The government securities are issued by the Central government, state government and semi-government authorities. Some of the examples of issuers (semi govt authorities) are city corporation, municipalities, port trusts, state electricity board, public sector corporations and other government agencies such as IDBI, IFCI, NABARD, housing boards. Govt securities are important financial instrument and RBI uses it to have monetary control through 2 major techniques: open market operations (OMO) and statutory liquidity ratio (SLR). Its issues are helpful in implementing the monetary policy of the govt. It is easier for the holders to obtain loans against the collateral of these securities from RBI and other institutions. As the government securities are direct claim on government, hence, they are secure financial instrument which guarantees both income and capital. Hence, it is also called as "gilt edged" security. They are risk free; hence, it helps to reduce market risk.
Forms of Govt Securities
The government securities are issued in the denomination of Rs 100 or Rs 1000. The face value has been increased from Rs 100 (prevalent since 1980s) to Rs 1000. The rate of interest is relatively less as compared to other financial instruments as they are risk free. Also, another reason for low interest is that the government requires minimizing the cost of servicing public debt. The interest is payable half yearly and is exempted from income tax. The value of the securities is exempted from wealth tax up to a limit. Most of the govt securities are in the form of promissory notes. They are issued through Public Debt Office (PDO) of RBI. The issues are notified a few days before they are open for subscription and it remains open till 2 or 3 days. As primary issues are notified to the public through govt notification and press communiqué, there is no issue of prospectus. The SEBI routinely grants "no objection" to the primary issues. The budgeted amount of issues is raised in a year to avoid market flooding with the securities at a given time. After the announcement of new issue, RBI suspends the sale of existing loans till closure of subscriptions to new loans. The govt reserved the right to retain subscription up to a specified percentage. Due to the seasonal character of the money market, issues are mostly concentrated during slack seasons. Commercial banks can buy the securities as much as they can, but while selling they have to maintain SLR.
Role of Dealers / brokers
The business in this market is done by any party in form of principal and not as agent. After opening of NSE, banks are permitted to undertake transactions among themselves and with non-bank clients through NSE members. RBI has its approved brokers and major part of the turnover in the market is achieved by these brokers. A method has been deployed by RBI to reduce the volume of business through official brokers. With effect from June 1978, RBI discontinued the practice of charging differential interests rates for the purchase and sale of the securities to enable the banks to approach it directly.
As regards to dealers, the agency of dealer - bank is more active than individual dealer. They are in contact with each other and the banks / other financial institutions. This relationship also helps in getting fine quotations for the securities.
Role of RBI
RBI plays a pivotal role in this market. It continuously sells and purchases the securities. It purchases these securities out of the surplus funds of IDBI, EXIM bank, and NABARD under special arrangements. Hence, RBI purchases the securities mostly in form of Switch operations rather than cash. Switch operations also helps financial institutions to improve their yields on their investment in the securities. Sometimes there are triangular switch transactions, wherein the transaction takes place between two parties with RBI as middle party. RBI has fixed a quota for the banks to indulge in the switch operations based on their size to prevent banks from selling the low yield securities. One of the unique features is "voucher trading". As the financial institutions income is taxed, hence, they are engaged in voucher trading. In voucher trading the financial institutions purchase the securities around the interest payment due date and offload thereafter, thereby earning the benefit of the whole interest period. However, this practice is not appreciated, hence, Chakravarty Committee has asked RBI to fix the quota for switch operations and also to suspend the trading one month prior to due date.
Role of Primary Dealers and Satellite Dealers
The system of primary dealers was created in 1994. The purpose is as follows:
strengthen the infrastructure in govt securities market
Ensure development of underwriting and market making capabilities for govt securities outside the RBI so that RBI can shed these functions gradually.
Improve secondary market trading system which contribute to price discovery
To make an effective channel for conducting open market operation.
Participating in auctions to help placement of primary issues.
To provide signals to RBI for market interventions.
The primary dealers have following rights:
to maintain clearing balances with the RBI
to borrow funds from RBI
to operate switches with RBI
to participate in securities auctions
to access open market operations
While developing the primary dealers, need was sought to develop the supporting infrastructure for the primary dealers. Hence, satellite dealers came in to foray. The prime objectives of satellite dealers are as follows:
To further strengthen the infrastructure by including intermediaries that have good distribution channel, thereby increasing the depth of secondary trading and increasing the investor base.
