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Effects of Multiple Arbitraging

The developments in the call money market in December 2006 have exposed the tenuous nature of the financial markets in a possible environment of liquidity shortages. A considerably unequal distribution in investment-deposit ratios creates scope for varied forms of arbitraging. Such arbitraging has been spawned by a situation of vast structural differences between different groups of players in the financial markets. These developments point to the substantially changed market structure, wherein arbitraging operations between markets, which are generally believed to remove misalignment of rates, have instead increased disparities.

Money market

Effects of Multiple Arbitraging

The developments in the call money market in December 2006 have exposed the tenuous nature of the financial markets in a possible environment of liquidity shortages. A considerably unequal distribution in investment-deposit ratios creates scope for varied forms of arbitraging. Such arbitraging has been spawned by a situation of vast structural differences between different groups of players in the financial markets. These developments point to the substantially changed market structure, wherein arbitraging operations between markets, which are generally believed to remove misalignment of rates, have instead

increased disparities.

EPW RESEARCH FOUNDATION

I Multiple Arbitraging

U
nexpected, though partly seasonal, events in December have sharply impinged on market sentiments and the liquidity scenario so much so that the call rates have touched a nine-year high, RBI’s liquidity support through the LAF repo window has been the highest so far and one-month forward premia for the US dollar in the domestic forex market have ruled above 8 per cent – an unusual phenomenon. The apparent reason for this turmoil has been the RBI’s unexpected hike in CRR by 50 basis points in two tranches of 25 basis points each on December 23 and January 5, with a view to absorbing liquidity and containing inflationary expectations. This precarious situation has turned explosive as the seasonal advance tax outflows began squeezing liquidity; with the improved macroeconomic performance over the past few years the size of advance tax outflows has increased substantially. Along with this, the holiday-shortened week for the banks to comply with the new CRR norms pushed the call rates to such high levels.

Despite these apparent reasons for the turmoil in the short-term market, it remains intriguing that even after the RBI injected a whopping Rs 2,09,575 crore which is the highest ever injection since the opertionalisation of LAF and which even exceeded the earlier high of Rs 1,49,115 crore in December 2005 in the wake of IMD redemptions, the call rates have risen so high. Also, the usual spread between call, CBLO and repo rates, which are generally around 100 basis points each, have touched peaks of 380 basis points (for call over CBLO) and 264 basis points (for call over repo) in the month.

This situation has apparently arisen because the markets have begun to readjust themselves to the regulatory actions taken in the recent past, which include the prudential norms imposed on the call money market. The prudential norms imposed on call market borrowings were introduced with a view to transforming the call money market into a pure inter-bank market and evolving call money and repo markets into an integrated set for equilibrating shortterm positions of banks and non-banks (Annual Report 2000-01: 149). In addition, this also had the objective of addressing the phenomenon of some segments of the banking industry resorting to a chronic reliance on the call market other than for meeting unforeseen mismatches (Annual Report 2001-02: 146). Thus, it was prescribed that with effect from the fortnight beginning December 14, 2002, call lending of scheduled commercial banks, on a fortnightly average basis, should not exceed 25 per cent of their owned funds; however, banks are allowed to lend a maximum of 50 per cent on any day during a fortnight. Similarly, their call borrowings should not exceed 100 per cent of their owned funds or 2 per cent of aggregate deposits, whichever is higher; but banks are allowed to borrow a maximum of 125 per cent of their owned funds on any day during a fortnight. Also, on recommendations of the Technical Group on Money Market (May 2005), the focus and policy thrust of the RBI have been towards encouraging the expansion of the collateralised segment in the short-term market and at the same time, ensuring a transparency through screen-based transactions which would in turn ensure better price discovery, provide avenues for better risk management and facilitate better monetary operations. As a result of this new regulatory regime, the exposure of banks in the overnight call money market has declined.

The financial market has been exposed to the new regulatory regime for quite some time. As a result of abundance of liquidity combined with a policy of maintaining a soft interest rate, the market has been able to adjust itself to the new regime without any serious disturbance to the short-term interest rate structure, which has an equilibrating ability. But, the developments of December 2006 have exposed the tenuous nature of the financial markets in a possible environment of liquidity shortages accompanied by depletion of SLR securities which have been otherwise a ready source of liquidity for the banking industry. With credit off-take galloping, the excess SLR securities have been pared down considerably by the banks. Creditdeposit ratios of scheduled commercial banks have shot up from 57 per cent at the end of March 2003 to 74 per cent at the end of December 2006, while the corresponding investment to deposit ratios have fallen from 43 per cent to 31 per cent. Though the latter is 25 per cent more than the statutory requirement, a considerably unequal distribution of their holdings creates scope for varied forms of arbitraging. Such arbitraging has been spawned by a situation of vast structural differences as between different groups of players in the financial markets.

Economic and Political Weekly January 20, 2007

Amongst them, the banking segment, which Finally, December seems to have seen and the forex market, on the other. It appears dominates treasury operations and hence intense arbitraging between the gilt-edged that the market participants have sold the overnight market, is the foreign bank and call money market, on the one hand, dollars in spot but booked forwards, thereby segment, and it has such a low bank deposit

Table 2: Weighted Averages of Daily Call/Notice Rates in Per Cent Per Annum:

base (5 per cent of aggregate deposits) but

Simple Statistical Characteristics

enjoys 15-17 per cent each of outright

Month/Week Simple Standard Coefficient Simple Standard Coefficient

settlement volumes of government

Mean* Deviation of Variation Mean* Deviation of Variation securities and reverse repo/repo volumes (Percentages)$ (Percentages)$

outside the RBI as well as 50-54 per cent

Call Money Notice Money**

of forex settlement volumes (aggregating November 2006 All four weeks 6.81 0.26 3.79 6.73 0.34 5.05

$13.16 billion a working day).

