Financial markets
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Financial markets



recent development in money market

recent development in money market



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Financial markets Financial markets Document Transcript

  • MONEY MARKET The money market is a component of the financial markets for assets involved in short-term borrowingand lending with original maturities of one year or shorter time frames. Trading in the money marketsinvolves Treasury bills, commercial paper, bankers acceptances, certificates of deposit, federal funds, andshort-lived mortgage- and asset-backed securities It provides liquidity funding for the global financialsystem. GROWTH OF MONEY MARKET IN INDIAWhile the need for long term financing is met by the capital or financial markets, money marketis a mechanism which deals with lending and borrowing of short term funds. Post reforms periodin India has witnessed tremendous growth of the Indian money markets. Banks and otherfinancial institutions have been able to meet the high expectations of short term funding ofimportant sectors like the industry, services and agriculture. Functioning under the regulation andcontrol of the Reserve Bank of India (RBI), the Indian money markets have also exhibited therequired maturity and resilience over the past about two decades. Decision of the government toallow the private sector banks to operate has provided much needed healthy competition in themoney markets, resulting in fair amount of improvement in their functioning.Money market denotes inter-bank market where the banks borrow and lend among themselves tomeet the short term credit and deposit needs of the economy. Short term generally covers thetime period upto one year. The money market operations help the banks tide over the temporarymismatch of funds with them. In case a particular bank needs funds for a few days, it can borrow
  • from another bank by paying the determined interest rate. The lending bank also gains, as it isable to earn interest on the funds lying idle with it. In other words, money market providesavenues to the players in the market to strike equilibrium between the surplus funds with thelenders and the requirement of funds for the borrowers. An important function of the moneymarket is to provide a focal point for interventions of the RBI to influence the liquidity in thefinancial system and implement other monetary policy measures.Quantum of liquidity in the banking system is of paramount importance, as it is an importantdeterminant of the inflation rate as well as the creation of credit by the banks in the economy.Market forces generally indicate the need for borrowing or liquidity and the money marketadjusts itself to such calls. RBI facilitates such adjustments with monetary policy tools availablewith it. Heavy call for funds overnight indicates that the banks are in need of short term fundsand in case of liquidity crunch, the interest rates would go up.Depending on the economic situation and available market trends, the RBI intervenes in themoney market through a host of interventions. In case of liquidity crunch, the RBI has the optionof either reducing the Cash Reserve Ratio (CRR) or pumping in more money supply into thesystem. Recently, to overcome the liquidity crunch in the Indian money market, the RBI hasreleased more than Rs 75,000 crore with two back-to-back reductions in the CRR.In addition to the lending by the banks and the financial institutions, various companies in thecorporate sector also issue fixed deposits to the public for shorter duration and to that extentbecome part of the money market mechanism selectively. The maturities of the instruments
  • issued by the money market as a whole, range from one day to one year. The money market isalso closely linked with the Foreign Exchange Market, through the process of covered interestarbitrage in which the forward premium acts as a bridge between the domestic and foreigninterest rates.Determination of appropriate interest for deposits or loans by the banks or the other financialinstitutions is a complex mechanism in itself. There are several issues that need to be resolvedbefore the optimum rates are determined. While the term structure of the interest rate is a veryimportant determinant, the difference between the existing domestic and international interestrates also emerges as an important factor. Further, there are several credit instruments whichinvolve similar maturity but diversely different risk factors. Such distortions are available only indeveloping and diverse economies like the Indian economy and need extra care while handlingthe issues at the policy levels.Diverse FunctionsMoney markets are one of the most important mechanisms of any deve-loping economy. Insteadof just ensuring that the money market in India regulates the flow of credit and credit rates, thismechanism has emerged as one of the important policy tools with the government and the RBI tocontrol the monetary policy, money supply, credit creation and control, inflation rate and overalleconomic policy of the State.Hence, the first and the foremost function of the money market mechanism is regulatory innature. While determining the total volume of credit plan for the six monthly period, the credit
  • policy also aims at directing the flow of credit as per the priorities fixed by the governmentaccording to the needs of the economy. Credit policy as an instrument is important to ensure theavailability of the credit in adequate volumes; it also caters to the credit needs of various sectorsof the economy. The RBI assists the government to implement its policies related to the creditplans through its statutory control over the banking system of the country.Monetary policy, on the other hand, has longer term perspective and aims at correcting theimbalances in the economy. Credit policy and the monetary policy, both complement each otherto achieve the long term goals determined by the government. It not only maintains completecontrol over the credit creation by the banks, but also keeps a close watch over it. Theinstruments of monetary policy, including the repo rate, cash reserve ratio and bank rate are usedby the Central Bank of the country to give the required direction to the monetary policy.Inflation is one of the serious economic problems that all the developing economies have to faceevery now and then. Cyclical fluctuations do affect the price level differently, depending uponthe demand and supply scenario at the given point of time. Money market rates play a major rolein controlling the price line. Higher rates in the money markets reduce the liquidity in theeconomy and have the effect of reducing the economic activity in the system. Reduced rates, onthe other hand, increase the liquidity in the market and bring down the cost of capitalsubstantially, thereby increasing the investment. This function also assists the RBI to control theoverall money supply in the economy. Such operations supplement the efforts of direct infusionof newly printed notes by the RBI.
