The Hindu Business Line : What we sought and what we got

The new measures introduced are useful for an orderly development of the financial markets. The new measures introduced are useful for an orderly development of the financial markets.

C. E. S. Azariah

Speculation about RBI's impending decisions regarding interest rates has finally ended with the release of the Annual Policy Statement for 2006-07 . Post-IMD redemptions, there were banks with excess SLR (Rs 1,56,504 crore), and some at the statutory minimum levels. The RBI's observation that "some market participants had not prepared for the liquidity implications of the movements in the interest rate cycle as also the one-off impact of IMD redemption and, as a consequence, found themselves facing a shortage of liquidity as well as eligible securities with which to access the Reserve Bank's liquidity facilities or even the collateralised money markets" hits the nail on the head. This "frictional" liquidity shortage in March resulted in speculation about CRR cut.

The subsequent return of liquidity with MSS unwinding, government spending, G-Sec redemptions, etc, brought about speculation of reverse repo and repo rate hikes.

The reasons propounded for rate rises were inflationary pressures due to rise crude oil prices, credit growth, and asset bubbles in equities and residential housing.

Looking at the inflation rate of 3.51 per cent for the week-ended April 1, sufficient liquidity (with the RBI in the liquidity absorption mode at 5.50 per cent at the time of the Policy statement) position, a growth target of 10 per cent (to match the Chinese growth rate) and the nervousness of the fixed income market participants about implementation of the FRBM Act, the RBI did what should have been obvious to a trader looking at all factors and forming a "view".

No CRR cut (enough liquidity at present). No reverse repo/repo hike (no sense in spooking the PDs and other fixed income brave-hearts who are taking the first steps in a fixed income market with FRBM in place and no support from the RBI for the massive government borrowings of Rs 1,13,788 crore). No bank rate hike (who wants to signal tightening when we are targeting 10 per cent GDP growth).

New measures

The RBI has rightly kept the smooth implementation of the FRBM Act foremost in mind and introduced the following for the financial markets:

i) NDS-CALL, an electronic screen-based, negotiated quote-driven system for dealing in Call/Notice and term money market developed by CCIL. This will speed up the call money trades, as it will bring both the borrower and lender anonymously to a single platform, where earlier dealt rates, ongoing bids/offers will impart much more transparency to the call money rates and help develop realistic Overnight Money Indices.

ii) Intra-Day and `When Issued' short selling of government securities. In a situation of rising yields, this will give a fillip to fixed income bond trading.

iii) Diversification of primary dealer business. This will help PDs diversify into equities and maybe foreign exchange trading, helping them explore other profitable trading avenues.

iv) Extension of NDS-OM module to new participants. With mutual funds, large pension/provident funds like CBOT/Seamen's/Coal Miner's funds accessing the NDS-OM, we will see greater volumes and number of participants along the G-Sec yield curve. Again, something to revive the currently moribund bond markets.

v) Purchase and resale of SDLs by the RBI under the overnight LAF repo operations, will help banks use their large SDL portfolios to generate liquidity for meeting their short term requirements, and also bid in State Govt Auctions.

vi) And, a roadmap for implementation of the High Level Expert Committee recommendations on corporate bonds, an urgent requirement for activating and giving depth to corporate bond trading.

Other measures such as guidelines relating to classification and valuation of investments in alignment with international standards and asset-liability management guidelines are useful for an orderly development of the financial markets, while the prudential provisioning requirements will take care of the worries about asset bubbles.

RBI's caution

While we wait for July 25 for reviewing what we got now, let us keep the RBI's cautioning words in mind "...It is important to undertake a careful assessment of the downside risks... Recent developments indicate that while domestic factors continue to be significant, the global factors are gaining greater importance in determining the near-term outcome and, accordingly, the monetary policy response."

(The author is Chief Executive Officer, Fixed Income, Money Market and Derivatives Association of India. The views are personal.)