To provide retail outlet for the securities.
Repos market in Government Securities
Repo is a transaction based agreement in which one party sells the security to another party agreeing to repurchase after specified period. For seller, the terminology is Repo, whereas for buyer the terminology is reverse repo.
Repo market was active in 1980s; however, after break out of security scam in 1992, they were completely banned. Thereafter only few instruments (91 day and 364 day TBs, zero coupon bonds) were allowed for trading. Now, in order to develop the repo market, all dated securities have been allowed for trading since April 15th, 1997.
The participants in repo market are securities dealers, commercial banks, STCI, RBI and co operative banks. NBFCs, like LIC, GIC, UTI and other corporate are not allowed to participate. Since, it is low risk, flexible, short term instrument, and offers low cost investment over combination of yield, collateral flexibility; it is widely used to implement arbitrage activities and other short term positions.
RBI is a major participant in the repo market. In order to inject reserved in to the system, it purchases the govt securities, whereas when it wants to absorb reserves, it sells the govt securities. Hence, on Dec 4th, 1992, RBI announced a scheme of repos auction for govt securities. The features of this scheme are:
Banks and other financial institutions maintaining current account with RBI can participate in the scheme. State govt are not eligible for participation.
The offers for repos are accepted by RBI on the basis of bids tendered. The freq of repo auctions and the repo duration is decided by it time to time.
Minimum amount for repo tender is Rs 1 crore (based on security face value) and multiples of s 1 crore.
RBI determines the total amount of repos to be offered at each auction on the basis of tenders received.
The objective of the scheme is to improve short term management of liquidity in the system.
Importance of Government Security Market
Following are the main importance:
From the view point of the government, the development of a deep and liquid govt security market facilitates public borrowings at reasonable cost.
The govt security market helps pricing of various debt instruments through creation of a benchmark, and enables a proper risk evaluation.
It facilitates the development of indirect instruments of monetary policy. The govt security market affects the overall investment in the economy in 2 ways:
Increase in the supply of government securities to finance the budget deficit, would lead to decrease in its prices, leading to substitution of government securities with another private bonds.
The government securities market can have a positive influence on private instruments by enabling the development of private bond market in following ways:
Putting in place a basic financial infrastructure, like, laws, products, services, repo and derivative market.
Playing as a role of an informational benchmark.
The government security market acts as a channel of integration of various segments of the financial market. Govt securities are used by dealers as a major hedging tool for interest rate risk and as underlying assets and collateral for related markets, such as repo, futures and options. From the perspective of the issuer, the govt security market facilitates its borrowings from the market at reasonable cost. A greater ability of the government to raise resources from the market at market determined interest rates allows it to refrain from monetization of deficit through RBI. For RBI, a developed government security market allows greater application of market based instruments of monetary policy.
Policy Developments
Reforms were undertaken to strengthen the primary and secondary markets of the govt security market.
In the primary market, measures were taken to raise resources from the market in a cost effective manner. In the secondary market, measures were initiated to improve the trading systems, clearing and settlement system and the risk management frameworks.
In the primary market, a price discovery mechanism was activated by introducing auction system. The uniform pricing technique is used when there is market uncertainty. The primary dealer system was revamped to ensure a more dynamic and active participation of PDs in view of the provision of the Fiscal Responsibility and Budget Management (FRBM) Act, 2003, whereby the RBI was prohibited from participating in the primary market, effective Apr 1, 2006. According to reserve banks mid term review of the annual policy for the year 2006-07, FIIs would be permitted to invest in central and state government securities by an incremental amount of 5% of total net issuances (issuance - repayments) in the previous financial year and the existing limit will be enhanced to US $ 3.2 billion by March 31st, 2007.
Marking to market of government securities is important for the development of the secondary segment of govt securities market. Valuation of securities at market prices requires the existence of a yield curve. In Feb 2006 on the basis of the recommendations of the Technical group on the central govt securities market, short selling has been allowed in the govt security market. Introduction of short selling paved the way for 'When issued' trading in Aug 2006. In order to provide participants with more processing time and facilitate better funds and risk management, the settlement cycle for secondary market government securities transaction has been standardized to T+1, effective May 11, 2005. In terms of RBI guidelines, the investment portfolios of banks is required to be classified in to 3 categories, viz, 'Held for trading (HFT), 'Available for sale' (AFS) and 'Held to Maturity' (HTM). A market in separate trading of registered interest and principal of securities (STRIPS) has been developed to selling securities in retail and developing yield curve.
