Emerging Fiscal Risks

MONEY MARKET REVIEW

levels. Since in counteracting inﬂation, it

Emerging Fiscal Risks

will be too risky to have an accommodative stance on both the monetary and ﬁscal sides, the central bank’s continued aggres-EPW Research Foundation sive policy actions may be viewed as a pre-

A review of ﬁscal developments during the current ﬁnancial year, an assessment of the possibility of failure to achieve the ﬁscal deﬁcit target, and, in case of a slippage, an examination of its implications for interest rates in the latter half of the ﬁnancial year.

1 Introduction

n its mid-quarter Monetary Policy Review of September, the Reserve Bank of India (RBI) has continued with its strong anti-inﬂationary stance. Apparently differing with the government’s signal for a pause, it raised the key policy repo rate by another 25 basis points (bps) to 8.25%. As policy guidance, the RBI said it is imperative to persist with the current antiinﬂationary stance. Given the unrelenting pressure of headline wholesale price inﬂation, it will not be surprising if another round of policy rate hike follows in its forthcoming second quarter review due on 25 October 2011. From early this year, monetary policy statements have been highlighting the underlying downside risks to ﬁscal projections. Even after adjusting for the one-time windfall revenue of the previous year from the spectrum auctions, the build-up of the ﬁscal deﬁcit till August has generated mounting concerns among analysts about the possibility of ﬁscal slippage in the latter half of 2011-12. While some moderation in revenue receipts is expected due to a slowdown in industrial activity, there are fears about intense pressures coming from non-plan revenue expenditure, due mainly to higher petroleum and fertiliser subsidies. The RBI has been quick to point to these suppressed elements while reviewing current inﬂation

ventive and anticipatory action to minimise increasing ﬁscal risks to inﬂation.

In the above backdrop, an attempt is made to review ﬁscal developments thus far during the current ﬁscal, assess the risks to achieving the ﬁscal deﬁcit target and, in case of a slippage, gauge its implications for the outlook on interest rates in the latter half of this ﬁnancial year.

1.1 Fiscal Developments

Fiscal consolidation was in progress in right earnest till 2007-08 when the ﬁscal deﬁcit of the central government came down to as low as 2.7% of gross domestic product (GDP) and the revenue deﬁcit to 1.1% of GDP. The impact or rather the perceived potential impact of the global ﬁnancial turmoil on domestic economic activity made both the government and the RBI pursue highly accommodative ﬁscal and monetary policies which led to relaxation of ﬁscal rules during the next two years when the ﬁscal deﬁcit touched 6% of GDP in 2008-09 against the budgeted 2.5%, and further went up to as high as 6.4% in 2009-10.

In 2010-11, the government managed to contain the ﬁscal deﬁcit to 4.7% against the budgeted 5.5%, thanks largely to surplus balances accumulated due to windfall revenues from the spectrum auctions. Over this period, there was considerable inﬂationary build-up following rising food prices and beginning late 2010, the RBI

Table 1: Fiscal Deficit, Revenue Deficit, State-Level Deficit and Combined Deficit (Rs crore)

2007-08 2008-09 @ 2009-10 @ 2010-11 @ 2011-12 BE Actual BE Actual BE Actual BE Actual BE Actual

Fiscal Deficit 1,50,948 52,569 1,33,287 3,36,992 4,00,996 4,18,482 3,81,408 3,69,043 4,12,817

(3.3) (1.1) (2.5) (6.0) (6.8) (6.4) (5.5) (4.7) (4.6)

Revenue Deficit 71,478 1,26,912 55,184 2,53,539 2,82,735 3,38,998 2,76,512 2,44,853 3,07,270

(1.5) (2.7) (1.0) (4.5) (4.8) (5.2) (4.0) (3.1) (3.4)

State Level Deficits 2007-08 2008-09 @ 2009-10 @ 2010-11

Gross Fiscal Deficit 75,455 1,34,589 2,16,101 1,98,539

(1.51) (2.41) (3.30) (2.52)

Revenue Deficit -42,943 -12,672 46,663 24,370

(0.86) (0.23) (0.71) (0.31)

Conventional Deficit -13,410 -8,959 35,889 18,687

Team led by K Kanagasabapathy and supported

(0.27) (0.16) (0.55) (0.24)

by Anita B Shetty, Vishakha G Tilak,

Primary Deficit -24,376 31,634 1,00,197 69,883

V P Prasanth, Rema K Nair, Shruti J Pandey,

(0.49) (0.57) (1.53) (0.89) Deepa Vaidya, R Krishnaswamy and @ actuals for 2008-09, 2009-10 and 2010-11 are provisional. Gross fiscal deficit for 2009-10 is revised. BE: Budget Estimates.

Sharan P Shetty. Figures in brackets are as a percentage of GDP at market prices. Source: www.cga.nic.in, www.indiabudget.nic.in

Economic & Political Weekly

SEPTEMBER 24, 2011 vol xlvi no 39

MONEY MARKET REVIEW

exited from accommodative policies and started tightening the policy stance which still continues. During the current ﬁnancial year, the government has also initiated ﬁscal reconsolidation efforts and has budgeted for a ﬁscal deﬁcit of only 4.6% (Table 1, p 73).

Though the government continues to maintain a brave face and promises to keep the ﬁscal deﬁcit target and hence the borrowing programme unchanged, trends in the ﬁscal situation beginning this ﬁscal have raised serious doubts about sustaining the budgeted levels of deﬁcit and borrowings.

