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Treasury Bills

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  • 1. MANAGEMENT OF FINANCIAL SERVICES TREASURY BILL MARKET Submitted by Manish Kumar Singh (13030) Ramanathan.N (13031) Pradhan.N (13032) Rahul Ghai (13039) Rakesh Pargi(13040)
  • 2. TABLE OF CONTENTS INTRODUCTION............................................................................................................................................................3 THE EVOLUTION OF THE GOVERNMENT SECURITIES MARKET .........................................................................3 METHODOLOGY OF THE STUDY.............................................................................................................................4 INTERNATIONAL T-BILLS MARKET......................................................................................................................5 BOOK ENTRY SECURITIES...........................................................................................................................................5 THE PRIMARY MARKET .............................................................................................................................................5 THE SECONDARY MARKET........................................................................................................................................6 T-BILL MARKET IN INDIA ..........................................................................................................................................8 91 -DAY TREASURY BILLS MARKET.........................................................................................................................8 182-DAYS TREASURY BILLS MARKET ....................................................................................................................11 COMPARISON WITH THEINTERNATIONALMARKETS.............................................................................11 T-BILL REFORM MEASURES SINCE LIBERALISATION.................................................................................14 FORMATION OF THE DISCOUNT AND FINANCE HOUSE OF INDIA.....................................................................14 REFORMS IN THE NINETIES......................................................................................................................................16 FUTURE OF INDIA’S T-BILLS MARKET................................................................................................................20 CONCLUSION...............................................................................................................................................................22 BIBLIPGRAPHY...........................................................................................................................................................23 APPENDIX......................................................................................................................................................................24
  • 3. TREASURY BILLS 3 INTRODUCTION Historically, the earliest securities markets in the world were the markets for government securities. In most countries today, the market for the government securities remains the largest securities market. Markets for government securities are important not only for their size. Government securities play a special role in the economy. The interest rate government securities is the risk free rate against which all other interest rate s are measured. In many countries, including our own, the central bank regulates the quantity of money by buying and selling of government securities. Treasury bills or T-bills as they are popularly called, are the short term debt of the government of a country; in India they are issued by the government of India. THE EVOLUTION OF THE GOVERNMENT SECURITIES MARKET Historically, the main cause of government borrowing has been wars. From the Middle Ages, wars begin to growing scale and in scope. Increasingly, the outcome was determined less by military skill than by financial strength. Initially, kings borrowed mainly from banks. The first public issue of government securities took place in Holland in 1542. This Dutch idea of borrowing money was perfected by the British. Later the idea was used in U.S. at the time of Revolutionary War. However, all these securities were of a long maturity. The need for shorter term securities was felt by the governments to finance their deficits and sometimes also for liquidity reasons. The English government first issued such short-term debt in 1696 in form of interest bearing “exchequer bill”. The treasury bill was created by the British Treasury in 1877 at the urging of Walter Bagehot, editor of The Economist. The T-bill is a discount bill intended to mimic the commercial bill. The idea was to tap the thriving London market that traded in commercial bill. Not only did it replace the exchequer bill as a source of short-term liquidity, but governments soon began to roll over Treasury bills to fund their long term borrowings.
  • 4. TREASURY BILLS 4 METHODOLOGY OF THE STUDY To understand the structure and functioning of the T-bills market today in India and to appreciate its trends, the study is divided into three parts. The first part looks at the international scenario as far as the T-bills market goes. It was felt by the group that this would help us appreciate the Indian T-bills market better, by drawing a comparison with the more developed markets. The second part looks at the state of the Indian T-bills market before 1990’s. This would put things in perspective and help appreciate the changes taken place after 90’s reforms.