24 (RF)* 6.55 0.40 6.05 6.44 0.26 4.03As a result of these imbalances, the 17 6.92 0.16 2.34 6.94 0.38 5.42

financial markets were exposed to three 10 (RF)* 6.85 0.12 1.72 6.72 0.37 5.46

3 6.91 0.05 0.75 6.83 0.15 2.16

types of arbitraging activities in the month December 2006 of December 2006. First, foreign banks as All five weeks 7.94 2.57 32.39 7.80 2.58 33.06 29 12.78 2.38 18.60 12.59 2.68 21.32

a group have shared 34 per cent to 46 per

22 (RF)* 8.21 0.22 2.66 7.81 0.70 8.97 cent of buy transactions in dated securities 15 7.25 0.76 10.46 7.17 0.82 11.39 8 (RF)* 6.12 0.01 0.20 6.13 0.09 1.46

and treasury bills and 44 per cent to 54

1 6.15 0.08 1.33 6.09 0.12 1.92

per cent of sell transactions in the last week

** Separate reportings began on March 15, 2005.

of December; they have also used the

* Including data for reporting Fridays (RF). $ Based on original unrounded figures.reverse repo route to the extent of 26 per Source: RBI.

cent share in total reverse repo trade Table 3: Comparison of Call, Overnight CBLO and Repo Rates volumes. While foreign banks’ share of

Week-Ending Weighted Average Rates Daily Average Volumes

call money lending and borrowing arrange

(in Per Cent) (Rs crore) ments are not known, CBLO lending and Call Overnight CBLO Repo Call Overnight CBLO Repo borrowings have been to the extent of only

3-Nov-06 6.90 6.32 6.67 19191 19604 11297

1.4 per cent and 6.3 per cent, respectively. 10-Nov-06 6.84 6.21 6.62 13623 18169 11029 17-Nov-06 6.97 6.88 6.89 13649 17538 10531

The second set of arbitraging may have

24-Nov-06 6.46 6.23 6.52 11567 15958 7757taken place between the collaterised and 1-Dec-06 6.16 5.97 6.13 16350 17279 9450 8-Dec-06 6.13 5.96 6.06 13956 16222 8645

uncollaterised market. The borrowers with

15-Dec-06 7.46 7.09 7.14 16141 18796 7837SLR securities could borrow in December 22-Dec-06 8.27 7.37 7.43 13882 16374 6027 at 7.25 per cent from the RBI through the repo 29-Dec-06 13.31 9.51 10.67 16206 11116 5117 route and lend in the call market wherein Source: The Clearing Corporation of India (CCIL). the weighted average call rate ruled above

Table 4: Details of Central Government Market Borrowing

the 8 per cent for almost the entire month (Amount in Rs crore) and touched the peak of 21 per cent in

Date of Loan Notified Competitive Competitive Indicative Devolveintra-day trades; these happened when the Auction Nomenclature Amount Bids Bids YTM at ment on market absorbed as much as Rs 36,000 crore Received Accepted Cut-off Primary

Price Dealers

through the repo window on December 28.

Number Amount Number Amount (in Per Cent) (Rs Crore)

It is also known that call money has a

8 Dec-06 7.37 per cent 5000 257 10713 104 4980 7.31 per cent

monopsony characteristic because the big

2014 (Rs 100.32) Nil banks have a proportionately high lending 8 Dec-06 8.33 per cent 4000 177 10439 29 3993 7.63 per cent 2036 (Rs 108.15) Nil

capacity and in periods of scarcity, they are known to dictate terms of lending. Source: RBI Press Releases.

Table 1: Money Market Operations (RBI’s Daily Data)

Average December 2006 Average November 2006 Items for Five for Four

Weeks 29 22(RF) 15 8(RF) 1 Weeks 24(RF) 17 10(RF)

No of working days 29 5 6 6 6 6 24 6 6 66

Call Money

Weighted average of call rates: per cent (weekly range) per annum 6.00-16.78 10.73-16.78 7.94-8.61 6.23-8.00 6.10-6.13 6.00-6.25 6.06-7.09 6.06-7.02 6.68-7.09 6.71-7.00 6.83-6.96 Daily averages (Rupees crore) (8.61) (6.13) (7.04) (6.71) Total call market borrowings 12211 12114 12361 12837 11115 13587 11756 8843 11051 11297 15831

(675) (514) (644) (752)

Notice Money

Weighted average of notice money rates: per cent (weekly range) per annum 5.95-16.89 9.51-16.89 7.00-8.71 5.99-8.14 6.01-6.23 5.95-6.28 6.16-7.43 6.16-6.82 6.32-7.43 6.24-7.20 6.64-6.98 Daily averages (Rupees crore) (6.16) (6.67) Total notice market borrowings 3027 4062 2250 3304 2842 2581 2752 2724 2598 2326 3360 (14138) (16635) (16137) (13496) Turnover in term money market 316 503 238 218 360 360 210 106 259 266 208 (borrowings) $$ (135) (75) (331) (190)

* Data for reporting Fridays are given within brackets and they are also included in the weekly range/daily averages. $$ No of reporting/traded days is fewer than given above. .. not available.

Economic and Political Weekly January 20, 2007

Graph A: Trends in WeightedGraph B: Spot Quotations for US Dollarstrain surfacing on short-term liquidity andAverages of Call Rates, Repo Rates,in the Domestic Inter-Bank Market

with the call rates breaking a nine-year

CBLO Rates and Call Money

(Dailyil iWorking Days December 2006) Monthly Averages (Jan 2001 to Nov 2006)
record and ruling well above the long-term

Borrowing – December 2006 50.0 17

25.5

gilt-edged yields; they were accompanied

16.5

16

15.5

by huge repo injections and one-month

15

forward premia touching peaks. Until a

14.5

20.5

14

48.0

dated securities loan floatation on Decem-

Weighted Average (Per Cent)

Rupees Thousand Crore Rupees per US dollar

13.5 13

12.5

12

15.5

11.5

11

10.5

10

9.5 9 10.5

8.5 8

ber 8, market sentiments remained positive

though apprehensive of the upcoming

advance tax outflows and expectations of

46.0

a rate hike in the impending quarterly

review scheduled towards the end of

7.5 7 5.5

44.0

January 2007. Unexpectedly, the RBI hiked

6

5.5 5

4.5

the CRR by 50 basis points in two tranches

4

0.5

December 2006

of 25 basis points each on December 23

ll l

-i

Call Money Volume (Rs Cr) Repo Rates – Outside the RBI 42.0

and January 5, 2007 to absorb an aggregate

ll

CBLO Rates

Call Rates

of Rs 13,500 crore with macro-economic using the short-term rupee liquidity in the suddenly turned volatile. The developments stability objectives in view. With the overnight market. As a result, the one-month in short-term money and foreign exchange statements by the finance minister that the forward premia jumped to a peak of 8.62 markets underwent dramatic shifts, CRR increase was intended to moderate per cent in the last week of December and particularly in their outlook towards credit growth and that the government was that too, in an environment of a gradually liquidity and interest rates, as the month ready to take further actions to fight inflaappreciating rupee. of December 2006 progressed with serious tion, the market sentiments turned anxious.