Volume and Composition of Issues
Various indicators can be used to study the growth of the govt securities market and the public response to the public issues. Tables 1 to 5 show the volume and composition of issues of govt securities. The size of annual floatation of securities has increased from Rs 2630 crore to 38,635 crore in case of central govt; and from Rs 300 crore to Rs 6274 crore in the case of State govt securities. In earlier years, public response to loan issues was poor; loans were kept open for long periods; whenever public subscription fell short of expectations, the residual amount was taken up by the RBI; and repayment of loans was many times higher than the amount of fresh loans. All this has changed over the years. It is apparent from table 1 that the absorptive capacity of the market has been quite high; the central as well as State govt loans were oversubscribed. It can be seen that the avg rate of oversubscription has been higher for the latter than the former. It means that State govt securities has become popular than central govt securities. Net sales of govt securities by RBI have increased every year. As a result of growth of bank deposit and substantial increase in SLR, RBI has been in a position to unload a part of its govt securities holdings without adversely affecting the market.
A study on the break up of funds raised by the govt reveals certain interesting facts.
1) The share of conversion subscription in total subscription to central govt loans first increased during 1960-61 to 1970-71 (from 38% to 45%) and declined thereafter to 22% in 1976-77, 3% in 1977-78, 7% in 1978-79, 5% in 1988-89 and nil in 1995-96. This does not mean that the extent of repayment in cash in each year has increased. It has actually declined. The ratio of cash payments to cash receipts (which indicates the policy with respect to switching or refunding) first increased from 32% in 1960-61 to 40% in 1970-71, an then declined. 3 important conclusions emerged from these trends:
a) The extent of refunding of loans resorted to by the govt has all along been quite high, and it has increased over time. As union budgets in most of the years have been in deficit, it would have been impossible to retire even a small part of issues scheduled to retire in each year.
b) The method of refunding has undergone a change over the years. Of the 2 methods mentioned earlier, the method of selling securities for cash settlement and use of the proceeds to retire old issues has been relied up on since 1970, while in the 1960s the method of offering new securities in exchange for maturing securities was more common.
c) The govt prefers fresh borrowings increasingly in terms of cash subscription, most probably because the cash requirements of the govt have increased over the years.
2) The practice of refunding of loans is less common in the case of State govt. No conversion loans were issued by tem in certain years. Whenever such loans were issued, there ratio to the total subscriptions was relatively low (the max being 20%) and the ratio of cash payments to cash receipts much higher.
The total gross amount of issues has increased from Rs 3204 crores in 1980-81 to Rs 181979 crores in 2002-03. The state govt securities market is quite small in relation to the central govt security market. Table 3 gives an idea about break up of issues of govt securities during 2001 -07.
The share of market borrowings in financing central govt gross fiscal deficit increased to around 70% in 2005-06 from around 18% in 1990-91. The share of market borrowings in financing the gross fiscal deficit of the state govt, however, showed a modest increase on account of availability of other sources of financing such a small savings. As a result, market borrowings financed around 46% of combined gross fiscal deficit of the centre and states in 2005-06 as compared around 20% in 1990-91. Gross and net market borrowings of the central govt has declined during the period 2003-04 to 2004-05 and it has increased during 2005-06 to 2006-07. The state govt securities market is quite small relation to central govt, but the gross and net market borrowings of the state govt have increased throughout the period 2002-03 to 2006-07. The share of dated securities is the highest for the central govt throughout the period and the gross and net dated securities have increased continuously during 2001-02 to 2006-07.
Govt securities market has developed significantly in the liberalization period in terms of size and liquidity. The outstanding stocks of govt securities has increased significantly, both in absolute terms and in relation to GDP, in tandem with the growing financing requirements of the govt. Significant changes in the primary market has also been observed in terms of wider participation and better price discovery. The system of PDs has emerged as an important element, both in the primary and secondary segments of the govt securities market (table 4). The outstanding stock of both the central and the state govt securities have increased significantly over the years. Implementation of the MSS from 2004-05 has also contributed to the growth of the outstanding govt securities over the recent years (table 5).
