and saving of time lag in issuance has led to the rapid growth of the private placement market in recent years. Total resource mobilisation from the private placement market has increased sharply over 4-fold between 1995-96 and 1999-00, The share of private placement issues in total mobilisation from the primary capital market (public issues and private placements) thus increased from about 40 per cent in 1995-96 to around 85 per cent by 1999-2000.

Banks and Primary Dealers are the major players in the secondary market for Government Securities. Most of Government Securities transactions in the secondary market are through over-the-counter (OTC) negotiated deals. However, banks are allowed to transact through brokers who are members of the National Stock Exchange and over-the-counter-Exchange of India, which facilitated screen based trading. Since 1994, the National Stock Exchange (NSE) launched the Wholesale Debt Market (WDM) segment, which provides the only formal platform for trading in a wide range of debt securities, including Government Securities. The trading system known as National Exchange for Automated Trading (NEAT) is a fully automated screen based trading system that enables members across the country to trade simultaneously. The trading system is an order driven system which matches best buy and sell orders on a price-time priority. However, in actual practice, most of the trades in Government and non-Government debt are usually concluded over-the-counter and later reported on screen. Thus, data regarding OTC deals are available on a near real time basis on the NSE screen. Similarly, the dissemination of daily data by the RBI on price and volume of Gilts traded in the secondary markets has greatly aided the price discovery process.

RBI has recently initiated several steps for developing an active retail market for government securities in the secondary martket through non-competitive bidding. These are discussed in subsequent articles in this module

Currently the Reserve Bank operates the Government Securities Settlement system for those having Subsidiary General Ledger Accounts in its Public Debt offices through Delivery Versus payments System. Setting up of a Clearing Corporation for money and debt securities is in advanced stage of implementation. This will pave the way for further opening up of the repo market to PSU bonds and bonds of financial institutions held in demat form in depositories and traded in recognised stock exchanges with essential safeguards.

The aggregate volumes of trading in Government and non-Government debt in the secondary market have increased substantially over the years. However, Treasury Bills and Government dated securities accounted for the bulk of the trading volume at over 96 per cent of the total trades. The average annual growth in secondary market transactions since 1994-95 was over 55 per cent, reflecting the increasing depth attained by secondary market in Government Securities. For instance, the average annual transactions increased over 10-fold between 1994-95 and 1999-2000.

The turnover in Government securities (calculated by counting twice the volume of transactions in the case of outright transactions and counting four times the volume of transactions in the case of repos) fiscal 1999-2000 amounted to Rs.12,370 billion of which the outright turnover aggregated Rs. 9,060 billion. Thus, the average monthly turnover in Central Government securities aggregated Rs. 1,030 billion in 1999-2000 of which the average monthly turnover of outright transactions amounted to Rs.755 billion. The daily turnover has also witnessed a significant increase and is about Rs. 34 billion. Reflecting this, the turnover ratio in dated securities (defined as the ratio of total turnover to total outstanding securities) increased to 3.2 as on March 31, 2000 from 1.7 as on March 31, 1999.

Development of technology is an integral part of reforming the debt market, especially in the context of providing a technologically superior dealing and settlement system. Hence, the RBI has embarked upon the technological upgradation of debt market. The RBI has just commenced a project for complete automation of the operations of its Public Debt Office (PDO) where the settlement for all Government Securities Transactions takes place. It will provide for connectivity between different PDOs, and facilitate on-line screen based execution for trade and settlement in Government Securities transactions. The project will be implemented in phases. The first phase will cover the PDO computeristion at Mumbai and facilitate screen based negotiated dealings in Government securities and money market instruments, tendering of screen based applications in auctions, full-fledged audit trail, debt servicing, information dissemination, price list for open market operations, central information system for access by monitoring and regulatory authorities, etc. It is expected that the first phase will be operationalised well within a year. In the second phase, other regional PDOs would be linked with the central PDO system. This phase will facilitate active open market operations of RBI through all regional PDOs. The entire project is expected to be operationalised in about a year. The RBI is also separately putting in place real time gross settlement system, which is scheduled to be operational within the same time frame.

In order to curb certain unhealthy trends that had developed in the securities market and to prevent undesirable speculation, the Government had prohibited forward trading in securities in June 1969 through a Notification. Recognising that rescinding the 1969 Notification is necessary for developing the debt markets, at the recommendation of the Reserve Bank, the Government recently brought about amendments to Securities Contracts (Regulation) Act 1956 which made it possible for Government to delegate some responsibilities to the RBI. Currently the regulatory jurisdiction over the Government and non-Government debt markets have been delegated to the Reserve Bank and Securities and Exchange Board of India by the Government. The Reserve Bank will regulate in relation to any contracts in Government securities, money market securities, gold related securities and in securities derived from these securities and in relation to ready forward contracts in bonds, debentures, debenture stock, securitised and other debt securities.

These amendments help RBI to put in place, from time to time, appropriate regulatory framework, keeping in view rapid changes in financial institutions, instruments and practices governing money, Government Securities and forex markets, apart from gold-related financial products. With the delegation of powers by Government to RBI in these matters, the procedural delays and constraints can be eliminated.

Transparency in operations and data dissemination is the hallmark of our Government Securities market. The process of policy making and implementation of reform are through consultative mechanisms. The entire market borrowing programme is announced at the beginning of the year. Based on this, a calendar of Treasury Bills is pre-announced to the market. Similarly, near real-time data is available with regard to auctions of Treasury Bills and dated Government Securities. The Reserve Bank also publishes all relevant data pertaining to Government securities market on daily, weekly, monthly and annual basis.

The Government Securities and their management by the Reserve Bank of India is governed by the Public Debt Act, 1944. The procedures prescribed are archaic and some of the provisions have ceased to be of relevance in the present context. A new legislation titled the Government Securities Act proposes to repeal and replace the Public Debt Act. The Government Securities Bill has already been approved by the Cabinet and is awaiting Parliament clearance. However, since the Public Debt Act, 1944, is applicable for marketable loans raised by the RBI on behalf of both the Central and State Governments, the proposal requires consent of all State Governments. The State Governments have to pass a Resolution for the purpose either prior to enactment by the Centre or subsequently adopt the same by passing a Resolution. Once the new Act is enacted, the RBI will have substantive powers to design and introduce an instrument of transfer suited to computer environment.