  • 5. TREASURY BILLS 5 INTERNATIONAL T-BILLS MARKET. The T-bills market of the United States of America was taken as an example of the international T-bill market. This is one of the most advanced systems and is even more important due to the special place the USD occupies in the world economy. Most of the U.S. government securities are issued by the Department of the Treasury. They are known in the market as Treasuries or governments. The shortest maturity Treasuries are 3-,6- and 12 month T-bill with face values of $10,000 to $1,000,000. BOOK ENTRY SECURITIES All new U.S. government securities are in form of book entries. These are actually records on a computer. The system is divided into two parts. The major part, officially called the Treasury/Reserve Automated Debt-Entry System(TRADES), but generally known as commercial book entry system, is operated by Federal Reserve Banks. The minor part , Treasury Direct, is operated by the treasury itself. In the commercial book entry system, the depository institutions(banks and thrifts) are eligible to hold a securities account at the Fed. Others-dealers, brokers, and their customers-can access the system indirectly by keeping a securities account at a depository institution that has an account at the Fed. Investors who keep the securities with the Treasury directly, do so through a system called Treasury Direct. Securities held in treasury direct cannot be transferred to others. THE PRIMARY MARKET New issues of Treasury securities are sold at auction organised by The Federal Reserve Bank of New York. The amount, maturity, and the denomination mix of each new issue are announced a week in advance. The size of the issue is about 10 to 12 billion dollars (T-bills plus longer term bonds/notes) each week. There are two types of bids: competitive bids specify a price, noncompetitive bids do not. The noncompetitive bidders are usually less sophisticated small investors.
  • 6. TREASURY BILLS 6 Successful competitive bidders pay the price they have bid; low bids get nothing. This type of auction is called an English Auction. Noncompetitive bids are all accepted at a price that is a weighted average of that paid by successful bidders. The most important source of bid price information for the dealers comes from the wi(when- issued) market. Trading usually starts with an announcement from the FED. This is basically a forward market in Treasury issues. The price discovery in this market gives an indication of the market consensus for the discount for the issue to be bid at. In the past few years Fed has started to accept electronic bids for the issue. Also the Fed has been experimenting with what is known as Dutch Auction. In this kind of auction, all successful bidders pay the price as the lowest accepted bid. On face, treasury would loose money by giving the entire issue at the lowest bid rate as compared with English Auction where the rates are different. However, this is more than adequately compensated by the higher bid rates since the bidders don’t have to worry about bidding too high; the danger in fact lies in bidding too low and not getting a piece of the action. THE SECONDARY MARKET While the primary market for the T-bills may seem large, it is dwarfed by the secondary market where the volumes(T-bills plus Bonds/notes) reach 100bn dollars per day. The secondary market of the government securities is very liquid; bid -ask spreads are small and market is deep. The principal partners are dealers, brokers and clearing banks. Dealers make the market. Those large enough to be recognized by the Fed as potential trading partners are known as the primary dealers. Primary dealers trade on the ‘inside’ market where they are connected to each other normally through dealers. They also sell the securities to public and other dealers known as secondary dealers. The intense competition ensure that the price at which the securities are available to outside customers are very close to the prices at which trades take place in the inside market. The U.S. Government securities under three conventions-same day , next day and forward settlement(which includes the wi market). all same day trades are settled directly between the counterparties. Other trades may be settled either directly or through the Government Securities Clearing Corporation., a clearing house.
  • 7. TREASURY BILLS 7 Increasing globalization of trading in U.S. government securities has put competitive pressure on domestic markets for government securities in other countries. As investors have found it easier to invest in the securities of the US government, domestic markets have had to modernize or face a loss of business. National governments , fearing that their ability to borrow might be compromised, have pushed through reforms.