List of Primary Dealers
Citibank N.A., Mumbai Branch
Standard Chartered Bank
Bank of America N.A.
J P Morgan Chase Bank, N.A.
HSBC Bank
Bank of Baroda
Canara Bank
Kotak Mahindra Bank Ltd.
Corporation Bank
HDFC Bank
Table 1 - Government market borrowings, 1980-81 to 1995-96 (Rs in crore)
Year
Central Government
State Government
Amt of issues
Amt subscribed
Cash subscription
Conversion subscription
Amt repaid in cash
Net borrowings
Amt of issues
Amt subscribed
Cash subscription
Conversion subscription
Amt repaid in cash
Net borrowings
1980-81
2,630
2,871
2,734
137
131
2,603
300
400
284
49
83
201
1985-86
5,325
5,764
5,554
210
453
5,001
1284
1414
1189
225
216
973
1990-91
8,988
8,989
8,531
458
529
8,001
2565
2569
2589
2569
1993-94
28,689
28,689
28,689
-
1,148
27,541
4145
4145
4145
507
3639
1994-95
21,251
21,251
21,251
-
954
20,297
5123
5123
5123
5123
1995-96
38,635
38,635
38,635
-
5,556
33,079
6274
6274
6274
343
5931
Table 2 - Market borrowings of Central and state government (Rs in crore)
Year
Central Govt
State Govt
Total
Gross Issue
Net issue
Gross Issue
Net issue
Gross Issue
Net issue
1
2
3
4
5
6
1980-81
2871
2605
333
206
3204
2811
1985-86
5764
5101
1414
973
7178
6074
1990-91
8989
8001
2569
2569
11558
10570
1995-96
40509
26790
6274
5931
46782
32721
2000-01
115183
73787
13300
12880
128483
86667
2001-02
133801
92302
18707
17261
152508
109563
2002-03
151126
104118
30853
29064
181979
233182
2003-04
147636
88816
50521
46376
198157
135192
2004-05
106501
46050
39101
33978
145602
80028
2005-06
160018
98237
21729
15455
181747
113692
2006-07
179373
111270
20825
14274
200198
125544
Table 3 - Break up of recent govt market borrowings (Rs in crore)
Year
Central Govt
State Govt
Total
Dated Securities
364 days TBs
Total
A
Gross
2001-02
114213
19588
133801
18707
153092
2002-03
125000
26126
151126
30853
182651
2003-04 (BE)
1400230
26000
166230
28145
194375
2003-04
121500
26136
147636
50521
198157
2004-05
80350
26151
106501
39101
145602
2005-06
131000
29018
160018
21729
181747
2006-07
146000
33373
179373
20825
200198
2007-08 (BE)
155455
32314
187769
35114
222883
B
Repayments
2001-02
26499
15000
41499
1446
43129
2002-03
27420
17588
47008
1789
49069
2003-04 (BE)
32909
26127
56036
4145
63522
2003-04
32694
26126
58820
4145
62965
2004-05
34316
26136
60451
5123
65574
2005-06
35630
26151
61781
6274
68055
2006-07
39084
29019
68103
6551
74654
2007-08 (BE)
45876
31066
76942
11555
88497
C
Net
2001-02
87714
4588
92302
17260
109963
2002-03
97580
6538
104118
29064
133582
2003-04 (BE)
107321
-127
107194
24000
131194
2003-04
88806
10
88816
46376
135192
2004-05
46034
16
46050
33978
80028
2005-06
95370
2867
98237
15455
113692
2006-07
106916
4354
111270
14274
125544
2007-08 (BE)
109579
1248
110827
23559
134386
Table 4 - Government Securities Market
Indicator
1991-92
1995-96
2000-01
2003-04
2004-05
2005-06
Outstanding Stock (end Mar) (Rs Crore)
76908
169526
453668
824612
929612
1032296
Outstanding Stock as ratio of GDP (end Mar) (%)
11.8
14.3
21.6
29.8
29.7
28.9
Turnover / GDP (%)
-
-
49.7
115.2
56.7
37.9
Avg maturity of Securities issued during year (Yrs)
-
5.7
10.6
14.94
14.13
16.89
Weighted avg cost of securities issued during year (%)
11.78
13.75
10.95
5.71
6.11
7.34
PD share in govt securities (%)
a) Primary market
-
-
-
51.47
52.88
40.36
b) Secondary market turnover
-
-
-
23.91
28.24
31.13
Table 5 - Outstanding Stock of central and state government securities (Rs in crores)
End March
Centre
State
Combined
1991
70377
15644
86021
1992
76909
18971
95879
1993
81693
23646
105339
1994
110581
26087
136668
1995
137515
31208
168723
1996
169526
37931
207457
1997
192893
43582
236475
1998
249024
50828
299852
1999
311605
61531
373136
2000
381881
73885
456766
2001
453668
86765
540433
2002
536324
104026
640350
2003
674203
133090
807293
2004
824612
179465
1004077
2005
929612
235172
1164784
Prices and Yields