These developments point to the

Table 6: Auctions of 182-Day Treasury Bills

substantially changed market structure (Amount in rupees crore) wherein arbitraging operations between

Date of Notified Bids Tendered Bids Accepted Subscription Cut-off Cut-off Amount markets, which are generally believed to Auction Amount Devolved Price Yield Outstanding remove misalignment of rates, have instead No Face Value No Face Value on PDs (Rupees) Rate on the Date

(Amount) (Amount) (Amount) (Per Cent) of Issue

increased the disparity of rates wherein different market segments with better 2005

Nov 30 500.00 27 1095.13 13 500.00 0.00 97.16 5.90 14886.50leveraged positions benefit the most. (0) (0.00) [97.16] [5.85]

Dec 14 500.00 38 1561.33 8 500.00 0.00 97.12 5.94 13886.50

(0) (0.00) (0) (0.00) [97.13] [5.61]Dec 28 500.00 41 1408.00 13 500.00 0.00 97.04 6.14 14996.00

II

(2) (609.23) (2) (609.23) [97.04] [6.10]

Money, Gilt-Edged and 2006 Dec 13 1500.00 30 1742.50 26 1500.00 0.00 96.51 7.25 20267.83

Forex Markets

(0) (0.00) (0) (0.00) [96.63] [6.99]

Dec 27 1500.00 36 2120.00 10 510.00 0.00 96.49 7.30 19677.83After experiencing reasonably stable (0) (0.00) (0) (0.00) [96.50] [7.27]

conditions almost continuously for over

Figures in the square brackets represent weighted average price and the respective yield. Figures in bracketsfive years, the short-term financial markets represent numbers and amounts of non-competitive bids which are not included in the total.

Table 5: Auctions of 91-Day Treasury Bills

(Amount in rupees crore)

Date of Notified Bids Tendered Bids Accepted Subscription Cut-off Cut-off Amount Outstanding Auction Amount Devolved Price Yield Rate on the Date of Issue No Face Value No Face Value on PDs (Rupees) Rate

(Amount) (Amount) (Amount) (Per Cent) Total With RBI Outside RBI

(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12)

2005 November 30 500.00 43 2015.50 18 500.00 0.00 98.59 5.72 28630.73 0.00 28630.73

  • (1) (363.00) (1) (363.00) [98.60] [5.68]December 7 500.00 35 2386.94 1 500.00 0.00 98.61 5.65 25437.95 0.00 25437.95
  • (4) (1230.89) (4) (1230.89) [98.61] [5.64]December 14 500.00 40 1820.11 10 500.00 0.00 98.58 5.78 21937.95 0.00 21937.95
  • (0) (0.00) (0) (0.00) [98.58] [5.76]December 21 500.00 41 922.15 26 500.00 0.00 98.52 6.02 21521.32 0.00 21521.32
  • (2) (3352.69) (2) (3352.69) [98.54] [5.93]December 28 500.00 32 1016.65 18 500.00 0.00 98.50 6.11 19719.73 0.00 19719.73
  • (1) (200.00) (1) (200.00) [98.51] [6.05]2006 December 6 2000.00 46 4216.25 16 2000.00 0.00 98.37 6.65 32476.27 0.00 32476.27
  • (2) (1500.00) (2) (1500.00) [98.37] [6.65] December 13 2000.00 38 1254.14 31 1059.14 0.00 98.26 7.10 31200.41 0.00 31200.41
  • (3) (830.00) (3) (830.00) [98.30] [6.95] December 20 2000.00 49 2426.61 16 756.51 0.00 98.26 7.10 30976.91 0.00 30976.91
  • (1) (500.00) (1) (500.00) [98.26] [7.10] December 27 2000.00 32 1650.25 10 630.25 0.00 98.24 7.19 30607.16 0.00 30607.16
  • (2) (2200.00) (2) (2200.00) [98.25] [7.14]

    Figures in parentheses in cols 3 to 6 represent numbers and amounts of non-competitive bids which are not included in the total. Figures in the square brackets under cols 8 and 9 represent weighted average price and respective yield.

    Economic and Political Weekly January 20, 2007

    Graph C: Annualised Forward Premia in Graph D: Yield Curves for Datedinjecting liquidity. Though in the recentPercentage for the US Dollar in theSecurities – Weighted Average for

    past, market participants preferred

    Domestic Inter-Bank Market and WeightedWeeks of December 2006

    1st Week 2nd Week 3rd Week 4th Week 5th Week
    collateralised short-term borrowings as

    Averages of Call Rates for December 2006 9

    6.0

    -i 6-month
    17.0

    compared with uncollateralised market, in

    5.5

    December, they seem to have preferred the

    8.5

    call and notice markets (Table 3). The month

    Yield (per cent per annum)

    began with the weighted average call rates

    Per cent per annum

    812.0

    ruling at 6 per cent on December 1, that

    1-month 3-month

    rose to 6.13 per cent on December 4 and

    ruled at it until December 8 despite central

    7.5

    loan flotation as well as the first reporting

    ll t iti

    Weighted Averages of 7.0

    Friday coinciding on the same day. There-

    Call Rates (Right Axis)