  • 8. TREASURY BILLS 8 T-BILL MARKET IN INDIA Treasury bill are the main instruments for short term borrowing by the Indian government. Although State Governments also issued treasury bills until 1950, since then it is only the Central Government that has been selling them. In terms of liquidity, for short term financing, the descending order is cash, call loans, treasury bills and commercial bills. Although the degree of liquidity of treasury bills are greater than the trade bills, they are not self-liquidating as the genuine trade bills are. T-Bills are claim against the Government and do not require any grading or further endorsement or acceptance. The important qualities of T-Bills are : • High liquidity • Absence of risk default • Ready availability on tap • Assured yield • Low transaction cost • Eligibility for inclusion in SLR • Negligible capital depreciation The market for these T-bills in India has evolved over time. To get a true picture of this market, its nuances, trends , the reforms and the compulsions/rationale behind these reforms it is necessary to study this evolution. This time study has been attempted in this section 91 -DAY TREASURY BILLS MARKET The market of 91 day T-bills is the oldest in India. These have traditionally been of two types 1. Ordinary · These are issued to the public and RBI to meet the needs of supplementary short-term finance by the Government. 2. Ad hocs · As the RBI acts as a banker to the Central Government, it was necessary, for smooth conduct of its banking business, the GOI should maintain a minimum balance in its books with RBI. It was mutually agreed in the mid 50’s that Rs 50cr should be held by the Govt, as such as a balance on Fridays. And reflected in the RBI’s weekly statement affairs. To adhere to
  • 9. TREASURY BILLS 9 this agreement it had become necessary to ensure that the account is replenished whenever the actual balances are below the Rs 5 core level by creation of ad hoc Treasury bills in favour of the RBI, generally in multiples of Rs 5 core. It followed from this arrangement that whenever the account is in surplus, ad hocs would be cancelled in such amounts as necessary so that the balance is at least at the agreed level. The practice has been in vogue in since 1954-55. Thus what was originally a purely temporary arrangement became a regular feature over the years. · Yet another development has been the Government’s conversion of the outstanding ad hocs into dated securities, commonly known as ‘funding’. Such funding has been in evidence since July 58. Initially the magnitude of such funding was in the range of Rs 50-100 crore a year. With the very large accumulation of ad hocs with the RBI and the attendant problems of rolling over a large amounts of short-term paper, since 1982 there was not only a spurt in the amount of funding but also a fundamental change in the basic characteristics of the conversions. Whereas the earlier conversions were in the form of Government dated security with some specific maturities, at varying rates of interest, in the post 1982 period, the conversion were into 4.6% special securities with no specific date of redemption and more importantly the post 1982 funding were exclusively taken up by RBI. · The ad-hocs also provided medium for investing temporary surpluses of State Governments, semi-government departments and foreign central banks thus help in eliminating undesirable fluctuations in the discount rate. · They were however not sold to general public (or banks) and were not marketable. However, their holders when need of cash could rediscount these bills back to RBI. Issue Mechanism 91 day T-Bills are issued at a discount by the RBI on behalf of the Central Government as its agent. TB rate is the rate of discount at which Treasury Bills are sold by the RBI. The effective return on T-Bills is the discount at which they are sold and is based on the difference between the price at which they are sold at the redemption value. Till 1965 there were two modes of selling the 91 day ordinary T-bills. The first way was to sell through weekly auctions. The announcement was made through a press communique, and tenders which quoted the lowest discount rate were accepted in full. The Balance if any was allotted to the next higher bid. Also what were known as “intermediate” treasury bills were also sold in some
  • 10. TREASURY BILLS 10 years. These bills also had a maturity period of 91 days and were sold at rates fixed by the RBI from the day succeeding the auction till the day preceding the day fixed for receiving the tender bids for the next auction. With effect from July 12, 1965, instead of inviting tenders every week for a specified sum, T-Bills were available on tap throughout the week at the rate announced from time to time. This change in the procedure was made to make a steady supply of bills available to all investors at all times for their temporary surpluses and also to mop up larger amounts for the government. The ad hocs on the other hand were issued in favour of RBI only, hence there was no question of selling them through tender; they were purchased by the RBI on tap and held in its issue department. The RBI could and did issue currency notes against these ad hocs. Size of the Market The size of the TB market can be gauged by the volume of T-Bills sold every year and the amount of them outstanding at the end of each year. In terms of the sheer volume of the bills and their turnover, there has been a market growth in the T-Bills market. Total sale s of T-Bills increased from Rs. 1394 crores (1950-51) to Rs 1142409 crores (1986-87). Participants The bulk of these bills is purchased and held by the RBI. Apart from the RBI, the T-Bills are also purchased by commercial banks, State Governments and other approved bodies and financial institutions like LIC, UTI and so on. The RBI and banks taken together account for about 90 percent of the sales of T-Bills every year. The shares of the RBI and the banks in the total sales have fluctuated over the period of time and these shares appear to be inversely related. In terms of outstandings, the RBI is the only major holder of the T-Bills. Since November 1986, RBI has introduced two measures to reduce the size of its holding of these bills. 1. Recycling of T-Bills i.e. selling back rediscounted bills to banks 2. Imposition of an additional early rediscounting fee for rediscounting bills within 14 days of purchase. These measures did not have the desired effects, in fact bank’s holding of bills have declined sharply. In spite of RBI’s encouragement to invest in T-Bills, banks participation in the TB market