The face value of the government security is Rs 100 or Rs 1000. During the period 1946 - 77, out of some 59 central issues, 14 issues were made below par. The discounts varied from 0.1 to 2%. No fixed relationship between length of maturity of issue and the extent of the discount is observable. During and after 1980s, the issues have been made at par. Table 6 to 10 provides the information regarding behavior of prices and yields on the govt securities. The index number of prices of the central govt securities has declined by 15 points during 1971-72 to 1996-97. In comparison, the prices of the state govt securities and semi govt securities have remained more or less at the same level throughout the same period. The decline in the central govt securities reflects the tightening of the interest rates. From table 7, we observe that the weighted average coupon rate (WACR) on central govt securities increased from 7% in 1980-81 to 13.69% in 1996-97, after which it has declined to 9.44%. The WACR on Central and State govt securities have been nearly same in all the years. The process of maturity elongation was facilitated by the benign interest rate regime which prevailed during the first half of the current decade. This brought down the cost of the resources raised for financing the govt deficit. The weighted average yields, which started moderating from 1996-97, declined to 5.71% and 6.13% for the Central and the State govt securities respectively by 2003-04. The yields have increased from 7.89% for Central govt and 8.10% for State govt in 2006-07 respectively. Table 8 shows the maturity wise gross redemption yields on the Central govt securities during 1970-71 to 1995-96. As expected, the yields are normally higher on longer maturities; however, during 1990-91 to 1992-93, this was not true. The yields on all maturities have gone up, but the increase appears to have been slightly greater on lower maturities than on higher maturities.
The yield curve has generally remained flat. The response of short term rates to changes in the policy rates has been quicker and more pronounced than the long term rates, reflecting the impact of policy changes. During 2002-03, repo rate cuts, reduction in administered interest rates and expectations of further reduction in US interest rates resulting in easing of liquidity condition and downward movements in yields. The decline in yield was more at the longer end of the maturity than at the shorter end on account of active trading at the long end in a period of low interest rates. This has resulted in flatness in the yield curve (table 9).
Table 6 - Index No. of Govt Securities Prices
Year
Central Govt
State Govt
Semi Govt
Govt and semi govt
1971-72
98.1
99.7
99.9
98.6
1975-76
95.3
99.2
101.4
96.4
1980-81
95.8
100
101.9
97
1985-86
86.69
98.8
100.98
89.33
1988-89
84.87
98.2
99.45
87.78
1991-92
82.87
98
100.06
86.14
1992-93
83.06
98
100.78
86.33
1993-94
83.06
97.7
100.78
86.23
1994-95
83.06
97.7
100.78
86.23
1995-96
83.06
97.6
100.17
86.23
1996-97
83.06
97.7
100.17
86.23
Table 7 - Interest rates on central and state govt dated securities (% per annum)
Year
Central Govt Securities
State Govt Securities
Weighted avg coupon rate (WACR)
Coupon rate range (CRR)
WACR
CRR
1980-81
7.03
5.98 - 7.5
6.75
6.75
1982-83
8.36
6.25 - 9.0
7.5
7.5
1984-85
9.98
7.75 - 10.5
9.0
9.0
1986-87
11.38
10.0 - 11.5
11.0
11.0
1988-89
11.40
10.0 - 11.5
11.5
11.5
1990-91
11.41
10.50 - 11.5
11.5
11.5
1992-93
12.46
12.0 - 12.75
13.0
13.0
1994-95
11.90
11.0 - 12.71
12.5
12.5
1996-97
13.69
13.4 - 13.85
13.82
13.75 - 13.85
1998-99
11.86
11.1 - 12.6
12.35
12.15 - 12.5
1999-2000
11.77
10.73 - 12.45
11.89
11.0 - 12.25
2000-01
10.95
9.47 - 11.7
10.99
10.5 - 12.0
2001-02
9.44
6.98 - 11.0
9.2
7.8 - 10.53
2002-03
7.34
6.57 - 8.62
7.49
6.67 - 8.0
2003-04
5.71
4.62 - 6.35
6.13
5.78 - 6.4
2004-05
6.11
4.49 - 8.24
6.45
5.6 - 7.36
2005-06
7.34
6.7 - 7.79
7.63
7.32 - 7.85
2006-07
7.89
7.69 - 8.75
8.1
7.65 - 8.66
Table 8 - Maturity wise gross redemption yield on central govt securities