    7

    after, the overnight rate crossed the upper

    band of the repo-reverse repo corridor of

    6.5

    7.25 per cent and touched 8 per cent on

    2.0

    2 3 4 5 6 7 8 9 1011121314151617182123272930

    Years to Maturity

    December 14 on account of outflows

    Working Days

    The call rates began ruling above the repo rate of 7.25 per cent and RBI began injecting liquidity through the repo window with a view to improving the liquidity scenario, given the huge advance tax outflows as well as state loan floatations. Also, the yields set at 91-treasury bills touched a peak of 7.10 per cent, that is, just 50-60 basis points below the 10-year benchmark yields. Even the euphoria about the US Fed holding the benchmark rate steady remained shortlived as the market expected a further tightening in the domestic rates as an RBI deputy governor reiterated no direct link between US fed and domestic rates. Ahead of the reporting Friday on December 22 wherein the new CRR norms were applicable (absorbing Rs 6,750 crore) as well as the holidays in the next week, pushed the call rates even higher. In the last week of the month, the short-term market was in turmoil as the daily average of call rates touched a peak of 16.78 per cent (Table 1) due to severe shortage of funds despite RBI injecting huge amounts which touched a peak of Rs 36,120 crore on December 28. In the forex market, the RBI continued to modulate the movements of therupee-dollar exchange rate, but as domestic liquidity remained under pressure, market participants undertook swap transactions given the attractive rupee yields. Given the arbitrage opportunity due to firm call rates and hardening of interest rate perceptions, the one-month forward premia rose steeply to 8.62 per cent on December 28. The corporate bond market turned subdued due to interest rate uncertainty.

    Call Money Market

    With the volatility in call rates becoming quite sharp, the coefficients of variation touched the highest levels of 32.4 per cent and 33.1 per cent for December in respect of call rates and notice money rates, towards state development loans and respectively (Table 2). The actual average advance tax payments, but then edged lower call rates ruled in a range of 6 per cent to to 7.77 per cent the next day. On top of

    16.78 per cent, despite the RBI continuously the already precarious state of liquidity,

    Table 7: Auctions of 364-Day Treasury Bills

    (Amount in rupees crore)

    Date of Notified Bids Tendered Bids Accepted Subscription Cut-off Cut-off Amount Auction Amount Devolved Price Yield Outstanding No Face Value No Face Value on PDs (Rupees) Rate on the Date (Amount) (Amount) (Amount) (Per Cent) of Issue

    2005 Dec 7 1000.00 33 2551.00 12 1000.00 0.00 94.35 6.00 48858

    (1) (170.00) (1) (170.00) [94.36] [5.98] Dec 21 1000.00 49 2161.00 31 1000.00 0.00 94.20 6.17 48858

    (0) (0.00) (0) (0.00) [94.23] [6.12]

    2006 Dec 6 2000.00 77 6115.00 22 2000.00 0.00 93.53 6.94 46098

    (0) (0.00) (0) (0.00) [93.55] [6.91] Dec 20 2000.00 83 7230.00 27 2000.00 0.00 93.27 7.24 47348

    (1) (250.00) (1) (250.00) [93.29] [7.21]

    Figures in the square brackets represent weighted average price and the respective yield. Figures in brackets represent numbers and amounts of non-competitive bids which are not included in the total.

    Table 8: Profile of Major Commercial Bond Issues during December 2006

    Sl Issuing Company/Rating Nature of Coupon in Per Cent Per Annum Amount in No Instrument and Tenor Rs Crore

    FIs/Banks

    1 Federal Bank Lower Tier II Bonds 9.25 per cent for 10 years 450 (250) AA & A+(ind) by Care & Fitch 2 HDFC Bonds 8.5 per cent for 2 years 500 (200) AAA by Crisil, Icra 3 IDBI Lower Tier II Bonds 8.85 per cent for 10 years 350 AA+ by Crisil, Icra & Fitch 4 Indusind Bank Upper Tier II Bonds 9.75 per cent for 15 years and step-up of 165 (65) A by Icra, Fitch 50 basis points if call is not exercised at the end of 10th year 5 State Bank of Indore Upper Tier II Bonds 8.95 per cent for 15 years and step of 50 basis 100 AAA by Crisil points if call is not exercised at the end of 10 years 6 NABARD Bonds 8.15-8.25 per cent for 3 years and 8.30-8.40 200 AAA by Crisil & Care per cent for 5 years with call option at the end of 1 year and 3 years, respectively

    NBFCS

    1 PNB Housing Finance Bonds 8.7 per cent for 10 years 100 (50) AA+ by Crisil, Care Central Undertaking

    1 Power Grid Corp Bonds 8.68 per cent for 10 years 700 (200) AAA by Crisil, Icra 2 Rural Electrification Corp Bonds 8.85 per cent for 10 years 1000 (500) AAA by Crisil, Fitch & Care Total 3565 Total for December 05 (a year ago): Rs 4,809 crore. Total for November 06 (a month ago): Rs 9,602 crore

    Note: The amount shown in brackets above denotes the greenshoe option of the issue. Source: Various media sources.

    Economic and Political Weekly January 20, 2007 the implementation of the first tranche of CRR by 25 basis points absorbing Rs 6,750 crore – and it coinciding with a holiday shortened week and few lenders available in the uncollaterised market even as many market participants were found without enough securities eligible for repo and CBLO transactions – induced the call rates gallop to 10.73 per cent on December 23; they rose continuously to touch a peak of

    16.78 per cent on December 29; and in intra-day trades, they touched a level of 21 per cent. However, it eased to 12.41 per cent on December 30 (Graph A).

    Unlike in previous months when volumes in the CBLO market generally exceeded those in the call market, the December month saw a significant increase in call market borrowings accompanied by a decline in CBLO and repo market volumes (Table 3); this happened even as the rates offered in the call market firmed up and exceeded those in the two collateralised markets, which could probably be due to a paucity of required collaterals with the market participants.