  • Future of Open MarketsFinancial openness is said to be a situation under which the residents of one country are in aposition to trade their assets with residents of another country. A slightly mild definition ofopenness may be referred to as financial integration of two or more economies. In recent years,the process of globalization has made the money market operations and the monetary policytools quite important. The idea is not only to regulate the economy and its money markets for theoverall economic development, but also to attract more and more foreign capital into the country.Foreign investment results in increased economic activity, income and employment generation inthe economy. Free and unrestricted flow of foreign capital and growing integration of the globalmarkets is the hallmark of openness of economies.Indian experience with open markets has been a mixed one. On the positive side, the growth rateof the country has soared to new levels and the foreign trade had been growing at around 20 percent during the past few years. Foreign exchange reserves have burgeoned to significantly higherlevels and the country has achieved new heights in the overall socio-economic development. Themoney market mechanism has played a significant role in rapid development of the countryduring the post-reforms era.On the flip side, the post-reforms period has witnessed relatively lesser growth of the socialsector. Money market mechanism has kept the markets upbeat, yet the social sector needs morefocused attention. With the base of the economy now strengthened, the money market
  • mechanism must also focus on ensuring that proper direction is provided to the credit flows sothat the poorest sections of the society also gain. Interesting developments in money marketThe Finance Ministry would appear confident of preventing an enlargement of the fiscal deficiteven with an increase in non-plan expenditure, as tax receipts have been quite heartening with aspurt in revenues from direct taxes.THE MONEY market has been passing through an interesting phase in recent months withcontrary forces at work and speculation about the trend of interest rates.The Prime Minister has observed that there will not be any change in interest rates despite thesharp rise in the inflation rate. This prognosis is presumably due to the impression that theaccentuation of inflationary pressures has been mainly on account of external factors and thatthere may be an improvement in the price situation within the country with the kharif harvestsfrom the middle of October.Though the kharif foodgrain estimate will come down to 100.29 million tonnes from 108 milliontonnes, the rabi performance is expected to be satisfactory and the output of fine and coarsecereals and pulses for the whole year may not be lower than 195 million tonnes. On the otherhand, the cotton crop is placed at an all time record level of 213 lakh bales while oilseedsproduction too may be higher this season.As world prices for crude also have been fluctuating in wide limits, though below the peak leveltouched a few weeks ago, the impression is gaining ground that they will come down in thecoming months and their inflationary impact may be less pronounced.GDP to grow at 6.5-7 p.c.With the gross domestic product likely to rise by 6.5-7 per cent in 2004-05 and high liquidity inthe banking system despite efforts to immobilise surplus funds to a certain extent throughoperations of the Market Stabilisation Scheme and a hike in cash reserve ratio, quite a fewbankers seem to be of the view that interest rates will remain stable with even a downward bias.But other bankers have been raising interest rates on housing loans and issuing new loans on afloating rate basis.Will interest rates go up?