  • 11. TREASURY BILLS 11 is not significant. Since the TB market is limited, open market operation of the RBI are conducted only in government bonds. 182-DAYS TREASURY BILLS MARKET With a view to widening the short-term money market and to providing more outlets for temporary surplus funds, a new money market instrument “The 182-day TB” was introduced in November,1986. This 182 day T-bill was sold in the market by the RBI in auctions. The market participants bid for the amount of bills at a discount rate of their choice. The acceptance by the authorities of the discount rate determined the “cut off” rate and the amount of treasury bills sold off in an auction. While this was a step towards introducing the market rate in the T-bills, it did so only n theory due to a floor price being fixed by the RBI. Still the rates available on 182 day T-bills were more attractive than the 91 day T-bills. The size of the issue was thus not fixed and varied with the bid rates and the floor prices. Another important difference between the 182 day bill and the 91 day bill was that these bills could not be bought by the State Governments and the provident fund. RBI too did not buy these bills. However the auction was open to any individual, firm, company, banks or Financial institution. COMPARISON WITH THE INTERNATIONAL MARKETS Till this point the state of the T-bills market till the beginning of 1990s has been described. It would be interesting here to compare this market with the international markets as this would put the reforms of the 1990’s in perspective. As it would be getting clearer by now, the T-Bill markets at that point of time were highly undeveloped as compared to the those in countries like USA and UK. In the USA and the UK treasury bills are the most important money market instrument. They are a very poplar form of holding short term surpluses by financial institutions, other corporations and firms, because they are free from any default risk, are highly liquid and yield a reasonable rate of return. For the government they are a very important form of raising money. For the central bank they are the chief instrument of open market operations. This has traditionally not been so in India. The RBI has been the chief holder of T-Bills holding about 93% of such outstanding bills (of the value of 23,000 crores) at the end of March 1986. The two main reasons for this are listed below
  • 12. TREASURY BILLS 12 1. Illiquid secondary market Before the reforms of 1990’s there were no dealers in T-bills outside the RBI who were willing to buy and sell any amount of such bills in the market. The RBI was the sole dealer in them.. Banks had rediscounting facility with the RBI; there were no independent discounting houses in India. Since the RBI has been freely rediscounting these bills, the market for such bills has remained artificial and volatile and bank’s investments in these bills have been extremely short-termed and fluctuating. 2. Administered interest rate Another important factor is the extremely low rate of return on investment in the treasury bills. The difference between the treasury bills rate and the deposit rates has been wide enough to dissuade investors like companies from investing in the treasury bills. As far as commercial banks are concerned, the RBI policy of requiring banks to invest in government securities for maintaining a statutory liquidity ratio and stable condition in the government securities market has reduced the importance of the treasury bills as an investment medium. The question that naturally arises that why should the government bother about the undeveloped market and reform it? The reasons are described below: 1. The low rate T-bills rate no doubt kept the cost of t-bills debt to the government very low,. But this had been at a huge cost to the economy. First, the low rate had been maintained by converting the RBI into a passive or captive holder of these bills. This had led to large scale monetarisation of the government debt, which along with things had been the main source of the excessive expansion of money supply and so also the inflation in the economy. Also the low rate tempted the government to use the short term financial instrument of T-Bills as a source of long term fund by rolling over the debt. 2. In the USA, UK and other developed countries, open market operations(OMO) are regarded as technically the most efficient instrument of the monetary policy, because they are highly flexible, they can be used in varying amounts, one way or the other as required, at the option of the central bank and they are easily reversible in time. Their direct effect on the high powered money is immediate and the amount of money created or destroyed by them is determined precisely. However in India OMO have not been a powerful instrument of
  • 13. TREASURY BILLS 13 monetary policy control. This because the market in the T-Bills and G-Secs is not well organised and developed. Thus the RBI is prevented from doing OMO in an effective way. 3. With increasing globalisation of financial markets, avenues for investment have been increasing and so have the potential investors for each market. Thus to attract these investors who have been used to highly sophisticated markets, government had to necessarily reform its T-Bills and G-Sec markets. The above three were ample reasons for the government to set its debt market on the reforms path . The introduction of the 182 day market and the formation of the DFHI(Discount and Finance House of India) were the first steps in these directions. These along with the other major changes which have changed the face of the T-bills markets have been outlined in the next section.