    Forex Market

    The rupee-dollar exchange rate appreciated in December by about 53 paise in the wake of the dollar weaknesses induced by expectations that the US fed would cut interest rates this year due to weaknesses in its economy; the rupee was also supported by a robust inflow of foreign currency assets and somewhat easy international crude oil prices. The forex market took in its stride the significant rise in trade deficit following relatively slower exports growth and a surge in imports. Though RBI intervened in the market sporadically, it generally allowed the rupee to respond to the market forces. The month began with the rupee-dollar exchange rate appreciating from Rs 44.67 on December 1 to Rs 44.51 on December 6, given the buoyancy in the domestic stock market and inflow of foreign currency assets. However, as the domestic rupee liquidity came under pressure following the hike in CRR and stock markets turning in for a correction, the rupee depreciated to Rs 44.69 on December 8 and further to Rs 44.83 on reported intervention by the central bank. The market participants turned cautious as they anticipated that the inflows would be affected, but as the stock market recovered and inflows continued, the appreciating trend persisted. With the US fed holding interest rates steady, the rupee turned buoyant and touched Rs 44.66 on December 15. Following the decision of the central bank of Thailand to impose reserve requirements on short-term capital flows on December 18 with a view to maintaining stability in the Thai Baht, the stock markets in Asia fell and the rupee depreciated to Rs 44.83 on December 19. However, with the subsequent relaxation in their norms, the rupee continued its appreciating trend to Rs 44.73 on December 21. In the last week of the month, due to subdued month-end demand for dollars and the banks selling dollars to generate rupee liquidity in view of the severe strain on domestic liquidity, the rupee-dollar exchange rate touched Rs 44.39 on December 27 and rose further to Rs 44.23 on December 29 (Graph B). Also, there was arbitrage opportunity in the offshore and onshore market supporting the appreciating trend. Over the month, the rupee appreciated against most of the currencies including Chinese yuan except Indonesian rupiah.

    On an annual basis the rupee appreciated during 2006 by 2.1 per cent and 3.0 per cent against the US dollar and Japanese yen, respectively, while depreciated against euro and pound sterling by 8.2 per cent and 10.6 per cent, respectively, but the rupee’s appreciation against the Asian currencies such as Indonesian rupiah and South Korean won was meagre.

    The gap between NEER and REER increased substantially in the recent past from 95.70 and 99.85 in August to 98.36 and 104.40, respectively, on December 15 indicating growing competitive disadvantages faced by the Indian export-import trade in real terms.

    Following the hike in CRR, the forward premia firmed up due to hardening of interest rate perceptions in the domestic market. The tightness in the call market pushed the one-month forward premia from

    2.28 per cent on December 1 to 2.82 per cent on December 11 and further to 4.98 per cent

    Table 10: Repo Transactions in

    Government Paper@ (Other than

    with the RBI) – December 2006

    Repo Period Amount Range of Interest in Number (Rupees (Per Cent of Days Crore) Per Annum)

    1 177823.80 5.25-12.00 (6.92) 2 807.98 5.00-7.75 (6.23) 3 33309.39 5.45-9.00 (6.46) 4 12273.12 5.95-18.5 (10.64) 5 146.50 6.00-7.25 (7.24)

  • 6 11.84 6.25-7.70 (7.37)
  • 7 10.00 7.15 (7.15) 11 250.00 7.25 (7.25) 18 12.00 6.25-7.75 (7.50) 21 150.00 7.25 (7.25) 31 10.00 8.50 (8.50) 33 26.00 8.00 (8.00)
  • 63 5.00 8.50 (8.50)
  • 90 4.00 8.50 (8.50)
  • 91 5.00 8.25 (8.25) 149 192.00 7.50 (7.50)
  • All Issues 1-149 225036.63 5.00-18.05 (7.05) [1-152] [252658.23] [5.00-8.50] [6.69]

    @ Cover all types of securities. Figures in round brackets are weighted average interest rate; in square bracket, the figure represents the previous month’s turnover/interest rate.

    Table 9: Operations of RBI’s Liquidity Adjustment Facility**

    (Amount in rupees crore)

    Range of Repo (Injection)* Reverse Repo (Absorption)* Net Injection Net For the Week Repo/RR Bids Received Bids Accepted Bids Received Bids Accepted (+)/ Outstanding (Nov-Dec 2006) Period Number Amount Number Amount Number Amount Number Amount Daily Average Absorption (-) Amount

    Days of Bids of Liquidity at the Accepted Week End@

    (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13)

    30 Oct - 03 Nov 06 1-3 0 0 0 0 51 24755 51 24755 4951 -24755 8315 06-Nov - 10-Nov-06 1-3 0 0 0 0 74 41730 74 41730 8346 -41730 8960 13 Nov - 17 Nov 06 1-3 0 0 0 0 26 21905 26 21905 4381 -21905 5135 20 Nov - 24 Nov 06 1-3 0 0 0 0 110 84805 110 84805 17368 -84805 15995 27 Nov - 01 Dec 06 1-3 0 0 0 0 117 78420 117 78420 15684 -78420 24530 27 Nov - 01 Dec 06 1-3 0 0 0 0 117 78420 117 78420 15684 -78420 24530 04 Dec - 08 Dec 06 1-3 0 0 0 0 160 140100 160 140100 28020 -140100 18095 11 Dec - 15 Dec 06 1-3 69 20605 69 20605 52 30840 52 30840 6168 -10235 -3090 18 Dec - 22 Dec 06 1-4 172 62575 172 62575 31 3320 31 3320 664 59255 -20280 26 Dec - 29 Dec 06 1-4 256 126395 256 126395 11 2835 11 2835 709 123560 -31685 02 Jan - 05 Jan 07 1-3 66 26660 66 26660 105 42150 105 42150 10538 -15490 5185

    Notes: * With effect from October 31, 2006 the Repo Rate is 7.25 per cent and Reverse Repo Rate at 6.00 per cent.** Includes Second LAF Auctions under Repo and Reverse Repo. @ Net of Repo and Reverse Repo Outstandings.