The ﬁscal deﬁcit for April-July this year at Rs 2.29 lakh crore is as high as 55.4% of the budgeted amount, while the same level was achieved last ﬁscal only by January 2011. As at end July 2010, the ﬁscal deﬁcit was only 23.8% of the budgeted amount.

The trends in tax and non-tax receipts of the government show that containing the ﬁscal deﬁcit within the targeted levels would be extremely difﬁcult. The revenue receipts as at end July was only 17% of targeted levels against 35% achieved last year. In particular, non-tax revenue was only 18.4% of the targeted level against

Table 2: Progressive Month-wise Position of Fiscal Deficit and Revenue Receipts

85% achieved last year, mainly as a result of the absence of any windfall revenues this year. Given the continued slump in the stock market, prospects of realising disinvestment receipts of Rs 40,000 is also in serious doubt (Table 2).

Among the taxes, receipts from corporate and income tax showed some deceleration. The April-July corporate tax revenues this year was only 11.9% of budgeted amount compared to 17.3% in the previous year and similar ﬁgures for income tax were 20.7% and 27.4%. Receipts from customs and excise duties however matched the performance of last year at about 33% and

Month Fiscal Deficit % of Actual Primary Deficit % of Actual Revenue Receipt % of Actual Non-tax Revenue % of Actual 23%, respectively. Service tax collection (Rs Crore) to Budget (Rs Crore) to Budget (Rs Crore) to Budget (Rs Crore) to Budget

was slightly higher at 27% against 24%

Apr 2010 53,993 14.2 39,859 30.0 12,979 1.9 2,917 2.0

last year, but its contribution to total reve-

Apr-May 2010 1,00,907 26.5 70,185 52.9 44,659 6.5 12,761 8.6

nue is not that signiﬁcant (Table 3).

Apr-June 2010 40,196 10.5 -27 0.0 1,99,810 29.0 1,15,816 78.2

Apr-July 2010 90,915 23.8 32,539 24.5 2,38,524 35.0 1,25,703 84.9 On the expenditure side, the progressive

Apr 2011 74,661 18.1 59,583 41.1 6,880 0.9 3,106 2.5

Apr-May 2011 1,30,726 31.7 94,306 65.1 28,716 3.6 5,613 4.5

Apr-Jun 2011 1,62,653 39.4 1,12,466 77.7 90,920 12.0 12,221 9.7

Apr-Jul 2011 2,28,753 55.4 1,61,212 111.0 1,37,155 17.0 23,077 18.4

(i) Non-tax revenue includes interest receipt and dividend and profit. (ii) Other non-tax revenue includes other general services (net) and economic services (net). Source: www.cga.nic.in

Table 3: Month-wise Cumulative Position – Major Receipts

Corporate As % Income As % Customs As % Excise As % Service As % Tax to BE Tax to BE Duty to BE to BE to BE

level was comparable to that of last year. It is however widely believed that the reduced budget for subsidies at Rs 1.44 lakh crore against the budgeted amount of Rs 1.64 crore last year is under-provided and may be breached, in particular, in respect of petroleum and fertiliser subsidies.

Budget Estimates 3,01,331 1,20,566 1,15,000 1,32,000 68,000 1.2 Fiscal Risks

April 2010 4,085 1.36 10,277 8.52 8,681.0 7.55 -323 0.24 2,133 3.14

One major risk arising from slippage of the

April-May 10,386 3.45 17,667 14.65 18,395.0 16.00 8,515 6.45 6,067 8.92

ﬁscal target would be the burden that may

April-June 44,753 14.85 24,402 20.24 28,487 24.77 19,440 14.73 10,424 15.33

result from a higher level of borrowing on

April-July 52,180 17.32 33,049 27.41 38,839 33.77 29,972 22.71 16,563 24.36 3,59,990 1,72,026 1,51,700 1,64,116 82,000

the ﬁnancial markets. A joint panel of the

April 2011 -3,510 -0.98 11,024 6.41 11,976 7.89 452 0.28 2,553 3.11 ﬁnance ministry and the RBI will meet on

April-May -3,086 -0.86 18,031 10.48 25,938 17.10 11,343 6.91 7,884 9.61 3 October to decide on the borrowing Apri.-June 32,298 8.97 24,877 14.46 39,227 25.86 23,946 14.59 13,667 16.67

calendar for the second half of the current

Apri.-July 42,899 11.92 35,628 20.71 50,767 33.47 36,262 22.10 22,100 26.95

ﬁscal. Most market participants expect the

BE - Budget Estimates

Source: www.cga.nic.in government to raise its market borrowing Table 4: Monthly Primary Market Yields of Treasury Bills and 5 and 10 year G-sec (Yield in %)

Date of Auction 91-Day Treasury Bills 182-Day Treasury Bills 364-Day Treasury Bills 5-year G-sec 10-year G-sec SDLs Bid Cover Ratio Cut-off Yield Bid Cover Ratio Cut-off Yield Bid Cover Ratio Cut-off Yield Bid Cover Ratio Cut-off Yield Bid Cover Ratio Cut-off Yield Bid Cover Ratio Cut-off Yield