  • The question now is for how long the prevailing low interest rates will continue and whether theywill tend to harden as the months pass by. It has also to be borne in mind that interest rates indeveloped countries are on the rise though the U.S. Federal Reserve is inclined to be cautiouswhen taking decisions about further rise in its discount rate.While it remains to be seen how the changes in interest rates elsewhere impact the structure ofinterest rates in India, there has been a noticeable slowdown in the growth of forex reserves inrecent months. However, the outgo of $4.6 billion in five weeks in July-September should beascribed to an outflow of interest bearing obligations, particularly NRI deposits. On the otherhand, inflow of non-debt resources has been quite sizable. After a pause, FII inflows have beenincreasing with purchases of equities on the bourses and support to new issues.BoP comfortableThus, even with foreign exchange assets rising at a slower rate by $5.37 billion upto September10, against $12.24 billion a year ago, the rupee has not come under any pressure. So long as thesecular trend is observed and the Balance of Payments position gets strengthened with areduction in interest bearing obligations and larger inflows of invisible receipts, the rupee willremain fairly steady and the variations may be due to a strengthening of the U.S. dollar and othercurrencies.High liquidity of banksThe money market has not witnessed any diversion of funds to the forex market as there hasbeen no volatility in rupee parity. Besides, additions to money supply will be satisfactory eventhough at a slower rate.The scheduled commercial banks have thus been experiencing an increasing growth in theirdeposits, though the additions this year upto September 3 are lower at Rs. 84,904 crores againstRs. 94,716 crores.But in the 12 months ended September 3, the growth in deposits has been spectacular at Rs.2,13,750 crores against Rs. 1,49,540 crores. It is interesting to note, of course, that banks havebeen utilising surplus funds more profitably, as incremental bank credit in the 12 months underreference has risen by 83.09 per cent of incremental deposits against 50.72 per cent comparably.Fresh investments out of incremental deposits accounted for only 42.89 per cent against 86.68per cent.If the UPA Government is keen on increasing credit availability to the farm sector and loansextended to borrowers in industry and trade also tend to rise, the liquidity in the banking systemmay slowly disappear. As the monetary authorities would seem to be keen on intensifyingoperations with the MSS with a view to containing inflationary pressures, the CRR is beingraised to 5.0 per cent from 4.5 per cent in two stages and an amount of Rs. 8,000 crores will get
  • immobilised by October 2. The intention is perhaps not to increase interest rates when the Credit Policy for the busy season is announced by the end of October. Centres borrowing This line of thinking is perhaps correct as the Reserve Bank has indicated that the target for the issuance of securities by MSS for 2004-05 has been raised to Rs. 80,000 crores from Rs. 60,000 crores. The issue of new loans by MSS in the coming months may nevertheless have larger notified amounts, as Government borrowing is slated to be only Rs. 44,000 crores in October-March 2004-05 against Rs. 66,000 crores in April-September or a total of Rs. 1,10,000 crores against the target of Rs. 1,15,501 crores for net borrowing in 2004-05. The Finance Ministry would appear confident of preventing an enlargement of the fiscal deficit even with an increase in non-plan expenditure, as tax receipts have been quite heartening with a spurt in revenues from direct taxes by 50.69 per cent upto September 15 to Rs. 27,240 crores from Rs. 18,077 crores. What is significant is the sharp rise in income tax collections by 55.51 per cent to Rs. 17,999 crores from Rs. 11,574 crores. As the demand for various products has been rising and industrial production also has increased by 7.8 per cent in April-July against 5.9 per cent comparably, the revenues from indirect taxes too may not show any shortfall from Budget estimates. As there has been no aggressive borrowing by the Centre and State governments also have not been securing their requirements in a big way till now, the yields on new loans have not risen noticeably, though the yields on gilt-edged securities in the open market have been rising slowly and banks with excess holdings of securities, particularly in long-term loans, fear that the income from treasury operations may not be of last years dimensions and their net profits may not rise at the rate seen in recent years. The happenings in the money market during the busy season may thus be on different lines and it will be interesting to watch whether MSS operations will have to be slowed down if the credit deposit ratio continues to rise impressively. It may thus not be feasible to raise the CRR further and also immobilise additional funds through as it will add to the interest burden ofo the Central Exchequer. Reforms made in the Indian Money Market are:-1. Deregulation of the Interest Rate : In recent period the government has adopted an interest rate policy of liberal nature. It lifted the ceiling rates of the call money market, short-term deposits, bills rediscounting, etc. Commercial banks are advised to see the interest rate change that takes place within the limit. There was a further deregulation of interest rates during the economic reforms. Currently interest rates are determined by the working of market forces except for a few regulations.
  • 2. Money Market Mutual Fund (MMMFs) : In order to provide additional short-term investment revenue, the RBI encouraged and established the Money Market Mutual Funds (MMMFs) in April 1992. MMMFs are allowed to sell units to corporate and individuals. The upper limit of 50 crore investments has also been lifted. Financial institutions such as the IDBI and the UTI have set up such funds.3. Establishment of the DFI : The Discount and Finance House of India (DFHI) was set up in April 1988 to impart liquidity in the money market. It was set up jointly by the RBI, Public sector Banks and Financial Institutions. DFHI has played an important role in stabilizing the Indian money market.4. Liquidity Adjustment Facility (LAF) : Through the LAF, the RBI remains in the money market on a continue basis through the repo transaction. LAF adjusts liquidity in the market through absorption and or injection of financial resources.5. Electronic Transactions : In order to impart transparency and efficiency in the money market transaction the electronic dealing system has been started. It covers all deals in the money market. Similarly it is useful for the RBI to watchdog the money market.6. Establishment of the CCIL : The Clearing Corporation of India limited (CCIL) was set up in April 2001. The CCIL clears all transactions in government securities, and repose reported on the Negotiated Dealing System.7. Development of New Market Instruments : The government has consistently tried to introduce new short-term investment instruments. Examples: Treasury Bills of various duration, Commercial papers, Certificates of Deposits, MMMFs, etc. have been introduced in the Indian Money Market.