    Economic and Political Weekly January 20, 2007 on December 22. But, as rupee liquidity holiday-shortened week, banks sold dollars cent on December 26 even as the spot rupee remained pressurised because the banks to raise rupee liquidity, thereby pushing continued to appreciate. Thereafter, it eased had to comply with new CRR norms in a the near term forward premia to 8.62 per to 6.65 per cent on December 29. Unlike

    Appendix Table: Secondary Market Operations in Government Paper – RBI’s SGL Data

    (Amount in rupees, crore)

    Descriptions Week Ending December 2006: Yield to Maturity on Actual Trading Total for the Month
    29 22 15 8 1 of December 2006
    AMT YTM CY AMT YTM CY AMT YTM CY AMT YTM CY AMT YTM CY AMT YTM CY
    1 Treasury Bills A 91-Day Bills B 182-Day Bills C 364-Day Bills 2 GOI Dated Securities 278.53 92.80 324.78 7.34 7.25 7.23 682.72 77.30 745.86 7.08 7.08 7.11 372.90 425.79 292.89 7.00 7.19 6.93 241.74 467.50 1661.66 6.58 6.64 6.82 645.23 69.66 600.20 6.49 6.46 6.69 2221.12 1133.05 3625.39 6.87 6.92 6.90
    A Regular (Per Cent: Year) 11.50, 2007 30.00 7.28 11.16 - - - - - - - - - - - - 30.00 7.28 11.16
    11.90, 2007 550.00 7.27 11.68 30.00 7.24 11.68 1.30 6.70 11.63 300.00 6.91 11.63 201.17 6.95 11.63 1082.47 7.11 11.66
    13.05, 2007 30.00 7.26 12.82 - - - - - - - - - - - - 30.00 7.26 12.82
    11.40, 2008 415.00 7.39 10.74 - - - - - - 0.10 7.50 10.73 0.10 7.48 10.73 415.20 7.39 10.74
    12.00, 2008 225.00 7.25 11.32 120.00 7.17 11.30 - - - 132.13 7.02 11.27 55.00 7.02 11.25 532.13 7.15 11.30
    12.10, 2008 - - - 200.00 7.23 11.33 - - - - - - - - - 200.00 7.23 11.33
    12.25, 2008 30.00 7.42 11.27 - - - - - - 50.00 7.05 11.30 50.00 7.04 11.29 130.00 7.13 11.29
    6.65, 2009 - - - - - - 25.00 7.14 6.72 - - - - - - 25.00 7.14 6.72
    7.07, 2009 5.00 8.15 7.23 - - - - - - 25.00 7.70 7.16 - - - 30.00 7.78 7.18
    7.07, 2009 OMC SB 260.00 8.09 7.22 - - - - - - 35.00 7.69 7.16 - - - 295.00 8.05 7.21
    7.33, 2009 - - - - - - - - - 25.00 7.69 7.39 - - - 25.00 7.69 7.39
    7.33, 2009 Oil Mkt Bonds420.00 8.10 7.44 - - - - - - 25.00 7.66 7.38 - - - 445.00 8.07 7.44
    11.50, 2009 50.00 7.56 10.61 2.20 7.37 10.56 0.20 7.47 10.57 - - - - - - 52.40 7.55 10.61
    7.55, 2010 175.00 7.50 7.54 0.60 7.32 7.50 70.00 7.48 7.53 5.25 7.16 7.46 30.02 7.17 7.46 280.87 7.45 7.53
    11.50, 2010 115.00 7.56 10.29 - - - - - - 25.00 7.23 10.17 - - - 140.00 7.50 10.27
    12.25, 2010 5.00 7.50 10.70 150.00 7.45 10.68 - - - 5.00 7.25 10.61 60.00 7.26 10.61 220.00 7.39 10.66
    12.29, 2010 15.00 7.51 10.88 425.00 7.42 10.85 - - - 80.00 7.24 10.78 - - - 520.00 7.39 10.84
    9.39, 2011 100.00 7.56 8.79 660.06 7.47 8.76 1225.06 7.55 8.78 295.00 7.28 8.69 688.23 7.27 8.68 2968.35 7.44 8.74
    11.50, 2011 - - - 1.00 7.50 9.97 - - - 15.00 7.30 9.89 - - - 16.00 7.31 9.89
    12.32, 2011 - - - - - - 75.00 7.48 10.54 10.00 7.29 10.47 10.00 7.25 10.45 95.00 7.43 10.52
    6.72, 2012 - - - - - - - - - - - - 25.00 6.76 6.73 25.00 6.76 6.73
    6.85, 2012 - - - 1.10 7.52 7.06 - - - - - - 5.00 7.28 6.98 6.10 7.32 6.99
    7.40, 2012 35.00 7.55 7.45 81.80 7.45 7.42 7.87 7.46 7.42 53.74 7.22 7.34 240.50 7.23 7.34 418.91 7.30 7.37
    7.44, 2012 - - - - - - - - - 55.00 7.77 7.55 - - - 55.00 7.77 7.55
    7.44, 2012 OMC SB 25.00 8.03 7.63 65.00 8.00 7.62 55.00 8.02 7.63 130.00 7.80 7.56 220.00 7.77 7.55 495.00 7.85 7.57
    7.27, 2013 - - - - - - - - - 90.00 7.25 7.27 5.00 7.26 7.27 95.00 7.25 7.27
    7.37, 2014 177.38 7.59 7.46 68.33 7.46 7.41 197.50 7.45 7.40 1008.69 7.30 7.34 40.00 7.29 7.34 1491.90 7.36 7.37
    7.38, 2015 - - - 0.97 7.43 7.41 3.00 7.47 7.42 21.00 7.36 7.37 31.25 7.39 7.38 56.22 7.38 7.38
    7.59, 2015 - - - - - - - - - 146.74 7.90 7.74 - - - 146.74 7.90 7.74