Apr 2010 3.10 4.14 3.31 4.64 3.37 5.07 2.37 7.57 3.80 7.80 2.82 8.56

May 2010 2.54 4.39 2.82 4.76 4.10 4.92 2.60 7.33 2.24 7.57 2.76

June 2010 3.61 5.29 3.52 5.31 2.91 5.49 2.49 7.30 1.99 7.57 3.01

July 2010 3.61 5.56 2.44 5.86 4.26 5.99 2.46 7.52 1.90 7.73 2.34

Aug 2010 2.14 6.15 2.22 6.41 2.91 6.48 1.88 7.73 2.02 7.96 3.13 8.36

Sept 2010 3.11 6.14 2.84 6.46 3.07 6.59 2.55 7.69 2.28 7.86 3.45 8.39

Dec 2010 2.57 7.13 3.80 7.32 4.27 7.37 2.29 7.87 2.98

Jan 2011 2.96 7.17 2.95 7.37 3.76 7.55 1.98 8.11 1.71 8.19 2.37 8.49

Feb 2011 3.07 7.15 3.47 7.51 2.76 7.68 3.25 8.17 2.11

Mar 2011 2.14 7.23 4.28 7.49 3.71 7.61 2.38

Apr 2011 2.51 7.36 2.95 7.63 3.25 7.67 1.39 8.21 2.56 7.94 2.98 8.40

May 2011 2.30 8.05 2.58 8.25 2.74 8.25 2.16 8.45 1.85 8.36 3.02 8.65

June 2011 2.78 8.21 3.65 8.19 2.74 8.32 2.10 8.37 2.24 8.25 2.54 8.58

SEPTEMBER 24, 2011 vol xlvi no 39

Economic & Political Weekly

MONEY MARKET REVIEW

Graph A: Trend in Yield and Spread Government Securities (%) Secondly, it is observed over 1-year maturity narrowed to almost

8.3 8.3 8.3 8.3 8.3 that the central govern-zero in September from 3.68 percentage

10 Year G-Sec

ment issued a huge amount points early this year (Graph A).

of cash management bills The moderate shift in longer maturity

(CMBs) during the current yields is partly attributable to improvement ﬁscal to tide over the mis-in liquidity conditions over the period.

match between receipts and The government’s cash balances, which

payments. A gross amount were absorbing huge liquidity from the

of a whopping Rs 84,000 system early this year, have slowly been

crore of CMBs were issued released into the system with government till 8 August. The response expenditure growing faster than revenues

4.0

Spread of 1 Year and 10 Year G-Sec (%)

to these issuances has become weak of late and the yield rates have substantially increased in tandem with TB rates. The government’s intention is perhaps to tide over the situation without causing beginning April. Secondly, deposit growth gradually caught up with credit growth and the gap between the two has narrowed. Beginning October, liquidity is expected to tighten partly because of the pressure from seasonal credit demand rising and partly because of the additional borrowing programme of the central government. Given the current inﬂationary pressure, the monetary policy stance is likely to be strongly anti-inﬂationary and with any further policy rate hikes, the longer maturity yields are expected to become more sensitive than what hitherto has been the case.

Though the policy rate may see its peak within the next three to six months, there are surely mounting concerns about the possibility of a ﬁscal slippage in the second half of this year. If the borrowing programme of the government signiﬁcantly increases on that count, the medium to long-term government securities yields may witness hardening in the range of 30 to 50 bps and may test the level of 9%. The bonds market rate also will see parallel shifts. Banks may also consider raising deposit rates in order to meet growing credit needs.

Table 6: RBI’s Market Operations (Rs crore)

Month/Year	OMO	LAF (Average Daily
	(Net Purchase(+)/Sale(-))	Injection (+)/Absorption(-))
Apr-2011	16	4,264
May-2011	1	53,666
Jun-2011	981	72,204
Jul-2011	-6	37,683
Aug-2011	-6	36,948

Source: RBI’s Weekly Statistical Supplement.

by Rs 30,000 crore and up to Rs 70,000 crore, depending upon the extent of slippage in other non-debt sources of funds. It is expected that the ﬁscal deﬁcit would turn out to be at least 5.2%, which would imply a slippage of the order of about 0.6 percentage points in the target for the ﬁscal deﬁcit to GDP ratio. In that case, the EPWRF estimates show that it would result in an increase in the borrowing programme by more than Rs 50,000 crore to Rs 4.67 lakh crore.

Out of a gross borrowing target of Rs 4.17 lakh crore for the current ﬁscal, the government has completed its targeted borrowing for the ﬁrst half amounting to Rs 2.5 lakh crore. This translates into 60% of the targeted borrowings.

The annual report of the RBI, released in late August 2011, raised concerns about managing the borrowing of the government even at the present targeted levels. The report said that the conduct of the market borrowing programme will be inﬂuenced by the ability of the government to rein in the ﬁscal deﬁcit and its ﬁnancing by way of market borrowings. The government could face difﬁculties in managing its borrowing programme for the current ﬁscal amid the prevailing tight any serious dent on compliance to the ﬁscal deﬁcit target for the year. The success of this strategy would very much depend upon the progressive revenues from tax and non-tax sources and containment of expenditure within targeted levels. In both ways, as shown earlier, the current trend points towards difﬁculties in the later part of the year. Hence, the ﬁscal gap met out of CMBs may turn out to be of a structural character and not purely frictional and this would translate into enlarged medium to long-term borrowings of the government.