Year
Under 5 years
Between 5 and 15 years
Over 15 years
Range
Average
Range
Average
Range
Average
1970-71
3.85 - 4.28
4.06
4.32 - 4.84
4.58
4.77 - 5.53
5.15
1977-78
5.06 - 5.59
5.32
5.42 - 5.98
5.7
6.03 - 6.46
6.24
1980-81
4.74 - 6.01
5.37
5.8 - 6.75
6.27
6.44 - 7.49
6.96
1985-86
5.42 - 9.84
7.63
6.49 - 9.5
7.99
8.3 - 11.5
9.90
1986-87
6.85 - 10.2
8.52
6.5 - 10.5
8.5
9.14 - 11.46
10.3
1987-88
8.86 - 11.18
10.02
6.51 - 12.8
9.65
9.17 - 11.5
10.33
1988-89
7.03 - 12.62
9.82
6.76 - 13.77
10.76
9.36 - 11.57
10.46
1990-91
7.04 - 21.7
14.37
9.44 - 12.7
11.07
10.86 - 12.04
11.45
1991-92
8.37 - 26.26
17.31
9.5 - 13.42
11.46
9.91 - 12.38
11.14
1992-93
9.08 - 23.77
16.42
9.5 - 14.78
12.14
8.82 - 12.47
10.64
1993-94
11.86 - 12.86
12.36
12.7 - 13.3
13.0
12.85 - 13.43
13.14
1994-95
9.75 - 11.76
10.75
11.3 - 13.86
12.58
11.77 - 13.47
12.62
1995-96
6.0 - 14.28
10.14
5.75 - 14.07
9.91
11.84 - 13.02
12.43
Table 9 - Yield spreads (Basis points)
Year
10 year - reverse repo rate
10 year - 1 year
20 year - 10 year
30 year - 10 year
5 year AAA bond - 5 year G sec
2004-05
164
101
56
77
2005-06
196
106
36
45
64
2006-07
189
77
32
43
48
Jan 2006
178
51
30
35
67
Feb 2006
186
53
25
30
98
Mar 2006
202
98
21
30
91
Apr 2006
190
118
40
57
105
May 2006
218
120
36
52
86
June 2006
237
113
38
41
74
July 2006
223
132
49
65
69
Aug 2006
206
103
49
65
96
Sep 2006
167
94
43
61
91
Oct 2006
167
54
30
46
92
Nov 2006
142
47
17
19
95
Dec 2006
161
34
12
17
146
Jan 2007
176
36
32
35
126
Feb 2007
198
37
16
21
152
Mar 2007
197
42
26
37
142
Apr 2007
217
27
19
33
162
May 2007
212
41
25
36
174
June 2007
220
65
23
31
186
July 2007
190
77
30
47
137
Secondary Market Transactions
The secondary market transactions are of 2 types: outright and repo. The trading members of the NSE, FIs, MFs, PDs, Indian and the foreign banks are the participants in the secondary market for govt securities. The banks, members and PDs are the major players in this market. Net traded value, avg daily value, no. of trades on the wholesale debt market is declining from 2003-04 to 2006-07, and the share of govt dated securities in WDM has come down from 92% to 70%. As a result of the development measures undertaken, the volume of transaction in the secondary market of the govt security market increased manifold over the past decade. However, markets are active and liquid when interest rates decline but turn illiquid when rates rise. This has resulted in slowdown in the turnover in recent years. The trading pattern of govt securities indicates that most of the trading activity takes place in Central govt securities. One of the key issues in the development of the market for a better price discovery is security liquidity. It was observed that out of the large number of outstanding securities, only few securities are actively traded in the secondary market. RBI has been persisting with the policy of passive consolidation through re issuance of existing securities with a view to enhance liquidity. The share of re issuances in the total securities issued was 97.7% during 2005-06. Security wise analysis indicates that the number of actively traded securities is low as compared with the total number of outstanding securities. As on Dec 2006, there were 102 Central govt securities with an outstanding amount of Rs 1055703 crore. Out of these, 46 securities with outstanding issues of Rs 10000 crore or more accounted for 77% of the total outstanding amount. The turnover to total outstanding ratio dipped sharply to 1.1 in 2005-06 from more than 3 in 2003-04. On a daily basis, 10 - 12 securities are traded and out of these 4 - 5 are actively traded. Without active trades in the market, the yield is kinked, thereby making it difficult to price securities. This also leads to situation where securities of similar maturity profiles trade at different yields, with sizeable illiquidity premiums on some occasions.