    7.59, 2015 OMC SB - - - 50.00 8.06 7.81 25.00 8.04 7.80 231.00 7.90 7.74 30.00 7.89 7.73 336.00 7.93 7.75
    7.61, 2015 - - - - - - - - - 20.00 7.86 7.73 - - - 20.00 7.86 7.73
    7.61, 2015 Oil Mkt Bonds - - - 30.00 8.06 7.82 20.00 8.05 7.82 80.00 7.89 7.74 180.00 7.91 7.75 310.00 7.93 7.76
    9.85, 2015 - - - 2.00 7.48 8.56 - - - 6.00 7.45 8.54 5.00 7.46 8.55 13.00 7.46 8.54
    11.43, 2015 - - - 2.48 7.64 9.24 3.00 7.50 9.17 25.00 7.45 9.14 - - - 30.48 7.47 9.15
    5.59, 2016 - - - - - - - - - 20.50 7.46 6.39 - - - 20.50 7.46 6.39
    7.59, 2016 200.06 7.61 7.60 1095.93 7.59 7.59 1267.67 7.62 7.61 832.89 7.39 7.49 1359.95 7.39 7.49 4756.48 7.51 7.55
    7.46, 2017 3.45 7.65 7.56 8.00 7.66 7.57 - - - 2.75 7.46 7.46 2.95 7.43 7.45 17.15 7.59 7.53
    7.49, 2017 - - - - - - 2.73 7.58 7.54 3.46 7.38 7.43 18.00 7.46 7.47 24.19 7.46 7.47
    8.07, 2017 130.47 7.61 7.82 568.73 7.60 7.81 1149.74 7.65 7.84 736.77 7.39 7.70 1731.84 7.39 7.70 4317.55 7.49 7.76
    6.25, 2018 0.75 7.65 6.97 6.20 7.66 6.97 5.00 7.60 6.94 8.00 7.55 6.92 13.35 7.62 6.95 33.30 7.61 6.95
    12.60, 2018 ON TAP - - - 5.00 7.74 9.17 5.00 7.75 9.18 - - - - - - 10.00 7.75 9.17
    5.64, 2019 0.50 7.68 6.70 2.00 7.61 6.66 - - - 3.50 7.54 6.63 11.00 7.61 6.67 17.00 7.60 6.66
    6.05, 2019 4.34 7.68 6.95 4.64 7.73 6.98 0.25 7.54 6.87 25.00 7.52 6.86 0.52 7.52 6.86 34.75 7.57 6.89
    6.35, 2020 10.50 7.76 7.17 0.60 7.66 7.11 - - - 2.14 7.51 7.02 11.30 7.51 7.02 24.54 7.62 7.09
    10.70, 2020 0.01 7.74 8.61 10.00 7.75 8.61 - - - - - - 10.01 7.61 8.51 20.02 7.68 8.56
    7.75, 2021 - - - - - - - - - 74.00 7.75 7.75 - - - 74.00 7.75 7.75
    7.94, 2021 - - - 31.44 7.67 7.76 30.59 7.76 7.82 35.00 7.52 7.66 79.98 7.51 7.65 177.01 7.59 7.70
    8.13, 2021 OMC SB - - - 0.40 7.90 7.97 4.00 7.91 7.98 37.90 7.87 7.95 168.45 7.89 7.97 210.75 7.89 7.96
    10.25, 2021 5.00 7.69 8.40 - - - - - - 6.19 7.56 8.30 36.03 7.58 8.31 47.22 7.59 8.32
    5.87, 2022 - - - - - - - - - - - - 15.00 7.50 6.90 15.00 7.50 6.90
    8.15, 2022 FCI SB 6.36 7.96 8.02 22.66 7.96 8.02 79.11 7.95 8.01 124.66 7.86 7.94 34.19 7.91 7.98 266.98 7.91 7.98
    6.17, 2023 2.01 7.95 7.36 - - - 2.80 7.60 7.12 17.25 7.63 7.14 7.52 7.69 7.18 29.58 7.66 7.16
    6.01, 2028 6.55 7.61 7.22 19.38 7.70 7.29 10.02 7.75 7.33 5.80 7.65 7.25 11.19 7.59 7.21 52.94 7.67 7.27
    6.13, 2028 3.25 7.72 7.34 2.75 7.74 7.36 2.00 7.73 7.35 1.10 7.61 7.26 3.25 7.61 7.26 12.35 7.69 7.32
    7.95, 2032 - - - 0.50 7.72 7.76 20.07 7.74 7.77 0.50 7.60 7.65 5.23 7.61 7.66 26.30 7.71 7.75
    7.50, 2034 49.05 7.75 7.72 25.50 7.74 7.71 66.47 7.75 7.72 78.37 7.61 7.60 438.46 7.59 7.58 657.85 7.63 7.61
    7.40, 2035 10.00 7.77 7.73 4.00 7.80 7.75 2.25 7.75 7.71 24.24 7.63 7.60 46.30 7.62 7.59 86.79 7.65 7.62
    8.33, 2036 46.62 7.76 7.81 75.00 7.74 7.80 107.42 7.71 7.77 134.71 7.62 7.69 124.32 7.60 7.68 488.06 7.67 7.74
    Sub-total 3146.58 7.59 9.27 3782.07 7.53 8.68 4471.82 7.62 8.04 5078.02 7.42 8.06 6019.18 7.42 7.96 22497.67 7.50 8.30
    B RBI’s OMO: Sales 4.00 - - - - - - - - - - - 39.00 - - 43.00 - -
    Purchase - - - - - - 10.00 - - 5.00 - - - - - 15.00 - -
    Sub-total 4.00 - - 0.00 - - 10.00 - - 5.00 - - 39.00 - - 58.00 - -
    (A+B) 3 Market Repo Govt Securities 3150.58 25436.13 7.59 9.27 3782.07 38007.58 7.53 8.68 4481.82 48322.30 7.62 8.04 5083.02 54333.66 7.42 8.06 6058.18 58936.97 7.42 7.96 22555.67 225036.64 7.50 8.30
    Sub-total 25436.13 38007.58 48322.30 54333.66 58936.97 225036.64
    4 State Govt Securities 171.03 7.72 8.37 376.75 7.68 8.45 183.94 7.56 8.87 407.40 7.59 7.88 326.91 7.60 8.18 1466.03 7.63 8.27
    Grand total (1 to 4) 29453.85 43672.28 54079.64 62194.98 66637.15 256037.90