1.3 Outlook for Interest Rates

It has been generally observed that the shift in yields of government securities reﬂects a steep increase in policy rates at the shorter end and a tapering off for elongated maturities. The increase in policy rates since early 2011 has thus caused a shift in the yield of 1-year maturity by 426 bps from 4.03% to 8.29%, whereas the shift in 5-year maturity was by 131 bps from 7.20% to 8.33% and that of 10-year maturity was only by 60 bps from 7.71% to 8.31%. As a result, the spread of 10-year

Table 5: Money Market Activity (Volume and Rates)

liquidity conditions as banks hold a higher proportion of government securities. Progress in the conduct of auctions of treasury bills (TBs) and dated government securities conﬁrms this proposition. The	Instruments Call Money Notice Money Term Money @	Daily Average Volume (Rs Crore) 8,381 2,649 209	August 2011 Monthly Weighted Average Rate (%) 7.97 7.96 -	Range of Weighted Average Daily Rate (%) 7.02-8.00 6.70-8.02 7.00-10.15	Daily Average Volume (Rs Crore) 11,040 3,031 221	July 2011 Monthly Weighted Average Rate (%) 7.60 7.69 -	Range of Weighted Average Daily Rate (%) 6.47-8.02 5.35-7.95 6.30-10.00
auctions seem to have received a lower	CBLO	38,634	7.86	5.77-8.00	44,173	7.33	1.45-7.98
response in terms of bid cover with yield rates ﬁrming up over months (Table 4, p 74).	Market Repo 14,450 7.94 @: Range of rates during the month. Source: www.rbi.org.in. and www.ccilindia.com	5.00-8.04	12,238	7.52	1.50-8.01

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MONEY MARKET REVIEW

2 Money, Forex and Debt Markets

Money market rates continued to stay in the upper range of the corridor though the liquidity situation seemed under control as in the previous month. Bank credit continued to expand and caused Rs 40,000 crore outﬂows but aggregate deposits augmented inﬂows of Rs 28,000 crore. The government’s aggressive market borrowing absorbed funds of around Rs 44,000 crore, while net variation in foreign currency assets added to Rs 54,000 crore in August supporting liquidity in the system.

2.1 Money Market

Mixed market expectations about another policy rate hike by the RBI on the back of rising inﬂation, in addition to the huge market borrowing, kept the short-term money market rates ﬁrm during August. The month experienced some relief on the liquidity front but pressure of demand from the borrowing banks kept the short-term

Table 7: Foreign Exchange Market: Select Indicators

Month	Rs/$ Reference	Appreciation (+)/	FII Flows	BSE Sensex	Dollar Index
	Rate (Last Friday	Depreciation (-)	(Equity +Debt)	(Month-end	(Average)#
	of the Month)	of Rs/$ (in %)	in $ Million	Closing)
Apr-2011	44.38	0.61	1616	19,136	69.75

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

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

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

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

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

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

Month Merchant Interbank Spot Forward Total

Apr-2011 14.1 (10.8) 40.1 (14.7) 27.7 (20.1) 26.5 (7.6) 54.2 (13.6)

May-2011 13.5(-16.7) 48.3 (-6.3) 28.9 (-9.7) 33.0 (-8.0) 61.9 (-8.8) Jun-2011 12.7 (-5.8) 48.1 (-0.5) 27.4 (-5.2) 33.4 (1.47) 60.8 (-1.7)

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

*: Includes trading in FCY/ INR and FCY/FCY. Figures in brackets are percentage change over the previous month. Source: RBI’s Weekly Statistical Supplement, various issues.

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

rates in the upper bound across the segments throughout the period.

The overnight rates displayed a rising trend from the beginning of the month increasing the weighted average call rate by 37 bps to 7.97% during the period of one month. The notice money rates also moved in tandem, increasing by 28 bps. The collateralised instruments, such as CBLO and market repo rates also witnessed a steady upward trend and increased by 52 bps to 7.96% and 41 bps to 7.94% respectively during the same period.

Compared to the previous month, the money market segment witnessed less volatility in rates. Thus, trading activity in all the segments except market repo collectively recorded a 15% fall over the month. The overnight segment reported the highest drop of 24% in its turnover followed by notice money and the collateralised borrowing and lending obligations (CBLO) market showing a 13% fall each. However, the market repo registered an 18% increase in

traded volume during the review period. In terms of total transactions, the market continued to be dominated by the collateralised segment (Table 5, p 75).

The short-term certiﬁcates of deposit (CDs) market has seen a spike in coupons with banks preferring to borrow for the near term predicting a likely softening of rates in the medium term. As there is not too much pressure on banks to mobilise resources owing to relatively lower credit demand compared to deposits growth, banks preferred to stay away from longer term CDs. As per the latest available data from the RBI, the outstanding amount of CDs registered a gradual fall by Rs 8,900 crore in a period of one month but over the fortnight it increased by Rs 6,200 crore and amounted to Rs 4,12,000 crore as on 29 July. The volume of outstanding commercial papers (CPs) issued by scheduled commercial banks expanded by Rs 29,000 crore in one month to Rs 1,34,000 crore as on 31 July while, in a period of 15 days, it improved by Rs 5,300 crore. However, the discount rates continued to remain in the upper bound. According to Fixed Income Money Market and Derivatives Association (FIMMDA), the CDs recorded a notable 20% rise while CPs recorded a marginal 1% increase in their daily trading activity during August compared with July.