  • 14. TREASURY BILLS 14 T-BILL REFORM MEASURES SINCE LIBERALISATION FORMATION OF THE DISCOUNT AND FINANCE HOUSE OF INDIA In different countries, various institutional arrangements, facilities and practices have evolved which provide smoothened liquidity flows in the money markets. UK Discount Houses The London discount market is about 180 years old and consists of about a dozen discount houses. These are subsidiaries, are the expert financial intermediaries which perform various specialised function or task that no other financial institution would do. Discount houses are strictly commercial concerns organised in the form of public companies, which are owned and operated independently. They are engaged in the business of lending and borrowing, which is predominantly secured. They lend short, but borrow even shorter. They operate as principals, dealers, jobbers, brokers, and commission agents and take their money from these activities. They operate both in primary and secondary markets for financial instruments. On the whole, they deal in inland bills of exchange, foreign bills of exchange, treasury bills, gilt-edged securities, negotiable CD's, negotiable bonds, call money, foreign exchange, loan and FI and the like. Their services are virtually indispensable in selling T-bills. They have a privileged position in the functioning of the monetary system, which comes from their capital strength and the confidence or reputation that they would meet their commitments under any circumstances. The sources of funds of discount houses comprise their own capital, borrowing from Bank of England, London Clearing Banks and other banks. They earn their profits mainly by borrowing money more cheaply than they lend it. To a certain extent, their profits are also derived from the commission in respect of buying and selling of bills on behalf of customer outside banks, and from jobbing business. DISCOUNT AND FINANCE HOUSE OF INDIA(DFHI) The Chore committee opined that the manner in which the UK discount houses operated could be adopted in India as well. It recommended that they should have the following functions
  • 15. TREASURY BILLS 15 • It should be the sole depository of the surplus liquid funds of the banking system as well as the non-financial institutions. • It should use surplus funds to even out the imbalances in liquidity in the banking system subject to RBI guidelines. • It should create ready market for commercial bills, T-billsm and Government/Government guaranteed securities by being ready to purchase from and sell to the banking system such securities. Though these recommendations were made in 1979, the DFHI was set up in 1988. It is a joint- stock company in form and is jointly owned by the RBI, the public sector banks, and all India FI's which have contributed its paid up equity capital of Rs 150 crore. The RBI has sanctioned a refinance limit for the DFHI against the collateral of T-bills and against the holding of eligible commercial bills. The role of DFHI is both developmental and stabilising. It would facilitate the smoothening of short-term liquidity imbalances by developing active primary and secondary money market. In other words, it would work as a specialised money market intermediary for stimulating activity in the money market instruments and developing secondary markets in those instruments. It would discount or deal in not only commercial bills but also treasury bills and other money market instruments. It would undertake short-term, buy-back operations in the government and approved dated securities also. DFHI has consolidated its business by achieving significantly higher turnover in its operations in each sector of activity. It has also been playing a vital role in developing an active secondary market in money market instruments. The presence of DFHI in the secondary markets has facilitated corporate entities to invest their short-term surpluses and liquefy them whenever necessary. The turnover of all money market instruments has increased enormously. Due to repos facility provided by DFHI, banks, FI and mutual funds have been able to earn an income by investing their money for short periods and also raise money for short periods without having to divest their investment. To aid DFHI in its operations, RBI extends refinance facility against the collateral of instruments it deals in. The volume of refinance and interest rates charged on it have often been varied in a wide