    (-) means no trading. YTM = Yield to maturity in percentage per annum. CY = Current yield in per cent per annum. SGL = (RBI’s) Subsidiary General Ledger. OMO = Open Market Operations. OMC SB: Oil Marketing Companies Special Bonds. Securities with small-size transactions (Rs 5 crore or less) have been dropped from the above list but included in the respective totals. Notes: (1) Yields are weighted yields, weighted by the amounts of each transaction. (2) Current yield has not been worked out for treasury bills. (3) For Floating Rate Bonds (FRB’s) Current yields are based on the latest half-year yield determined in the auction.

    Economic and Political Weekly January 20, 2007 the volatility in the one-month tenure, the other three-month and six-month tenures remained relatively stable (Graph C).

    Primary Market

    Dated Securities

    In December, the government deviated from the indicative calendar for issuances in terms of notified amounts; while it was scheduled to auction a 5-9 year security for a notified amount of Rs 6,000 crore and a 20-year and above security for Rs 3,000 crore, it issued instead a eight-year security,

  • 7.37 per cent 2014, and a 30-year security,
  • 8.33 per cent 2036, for notified amounts of Rs 5,000 crore and Rs 4,000 crore respectively; both were reissued through price-based auctions using a multiple price method on December 8. The eight-year and 30-year papers were earlier auctioned in June 2006 at coupon rates of 7.92 per cent and 8.33 per cent respectively; these are to be contrasted with the offering of much lower rates in the current issues at 7.31 per cent and 7.63 per cent, respectively (Table 4).
  • Eight state governments offered to sell 10-year state development loans on December 14 for an aggregate amount of Rs 1,963.236 crore through a yield-based auction using the multiple price auction method, with the exception of Tamil Nadu which had an option to retain additional subscription of a maximum of Rs 100 crore over and above the notified amount of Rs 400 crore. The yields offered were higher at a range of 7.81-7.99 per cent as against 7.74-7.82 per cent in November, though Nagaland offered a marginally lower rate of 7.81 per cent instead of 7.82 per cent.

    Treasury Bills

    The pressure on liquidity manifested itself in an unusual firmness in yields as well as unwinding of MSS borrowings in case of 91-day and 182-day treasury bills. The yield on 91-day treasury bills rose from

    6.65 per cent on December 6 to touch a high of 7.10 per cent on December 13; it ruled steady at it on December 20 and then peaked again at 7.19 per cent on December 27 (Table 5). Similarly, the yield on 182-day TBs surged from 6.89 per cent on December 1 to 7.25 per cent on December 13 and further to 7.30 per cent on December 27 (Table 6). The increase in yield rate for 364-day TB was relatively smaller; it was from 6.94 per cent on December 6 to 7.24 per cent on December 20 (Table 7) and as a result, the spread in yields between 364-day and 91-day bills, which had declined from 63 basis points in June to 29 basis points in October and which fractionally rose to 33 basis points in November, fell rather sharply to 8 basis points in December.

    Corporate Bonds Market

    Given the upheaval in the government securities market, the primary issuance of corporate debt securities turned subdued with mobilisations dipping to Rs 3,565 crore in December as against Rs 9,602 crore in November and Rs 4,809 crore in December 2005. The finance ministry allowed the Rural Electrification Corporation (REC) to issue capital gains tax exemption bonds for Rs 3,500 crore, over and above Rs 4,500 crore permitted in June which were fully subscribed in August itself, the increase was following investors’ demand for raising the limit of these bonds. Investments in such bonds would allow an investor to claim tax benefits under Section 54EC of the Income Tax Act. This provision allows tax exemption on the capital gains arising from the transfer of a long-term asset so long as such gains are invested in notified bonds.

    Among the banks/FIs, IDBI mobilised Rs 350 crore by offering 8.85 per cent for 10 years while, in October 2006, for the same maturity it had to offer 8.95 per cent; earlier in January 2006 it had offered only

    7.70 per cent. Similarly, REC tapped the market in January 2006 by offering 7.65 per cent for 10 years while in December it offered 8.85 per cent (Table 8).

    IV Secondary Market

    As against the buoyancy in the secondary market gilt-edged turnover in November, the weekly turnover in December dwindled from Rs 31,543 crore in the week ending December 8 to Rs 7,046 crore in the week ending December 29 due to strained liquidity scenario. Though the yields increased across maturities leading to a shift in the yield curve, yields generally remained range-bound and the yield curve turned flatter with the short-end experiencing sharp increases in yields exceeding those on medium- and long-end. Though the RBI expressed concerns about the overheating of the economy and surging inflation rate, the yield curve movements remained stubborn.

    The spread between 11.90 per cent 2007 and 7.59 per cent 2016 narrowed from 44 basis points in week ended December 1 to 36 basis points on December 22 and further to 35 basis points on December 29, while the spread between above 10-year paper and 7.40 per cent 2035 narrowed from 23 basis points to 16 basis points (Graph D) (see also Appendix Table).

    RBI Reverse Repos, OMOs and MSS

    The pressure exerted on the liquidity overhang in the system due to advance tax outflows and CRR outflows manifested itself in the repo amounts exceeding reverse repo amounts for the month and yet the call rates continuing to rule above the repo-reverse repo corridor for most part of the month. In the first week ending December 8, the reverse repo bids worth Rs1,40,100 crore were accepted given the improved liquidity scenario. In the next week, RBI injected Rs 20,605 crore while absorbing Rs 30,840 crore. In the week ended December 22, the RBI injected a whopping Rs 62,575 crore while absorbing only Rs 3,320 crore as the market grappled with advance tax outflows. In the last week, the RBI injected a record of Rs 1,26,395 crore while absorbing Rs 2,835 crore. During the month as a whole, the RBI injected a massive amount of liquidity of Rs 2,09,575 crore at 7.25 per cent and absorbed Rs 2,01,625 crore (Table 9).

    Following the subdued secondary market for gilt-edged securities, the repo transactions outside RBI fell to Rs 2,25,036 crore from Rs 2,52,658 crore in November and the interest rates were in the range of 5-18.05 per cent as against 5-8.50 per cent (Table 10). The borrowings under market stabilisation scheme declined from Rs 46,112 crore in December 2005 to Rs 37,314 crore with a year-on-year variation of (-)Rs 8,798 crore.

    Commercial Bonds

    Given the interest rate uncertainty, the daily average secondary market turnover for corporate debt fell from Rs 54 crore in November to Rs 40 crore in December. Interestingly, the turnover in floating rate bonds declined sharply from Rs 335 crore to Rs 35 crore.

    EPW

    [The note has been contributed by PiyushaHukeri, who has prepared the initial draft andV P Prasanth who has compiled the requiredtabular data.]

    Economic and Political Weekly January 20, 2007

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