With the demand for credit moderating, the RBI’s Liquidity Adjustment Facility (LAF) window exhibited some moderation in net injection of funds into the system. The repo tendered amount averaged to Rs 37,700 crore for August, somewhat lower than Rs 38,300 crore of the previous month. In addition, the reverse repo window also revealed banks starting to park their funds though to a smaller extent. The liquidity condition was somewhat tight in the beginning of the month but returned to a normalcy, since on 5 August banks borrowed just Rs 16,120 crore in the repo window. However, the situation again got tightened on the reporting Friday and the injection of funds by RBI peaked to Rs 57,445 crore on 12 August. Overall, the liquidity situation in August appeared normal but

Date of Auction Nomenclature of Loan Notified Amount Bid-Cover Ratio Devolvement on YTM at Cut-off Cutt-off Price the burden of cash crunch in the system Primary Dealers Price (in %) (In Rupees)

may again show up in the month of Sep

05-Aug-11 8.07% 2017 R 4,000 2.29 nil 8.3 99

tember following Q advance tax pay

8.13% 2022 R 5,000 2.78 nil 8.39 98.12 2

8.28% 2027 R 3,000 2.88 nil 8.6 97.21 ments. RBI’s OMO window hardly reported

12-Aug-11	7.83% 2018	R	3,000	1.91	nil	8.29	97.67	any activity (Table 6, p 75).
	7.80% 2021	R	6,000	1.77	nil	8.28	96.85	The trading activity in the two months
	8.30% 2040	R	3,000	2.29	nil	8.59	96.52	old 91-day treasury bills interest rate
18-Aug-11	8.07% 2017	R	4,000	1.67	nil	8.29	99.04	futures (IRFs) in NSE remained subdued and
	8.08% 2022	R	4,000	2.56	nil	8.41	97.68
	8.28% 2032	R	3,000	2.42	nil	8.6	96.95	the daily average turnover fell to Rs 16
26-Aug-11	7.83% 2018	R	3,000	1.82	nil	8.34	97.41	crore in August as against Rs 181 crore
	7.80% 2021	R	6,000	2.03	nil	8.3	96.7	recorded in July.
	8.28% 2027	R	2,000	2.92	nil	8.58	97.36
Total for August 2011		46,000	2.23		8.39	97.54	2.2 Forex Market
Total for July 2011		48,000	2.22		8.46	95.74	Forex markets also reﬂected worries resur-
R: Reissue. Source: RBI press releases.							facing across the world in the backdrop of
76					SEPTEMBER 24, 2011	vol xlvi no 39		Economic & Political Weekly

MONEY MARKET REVIEW

economic stagnation in the US, and Standard & Poor’s decision to downgrade US sovereign debt. After remaining lacklustre for the past several months, the US dollar exhibited a revival in its value in the beginning of August, as increased world economic concerns and a fresh slide in global stocks boosted the safe-haven demand for the dollar. The US dollar advanced against most of the commodity-linked currencies also as worries over global growth pushed investors towards dollar liquidity. However, the US dollar came under pressure in the latter part of the month as a survey stoked fears that the US economy was heading towards recession and raised speculation of a fresh round of quantitative easing from the Federal Reserve. On the other hand, the euro surged against the dollar as European Central Bank’s (ECB) intervention to tame the sovereign debt crisis supported the currency.

However, worries over contagion from the eurozone debt crisis rattled investors, and combined with fears over global growth, drove a deep sell-off in risky assets from equities to commodities and boosted the safe haven demand for the Japanese yen and the Swiss franc. In an effort to control the yen and the Swiss franc, both Japan and Switzerland intervened in their respective currency markets. The continued campaign of the Swiss National Bank to weaken its currency resulted in the Swiss franc posting 1% depreciation against the dollar in August. Despite intervention, the Japanese yen still ended with a 1.3% appreciation vis-à-vis the dollar. In general, Asian currencies depreciated substantially against the dollar during August. The mixed behaviour of the dollar against global currencies resulted in the marginal increase in US dollar index during the month. The US dollar index [Nominal Major Currencies Dollar Index (March 1973=100)] increased by 32 bps in August over July.

In the domestic market, the Indian rupee continued its slide against the US dollar, as worries over contagion from the euro area debt crisis combined with fears over global growth rattled investors and equities global currencies. The rupee slipped to the level of 46 against the US dollar and depreciated by 4% in August, struck by a huge sell-off in the local share market with the BSE Sensex losing 1,500 points in one month coupled with a massive outﬂow of foreign funds to the tune of Rs 7,900 crore following discouraging growth prospects. A huge demand for dollars from oil importers and the expectation of likely peaking of domestic interest rates also fuelled negative sentiment on the rupee (Table 7, p 76).

The local currency began the month at Rs 44.05 per dollar with a marginal gain of 11 paise; thereafter, it depreciated, particularly after S&P’s downgrade of the US credit rating on 5 August to end at Rs 45.37 per dollar on 12 August. Weak global and domestic equities, sustained demand for dollars from oil importers, signiﬁcant capital outﬂows, a slowdown in the global economy and weak Asian currencies also

touched record lows world-Table 11: Yield Spreads (Weighted Average) – Central Government Securities

(August 2011)

wide. An intense bout of vola-

Yield August 2011 Previous Three Six Months tility in the currency markets Spread in bps Last Week First Week Entire Month Month Months Ago Ago