  • 16. TREASURY BILLS 16 range by the RBI depending on its perception about liquidity in the money market and the needs of monetary policy. REFORMS IN THE NINETIES 1992-93 • 364 day T-bill was introduced in April 1992 with the objective of widening the T-bill market. They were offered for sale on auction basis. • From April 92 DFHI started offering a 2 way quote in Government securities to develop a secondary market for T-bills. • 182 day T-bill - No fresh 182 day treasury bills were issued after April 16, 1992. The outstanding treasury bills were all repaid before Oct 92. 1993-94 • STCI(Securities Trading Corporation of India) was setup. • Funding of 364 and 91 day T-bills was effected as an important aspect of Internal Debt Management. 1994-95 • GOI indicated that the practice of automatic monetisation through ad hoc T bills would be phased out over a three year period so as to strengthen the fiscal discipline. This was formalised by an agreement signed on Sep 9, 1994 between RBI and GOI on the net issue of ad hoc T bills. As per the agreement , the net issue of ad hoc Treasury bills for the year 94-95 was not to exceed Rs. 6000 crore at end of the year. If the net issue of ad hoc T-bills exceeded Rs 90000 crore for more than ten consecutive working days any time during the year, RBI would issue fresh Government paper to curtail the level of ad hoc T bills within the stipulated limit. Similar ceiling would be stipulated for the next two years and from 97-98 the system of ad hoc Treasury bills would be totally discontinued. • From July 4, 1994 State Governments and non-Government Provident Funds were allowed to participate in 91 day T bills auctions on a non-competitive basis with allotment at weighted average price.
  • 17. TREASURY BILLS 17 1994-95 • An auction system for conversion of T-bills into Government dated securities was introduced in April 1995. • The DVP (Delivery Vs Payment) system in Government securities was extended to T-bill auction from Feb 14, 1996. 1996-97 Primary dealers One of the constraints in having effective monetary management based on indirect instruments has been the weak institutional structure in respect of Government securities transactions. It is in this context that 6 PD’s (Primary Dealers) were given in principle approval on November 13, 1995. The DFHI and STCI were the first of the PD’s to come into operation in March 1996. Four more institutions became operational subsequently in June 1996. They are SBI Gilts, PNB Gilts, Gilts Securities Corporation and ICICI Securities and Finance Co. To encourage PD to be active in the market attractive alternative structures of commissions on purchases(including the underwriting commitment) throughout subscriptions in all floatations in the primary market accounting 25 paise(since reduced to 12.5 paise effective Aug 23 1996) on 91-day T-bills, 50 paise on 364 day T-bills and one rupee on Government of India dated securities were announced from July 10, 1996. With the arrival of PD’s the volume of Government securities traded in the secondary markets has improved considerably. In order to improve their liquidity position, PDs were allowed to tap the CP market in Sep 1996. They were also permitted to participate in the call/notice/ term money market, both as lenders and borrowers., so as to impart flexibility in the use of their funds. From July 96 liquidity supports in the form of reverse repo facility in GOI securities and 91 day T- bills have been extended to all six primary dealers in proportion to their bidding commitments. The support by way of refinance facility against T-bills, earlier extended to DFHI and STCI has been withdrawn. Role of Primary Dealers A Primary Dealer(PD) is not a final repository for the unwanted securities of large holders. Rather, the PD is an institution which will help investor to buy and sell by offering two-way quotes
  • 18. TREASURY BILLS 18 in a few select securities. The PD would be transient holder of securities. Thus if a PD finds itself with excessive securities relative to its holding power, the PD would tilt prices in a manner which would discourage large unloading. Equally as the PD would not wish to hold on to the securities, but to attain an increased volume of turnover, the PD would be willing to access the securities to other investors. It must be stress that the depth of the market would not emerge instantly, just because there is a scheme of PDs. Such a market would however, gradually develop as the PDs build up their capacity to access the securities deeper into the market. Also the market quotation rates increased to very high levels in 1995 due to lack of information and an absence of integration of various segments of the financial markets. A well functioning system of PDs, small distress sales of securities would have evoked strong buyer interest outside the captive market. But if there were to be a sudden large sales of securities, even in a mature market there would be steep fall in prices. Satellite dealers RBI announced on Dec 31, 1996 the guidelines for setting up Satellite Dealers(SD) with the aim of strengthening the infrastructure in the Government securities market, enhancing liquidity and turnover, providing a retail outlet and encouraging voluntary holding of Government securities among a wider base,. The SDs would be required to have a minimum net owned funds of Rs 5 crore and a standing arrangement with the Bank based on execution of an undertaking covering, inter alia , commitments • To generate outright turnover of Central Government securities, including T-bills of not less than 30cr a year. • To achieve an annual turnover of not less than five times in Government securities including T-bills and • To achieve a portfolio of not less than 20% in Government securities in relation to total assets before then end of the first year of operations after registration. 