Implications for Monetary Policy
RBI executes interest rate policy through changes in the bank rate, by fixing interest rates on govt borrowings and lending, and by influencing the behavior of prices and yields in the gilt edged market. The management of the gilt edged market has also a considerable bearing on the advances and liquidity of the commercial banks, such as to help monetary policy. But this is one of the objectives of debt management. The other objective is to ensure that suitable and inexpensive finance for the exchequer is available and will continue to be available in future.
The prices and yields on govt securities have not been used to influence other interest rates in the economy. The open market operations have not been used much for influencing the cost and availability of credit. They have been employed by RBI primarily to assist the govt in their borrowing operations and to maintain orderly in the market. The use of open market operations to provide seasonal finance to commercial banks also serves the purpose of maintaining stability in the market.
Recent Developments
The maximum coupon rate on govt securities has been raised from 5.5% in 1970-71 to 13.05% in 1997-98, while their max maturity period has been reduced from 30years to 10years.
The NSE has begun trading in govt bonds.
A delivery vs. payment system (DVP) has been introduced from July 17, 1995 to settle transactions in govt securities. It synchronizes the transfer of securities with cash payment, thereby reducing settlement risk. The settlement system has been computerized.
From Apr 15, 1997, repos in respect of all dated govt securities have been allowed which helps to integrate money market and govt security market. Such step enhances the liquidity of the market.
Many new financial instruments such as tax free bonds, capital indexed bonds (Dec 1997), zero coupon bonds (Jan 1994), floating rate bonds (Sep 1995) have been introduced in govt security market.
The practice of tax deduction at source in respect of investment in govt securities has been discontinued with effect from June 1, 1997. Besides, interest income on these securities up to Rs 15000 has been made eligible for deduction under Section 80L of the Income tax Act. This would help to promote retail market in these securities.
The transactions in govt security market which are recorded by RBI in SGL account are being published now to attain transparency in the market working.
In order to develop retail market in the govt security market, MFs are being encouraged to introduce special schemes or gilt funds which are dedicated to the securities. For this purpose, the govt decided on Apr 3, 1996 to provide liquidity support to MFs specializing in government security investment. Accordingly, RBI has been either purchasing outright or engaging in reverse repos up to a max of 20% of outstanding investment in govt securities by the MF. Further, gift funds are marketed through the agents of the UTI, LIC, GIC, post offices, banks and other MFs. The investors in units of such funds are provided liquidity by way of bank credit against such units.
The FIIs in the category of 100% debt funds have been permitted from Jan 30, 1997 to invest in Central and State govt securities in both primary and secondary markets.
The govt has been issuing floating rate bonds with a view to provide investor an effective instrument for hedging interest rate risk in the context of the elongation of maturity profile of government securities.
In May 2002, measures were introduced to accelerate the process of holding of securities in the dematerialized form and to reduce the scope for trading in materialized forms.
Buying and selling of govt securities through NSE, BSE and OTCE have been allowed with effect from Jan 16, 2003 on an anonymous screen based order driven basis. This measure was taken for the following expectations:
Facilitate country wide access and wider participation
Reduce time and cost involved in the trading
Enhance operational and informational efficiency of the market as well as its transparency, depth and liquidity.