1 Year - 5 Year 7 4 -2 24 32 62

put tremendous pressure on

5 Year - 10 Year -1 4 3 0 -15 4

the Indian rupee and the

10 Year - 15 Year ----7 42 22

domestic currency remained

1 Year - 10 Year 6 8 1 24 17 66 weak against most of the Source: As in Table 10.

Table 10: Secondary Market Outright Trades in Government Papers – NDS and NDS-OM Deals (Amount in Rs crore)
Descriptions		August 2011		Previous Month	Three Months Ago	Six Months Ago
	Last Week (26)	First Week (5)	Total for the Month	(July 2011)	(May 2011)	(February 2011)
	AMT	YTM	AMT	YTM	AMT	YTM	AMT	YTM	AMT	YTM	AMT	YTM
1 Treasury Bills	3,591		4,534		15,476		43,075		19,135		12,827
A 91-Day Bills	2,803	8.23	2,707	8.25	10,429	8.17	33,678	8.04	11,929	7.89	8,911	6.93
B 182-Day Bills	371	8.27	1,047	8.39	2,514	8.32	3,730	8.16	2,245	7.95	1,599	7.30
C 364-Day Bills	417	8.27	780	8.38	2,533	8.28	5,667	8.24	4,962	8.14	2,317	7.47
2 GOI Dated Securities	75,894	8.28	65,079	8.42	2,87,935	8.31	2,36,766	8.36	1,27,796	8.36	1,33,542	8.17
Year of	(No of
Maturity	Securities)
2011	(2)	20	8.55			21	8.58	317	9.08	315	7.96	737	7.40
2012	(5)	63	8.19	513	8.32	783	8.27	923	8.08	1,105	8.11	1,396	7.54
2013	(4)	301	8.21	85	8.31	490	8.23	210	8.16	295	8.19	800	7.73
2014	(8)	150	8.13	15	8.31	212	8.15	122	8.21	311	8.25	376	7.90
2015	(5)	145	8.20	91	8.38	456	8.22	826	8.33	1,650	8.37	13,870	8.10
2016	(5)	762	8.26	189	8.36	3623	8.25	2,968	8.32	4,106	8.43	129	8.16
2017	(3)	548	8.28	607	8.38	2535	8.29	2,649	8.34	405	8.38	12,635	8.12
2018	(3)	5,139	8.28	4,713	8.41	18,507	8.30	12,173	8.34	8,988	8.42	30	8.19
2019	(1)	0	7.58			0	8.07	101	8.45	0	8.18	70	8.20
2020	(3)	170	8.87	440	8.79	1,920	8.87	1,136	8.81	1,870	7.87	4,827	8.11
2021	(2)	49,755	8.25	42,937	8.40	1,85,767	8.28	1,54,392	8.32	49,678	8.28	18	8.20
2022	(3)	17,519	8.35	13,662	8.47	66,939	8.37	53,783	8.41	55,138	8.43	89,712	8.17
2027	(3)	424	8.56	1,181	8.63	4,271	8.56	3,777	8.63	2,740	8.61	7,183	8.51
2028	(1)	2	8.13			4	8.38	25	8.77			5	8.55
2032	(2)	790	8.58	0	8.65	1,120	8.58	1,411	8.58	333	8.61	53	8.50
2034	(1)	3	8.39			3	8.39	1	8.56	7	8.40	2	8.50
2040	(1)	105	8.57	646	8.70	1,284	8.64	1,947	8.61	833	8.60	1,600	8.57
3 State Govt Securities	709	8.57	236	8.65	2,328	8.57	3,960	8.59	2,708	8.58	3,177	8.47
Grand total (1 to 3)	80,194		69,849		3,05,738		2,83,801		1,49,639		1,49,545
(-) means no trading	YTM = Yield to maturity in per cent per annum	NDS = Negotiated Dealing System	OM = Order Matching Segment
1) Yields are weighted yields, weighted by the amounts of each transaction.	2) Trades were negligible in maturities of 2023 to 2026 and 2035 and 2039 in the recent period.
Source: Compiled by EPWRF; base data from RBI, CCIL.
Economic & Political Weekly		SEPTEMBER 24, 2011	vol xlvi no 39	77

MONEY MARKET REVIEW

put great pressure on the rupee and the currency lost around 3% during this period. Still, the rupee recovered some of the losses it incurred in the past nine trading days on 16 August, buoyed by a revival in capital inﬂows. However, the upturn was not sustained and yet again, the rupee lost 70 paise against the dollar in just three days, and even threatened to cross the psychological 46-mark on 22 August. Yet again the rupee managed to rebound on 23 August and appreciated by 0.6% against the dollar tracking gains in the euro, positive local shares and decent dollar inﬂows. After that, the performance of the local currency remained mixed which ended at Rs 46.02 per dollar on 30 August. The pick-up in foreign direct investment helped a bit but a bunch of negative global and local macro indicators continued to underpin market sentiments. Out of 20 trading days during August, only on 5 occasions the rupee advanced against the dollar. Overall, the rupee depreciated by a signiﬁcant 4.12% against the greenback.

There was a sharp increase in spot dollar demand on concerns of a dollar liquidity squeeze in the banking system. That led to a steep drop in rupee-dollar forward premia across all tenors, as banks entered into buysell swaps where they bought dollars in the spot market and sold them back in the forward market, driving down the forward premium in the process. Thus, the forward premia across three maturities softened considerably during August. The one-month premia moved in a wide range of 0.79% and 6.81% during the month and softened to end at 2.09% on 30 August. The 3-month and 6-month premia also softened substantially and closed at 2.91% and 2.89%.

The turnover in foreign exchange market continued its fall in July as in June. Despite a spurt in exports and imports, the total and average daily turnover across the segments together went down by 7% and 3% respectively over the month. The slump is partly due to depreciation of the rupee since the weak rupee is harming importers’ proﬁts. During July, a major fall in daily turnover was reported in forward and inter-bank trades by 8.8% and 6.3% respectively. However, merchant transactions registered 9.5% growth followed by spot transactions recording a 4% increase over the month in their daily average turnover (Table 8, p 76).

The growing uncertainty in external sector developments encouraged increased hedging activity in the currency derivatives market during August. The total turnover (in three exchanges) of trading in currency derivatives products together witnessed 10% increase over the month. The average daily turnover also improved by 15% during the same period. Individually, futures trading witnessed a 16% rise in daily trading while options trading recorded a 13% rise. Among the currencies traded on the futures segment, USD-INR recorded 11% growth and that of JPY-INR almost doubled compared to the previous month. As usual, USD-INR contracts dominated the currency futures market.