1997-98 • RBI introduced a system of payment of commission to PDs on their purchases(including devolvement) of Government securities through subscriptions in all floatations in the primary market. On June 2 1997, the system of payment of commission was replaced with payment of
  • 19. TREASURY BILLS 19 underwriting fee on underwriting amount offered by PDs on voluntary basis through competitive bidding. • The system of ad hoc T-bills was discontinued with effect from April 1, 1997 and the outstanding T-bills would be funded into special securities, without any specified maturity. • RBI granted preliminary approval to 16 entities for registration as SDs in the Government securities market on April 7,1997. • Repo/reverse repo transactions were permitted in respect of all Central Government dated securities, besides T bills of all maturities. • RBI permitted foreign institutional investors (FIIs) to invest in treasury bills, indicating governor Bimal Jalan's resolve to proceed with the capital account convertibility schedule suggested by the Tarapore Committee. 14 day T-bill and 28 day T-bill In order to help the cash management requirements of various segments of the economy, the Monetary and Credit Policy for the second half of 97-98 announced the introduction of 28 day Treasury bill on auction. The first auction of 14 day T-bill was conducted on June7,1997. The Monetary and Credit Policy, also announced the introduction of the practice of notifying amounts in the case of all the auctions including 364 day and 14 day T-bills. At present only 91 day T-bills and dated securities are indicated. On Nov 18, 1997 RBI decided to register nine companies as SDs in the Government securities market viz., • DSP Merill Lynch • Ceat Financial Services Ltd. • Kotak Mahindra Capital Company • Birla Global Finance Co. Ltd. • Hoare Govett(India) Securities Pvt. Ltd. • Tower Capital and Securities Pct. Ltd. • Tata Finance Securities Ltd.
  • 20. TREASURY BILLS 20 RBI also granted ‘in principle’ approval to Bank of America and Bank of Madura to be accredited as SDs in the Government securities market. The banks would be setting up separate units dedicated to the securities business, in particular the Government securities market. 1998-99 91 day T-bills RBI introduced uniform price auction method in these bills from 6, Nov 1998 in place of multiple price auction method. In case of multiple price auction method successful bidders pay their own bid process, while in uniform price auction method, all the successful bidders pay a uniform price. i.e. the cut off price emerging at the auction. The multiple price auction continues to be followed in other T-bills and dated securities. The routing of transactions, which was only through DFHI from April 91, has been extended to all PDs from April 26, 1997. Also the minimum size of a transaction was reduced from Rs 20 to Rs 10 crore to Rs 5 crore from October 22, 1997. FUTURE OF INDIA’S T-BILLS MARKET Lack of market clearing yields at primary auctions of Government debt is often being cited as a significant factor slowing the development of a secondary market. First, it hampers the efforts to broaden the investor Second, at times when cut-off yields in the primary market are lower than prevailing secondary market yields, it curbs secondary trading. Third, to the extent the cut-off yields are lower than secondary market yields, it constrains inventory build up of primary dealers. Finally, to the extent volumes of pick-up in primary auctions are reduced due to interest rate considerations, it reduces the availability of floating stock in the secondary market. There are four important factors inhibiting market clearing mechanisms viz. Notifying auction size, type of auction, element of non-competitive bids and frequency of auction of T-bills. At present there is no pre announced notified amount in 364-day and 14-day auctions. This procedure enables the RBI to determine either the cut-off price or the amounts to be accepted in a flexible manner. Notifying amounts in auctions will bring more transparency in the auction procedure by removing the uncertainty about volumes in auctions. In this context, it needs to be emphasised that the capacity of PDs to absorb auction supply as an underwrite is limited.