In order to consolidate govt debt, the practice of re issuance of existing securities was continued during 2001-03.
In 2002-03, the authorities have introduced the system of publishing a calendar by RBI that outlines the issues of dated govt securities every half year.
The govt security market earlier was predominantly a captive market, but now, the investment is not wholly statutorily fixed. A large part of investment in govt security market by banks is out of portfolio considerations.
The secondary market, particularly repos market, has grown and become more active. Interest rates in repos market now signal changes in other market interest changes.
Clearing Corporation of India (CCIL) commenced functioning on Nov 12, 2002. The purpose for the existence is that there are benefits of netting of obligations. The CCIL has contributed to developing to develop the collaterized borrowing and lending obligations (CBLO) for its members so that they can reduce their dependence on the call money market.
Government Securities Act, 2006, Sections 27 & 30 - Imposition of penalty for bouncing of SGL forms
RBI/2010-11/115
IDMD. DOD.15/11.01.01(B)/2010-11, July 14, 2010
a) In terms of the existing regulatory framework, if the SGL transfer form bounces three times in a half year, for want of either funds or the securities, the account holder is liable to be debarred from using the SGL account facility for a period of six months. After restoration of the facility, if the SGL transfer form of the account holder bounces again, such account holder is liable to be permanently debarred from using its SGL account.
b) The existing guidelines have since been reviewed in the light of the provisions of section 27 and sub-section (3) of section 30 of Government Securities Act, 2006 (Act). Accordingly, in the event of bouncing of SGL transfer forms and the failure of the account holder concerned to offer satisfactory explanation for such bouncing, the account holder shall be liable to pay penalties as under:
i. Graded monetary penalties subject to a maximum penalty of Rs. 5 lakhs per instance;
S. No
Applicable to
Monetary penalty
Illustration
[Penal amount on Rs. 5 crore default]
1
First three defaults in a financial year (April to March)
0.10%
(10 paise per Rs. 100 FV)
Rs. 50,000/-
2
Next three defaults in the same financial year
0.25%
(25 paise per Rs. 100 FV.)
Rs. 1,25,000/-
3
Next three defaults in the same financial year
0.50%
(50 paise per Rs. 100 FV)
Rs. 2,50,000/-
ii. On the tenth default in a financial year, the eligible entities will be debarred from using the SGL A/c for undertaking short sales in Government securities even to the extent permissible under circular IDMD.No /11.01.01(B) / 2006-07 dated January 31, 2007 as amended from time to time, during the remaining portion of the financial year. In the next financial year, upon being satisfied that the a/c holder in question has effected improvements in its internal control systems, RBI may grant specific approval for undertaking short sales by using the SGL A/c facility.
iii. The monetary penalty may be paid by the account holder concerned by way of a cheque or through electronic mode for the amount favouring the Reserve Bank of India, within five working days of receipt of intimation of order imposing penalty from RBI.
c) For the purpose of these instructions, 'SGL bouncing' shall mean failure of settlement of a Government securities transaction on account of insufficiency of funds in the current account of the buyer or insufficiency of securities in the SGL / CSGL account of the seller, maintained with the Reserve Bank of India.
d) The defaulting member shall make appropriate disclosure, on the number of instances of default as well as the quantum of penalty paid to the Reserve Bank during the financial year, under the "Notes to Account" in its balance sheet.
e) Notwithstanding anything contained in this circular, the Reserve Bank reserves the right to take any action including temporary or permanent debarment of the SGL account holder, in accordance with the powers conferred under the Act as it may deem fit, for violation of the terms and conditions of the opening and maintenance of SGL/ CSGL accounts or breach of the operational guidelines issued from time to time.
f) In addition to the above, as NDS Members they should strictly abide by all other provisions of the NDS (Membership) Regulations, 2002 as amended from time to time.
g) This circular shall come into force with immediate effect.
The major objectives of the financial reforms in govt securities market have been as follows:
To increase operational autonomy of RBI by taking measures such as discontinuation of automatic modernization of govt securities.
To improve institutional infrastructure
To improve the depth and the breadth of the govt security market by introducing a variety of new instruments and improving market micro structure (price based auction, non competitive bids, and re issue of dated securities)
To develop a sound legal and regulatory framework of the market.
To initiate and accelerate technology related developments
To improve transparency and the monitoring of the market and to bring standardization of accounting.