One major development in the currency derivatives segment was the imposition of transaction charges by the major two exchanges – NSE and MCX-SX – on 22 August. The burden of transaction charges hit the trading activity of these exchanges as large number of arbitrageurs stopped trading in currencies, as their operational costs would overtake proﬁts after these new charges. Thus, the daily trading in NSE and MCX-SX receded dramatically after 22 August. USE still has to decide on this matter and so the market share of USE in the total derivatives trading improved by 1.6 percentage points during August over July. However, MCX-SX continued to occupy the second position while NSE lost 1.8 percentage points in its market share. But it still managed to sustain its dominant position with a 43% share of the total derivatives turnover.

2.3 Central Government Securities

The central government has completed its borrowing target for the ﬁrst half of Rs 2.50 lakh crore, yet there are mounting

Table 12: Predominantly Traded Government Securities (Amount in Rs crore)
Descriptions		August 2011		Previous Month	Three Months Ago	Six Months Ago
	Last Week (26)	First Week (5)	Total for the Month	(July 2011)	(May 2011)	(February 2011)
AMT	YTM	AMT	YTM	AMT	YTM	AMT	YTM	AMT	YTM	AMT	YTM
GOI Dated Securities
9.39 , 2011							230	9.37	265	7.95	251	7.34
7.40 , 2012	35	8.21	345	8.31	505	8.26	676	8.05	1,040	8.10	738	7.49
7.27 , 2013	300	8.21	85	8.31	460	8.22	210	8.16	295	8.19	800	7.73
7.17 , 2015	145	8.20	84	8.39	438	8.22	786	8.34	1,649	8.37	13,408	8.10
7.02 , 2016			15	8.41	15	8.41	70	8.39	10	8.37	125	8.16
7.59 , 2016	752	8.26	174	8.36	3,588	8.25	2,700	8.31	4,096	8.43	3	8.18
7.49 , 2017	95	8.43			95	8.43	275	8.32	262	8.43	5,117	8.12
8.07 , 2017	453	8.25	536	8.38	2,348	8.28
7.99 , 2017							646	8.32	141	8.29	7,336	8.12
7.83 , 2018	5,134	8.28	4,713	8.41	18,502	8.30	11,976	8.35	8,901	8.42
7.80 , 2021	49,754	8.25	42,934	8.40	1,85,762	8.28	1,54,349	8.32	49,676	8.28	4,287	8.12
8.08 , 2022	11,090	8.36	5,369	8.48	26,559	8.38	20,292	8.42	24,889	8.45	39,453	8.18
8.13 , 2022	6,429	8.35	8,293	8.46	40,380	8.37	33,428	8.41	30,168	8.42	50,184	8.16
8.20 , 2022							45	8.40	80	8.47	75	8.16
8.26 , 2027	88	8.53	415	8.67	897	8.60	2,375	8.61	2,740	8.61	7,124	8.51
8.28 , 2027	332	8.56	759	8.60	3,363	8.55
8.28 , 2032	790	8.58	0	8.65	1,119	8.58	1,382	8.64	248	8.64	46	8.51
8.30 , 2040	105	8.57	646	8.70	1,284	8.64	1,947	8.61	833	8.60	1,600	8.57
Total (All Securities)	75,894	8.28	65,079	8.42	2,87,935	8.31	2,36,766	8.36	1,27,796	8.36	1,33,542	8.17
(-) means no trading	YTM = Yield to maturity in percentage per annum
1) Yields are weighted yields, weighted by the amounts of each transaction.
Source: as in Table 10.
78	SEPTEMBER 24, 2011	vol xlvi no 39		Economic & Political Weekly

MONEY MARKET REVIEW

concerns regarding ﬁscal slippage in the month as shorter-term yields have gone second half that could put pressure on up. In contrast, yields of longer maturities government securities yields across matu-alleviated during the month thanks to rities in the coming months. With front higher demand coming from banks and loaded borrowings thus far, September corporates. The demand for central govmay see lower primary market activity.ernment securities seemed to have become

In August, primary issuances of central stronger both in primary and secondary government securities, state development markets over the month. loans (SDLs), TBs and CMBs mopped up a The aggregate primary issuance by the gross amount of Rs 1,12,363 crore. With central government in August amounted redemptions worth Rs 88,000 crore, the to Rs 46,000 crore, in four auctions when net amount raised was only Rs 24,363 eight securities were reissued. Three auccrore. Reluctance of investors to invest in tions were for Rs 12,000 crore each while short-term securities was seen during the the last auction, held on 26 August, was for

Table 13: Details of State Government Borrowings (Amount in Rs crore) Rs 11,000 crore. Overall, the

Date of Auction Number of Total Bid Cover YTM at Weightedresponse rate in the auctions Participating Amount Ratio Cut-Off Average States Accepted Price (%) Yield (%) was good with a bid-cover

09-Aug-11 7 7,013 1.61 8.55 8.52

ratio of 2.23 times and there

23-Aug-11 7 5,350 2.44 8.6 8.58

was no devolvement on pri-

Total for August 14 12,363 1.97 8.57 8.55

mary dealers. Higher liquid-

Total for July 10 10,500 2.28 8.63 8.61 Source: RBI press releases. ity and absence of any trigger

to dampen the sentiments of

Table 14: Auctions of Treasury Bills (Amount in Rs crore)

investors have translated

Date of Auction Bids Bid Cover Cut-off Weighted Cut-off Weighted

Accepted Ratio Yield (%) Average Price (Rs) Average

into a fall in the weighted

Yield (%) Price (Rs)

primary yield by 7 bps from

A: 91-Day Treasury Bills 03-Aug-11 7,000 3.02 8.39 8.39 97.95 97.958.46% to 8.39% over the

10-Aug-11 7,000 2.36 8.31 8.27 97.97 97.98month (Table 9, p 76). 17-Aug-11 7,000 2.74 8.35 8.31 97.96 97.97

In the secondary market,

24-Aug-11 7,000 2.44 8.35 8.35 97.96 97.96

turnover of central govern-

Total for August 2011 28,000 2.64 8.35 8.33 97.96 97.97

ment securities increased by

Total for July 2011 28,000 3.51 8.21 8.17 98 98

around 22% to Rs 2,87,935

B: 182-Day Treasury Bills 03-Aug-11 3,000 1.98 8.47 8.44 95.95 95.96crore, with the overall trad

17-Aug-11 3,000 2.61 8.4 8.36 95.98 96 ed yield rate softening to Total for August 2011 6,000 2.24 8.42 8.40 95.97 95.98

8.31% from 8.36% in the

Total for July 2011 6,000 3.24 8.23 8.20 96.06 96.07

previous month. Although

C: 364-Day Treasury Bills

the ﬁrst fortnight of the

10-Aug-11 3,000 6.14 8.17 8.15 92.47 92.48

24-Aug-11 3,000 4.67 8.31 8.28 92.35 92.37

month started with a ﬁrm-

Total for August 2011 6,000 5.40 8.24 8.22 92.41 92.43 ing up of yields in the wake

Total for July 2011 6,000 3.71 8.37 8.35 92.3 92.31 of concerns regarding the

D: Cash Management Bills (CMBs)

key policy rate hike and a

8/2/2011* 8,000 2.94 8.36 8.36 98.89 98.89

likely slippage as regards

8/8/2011* 6,000 1.73 8.29 8.21 98.9 98.91

the targeted ﬁscal deﬁcit,

Total for August 2011 14,000 2.42 8.33 8.30 98.89 98.90 *Two issues of CMBs with maturity of 49 day each were conducted during August 2011. later on, yields softened on Source: RBI’s Press Releases.

the back of buying support Table 15: Details of Private Placement in Corporate Bonds in NSE and Public from banks and corporates, Issues During August 2011

reﬂected in higher turnover.

Institutional Category No of Volume in Range of Range of Maturity Issues Rs Crore Coupon Rates in Years (y) and A major share of the turn(in %) Months (m)

over, i e, 95% came from

Private Placement on NSE FIs/Banks 4 1,200 9.10-9.51 3-5 yearﬁve top traded securities,

NBFCs 4 4,720 9.45-9.80 1-10 years dominated around 10-year Central Undertakings 5 36,203 9.36-9.48 3-16 yearsmaturity, namely 7.80% Corporates 7 2,825 10.12-14.56 1-10 years

2021, 8.13% 2022, 8.08%

Total for August 2011 20 44,948 9.10-14.56 1 to 16

2022, 7.83% 2018 and 7.59%

Total for July 2011 34 8,034 0.00-11.40 1 to 11

2016. Yield rates softened

Public Issues

on all these securities. In

NBFCs 3 925 11.50-12.50 400 days-5 years Source: www.nseindia.com contrast, the yields hardened

Economic & Political Weekly

SEPTEMBER 24, 2011 vol xlvi no 39

for short-term maturities of up to three years resulting in further ﬂattening of the yield curve (Tables 10, 11, p 77 and Table 12, p 78).

State loans worth Rs 12,363 crore were raised with 14 state governments participating in two auctions. Though the overall response rate was a bit lower, cut-off and weighted average yields softened in tandem with central government securities over the month. In the secondary market also overall yield dipped over the period to 8.57%, with turnover also dropping to Rs 2,328 crore from Rs 3,960 crore in the previous month (Table 13).

2.4 Treasury Bills

Treasury bills issuances across regular maturities remained the same over the period. The notiﬁed amount for 91-day bills was at Rs 28,000 crore and for 182 and 364day TBs it stood at Rs 6,000 crore each. Two issuances of 49-day CMBs held in the ﬁrst fortnight of the month garnered Rs 8,000 crore and Rs 6,000 crore respectively. The demand for 364 day bills was stronger with bid-cover of as high as 5.4 times causing its yield to fall by about 13 bps. Yields of other shorter maturities ﬁrmed up.

The turnover of the TBs across maturities declined, but the steepest fall was in 91-day TBs by 69% to Rs 10,429 crore. An inching up of yield was seen in all categories. With secondary market yields of 10-year benchmark security and 364-day TBs being the same at 8.28%, the yield curve turned ﬂat. CMBs worth Rs 6,800 crore were traded in August (Table 14).

2.5 Corporate Bonds Market

With rising lending rates, the corporate bonds market remained active in the past few months. Funds raised though listed private placement issues on NSE saw a huge increase to Rs 44,948 crore against Rs 8,034 crore in the previous month, though the number of issues was less over the month. The coupon rate offered for these issues ranged between 9.10% and 14.56%. In August, coupon yield ﬁrmed up across issuers, but a steeper shift was seen in bonds issued by corporates, which offered yield rates in the range of 10.12% to 14.56%. Central undertakings, RECL and Power Finance Corporation raised the highest volumes during the month aggregating Rs 36,203 crore (Table 15).