  • 21. TREASURY BILLS 21 Currently, PDs underwrite to the extent of 50% of the amounts in auctions with notified amounts. In this scenario, there is a danger of devolvement on the RBI, if there is a preannounced notified amount. The extent of the devolvement on the RBI can be minimised by increasing the underwriting amounts to PDs. The RBI could also change the notified amounts between each auction, depending on prevailing market conditions, in order to minimise the devolvement risk on itself. The institution of 6 PDs has partly contributed to a significant increase in secondary market transactions in Government securities. Authorising PDs is an ongoing process. All eligible applicants will be considered by the RBI for primary dealership. At present SCRA(Securities Contracts Regulation Act), 1956 prohibits short selling of Government securities. Two options could be considered. First, whether to give exclusive access of primary auctions to PDs and simultaneously permit them to engage in short sales of Government securities. Second, whether to continue with the existing system of access to primary auctions and allow all participants to engage in short sales of Government securities. The timing and sequencing of this reform are the issues to be considered carefully. There is some debate over the type of auction that is most suitable for both the discriminatory and uniform price auctions. But, international practices seem to be in favour of discriminatory price auctions. In a switch over from one auction system to another, a number of considerations arise such as easy entry, cost to issuer, return to investor, role of PDs, incentive to gather information etc. This is another area to be considered. Non competitive bids are allowed in 91-day and 14-day T bill auctions. Major issue relates to the treatment of non-competitive bids. Country practices show that non-competitive bidders are made allocation within the notified amount. However, the non-competitive bidders in other countries consist essentially of the small, retail and inexperienced investors. Since the maximum bid is restricted to a small few, the competitive bid prices do not get distorted. There is a view in the Indian market that non-competitive bidders should also be allowed as competitive bidders. However, in our country, since State Governments are major non-competitive bidders, their volatile surplus funds position could make their participation in T bill auctions very uncertain. Thus, there could be large swings in terms of volumes in auctions. Another view is to make allocation for non competitive bidders outside the notified amount.
  • 22. TREASURY BILLS 22 There is a view in the market that the high frequency of auctions recently brought about by introducing 14 day T bills auctions(along with frequent repos) tends to hinder secondary market activities by reducing investor participation in the secondary market in favour of waiting for few days for primary issues. Also, the staggered settlements dates for treasury Bills falling on different days in a week make secondary market trading across different maturities of T bills less efficient. Perhaps reducing auction frequency and adjust settlement dates of different maturity Treasury bills to fall on the same day in a week so as to improve the fungibility and thereby price discovery and market efficiency. CONCLUSION Though the reform has been criticised as too slow, it needs to be remembered that the institution building is the hardest part of any reforms process and while it is necessary to spur faster development of the secondary market of Government securities, it would be imprudent to increase the speed of reforms without adequate safeguards.
  • 23. TREASURY BILLS 23 BIBLIPGRAPHY 1. Economic Times - Nov 13, June 20, Nov 23, Jan 5, Apr 30, Sep - 25, Feb 23, Apr -4 2. RBI Annual Report - 1992-93, 1993-94, 1994-95, 1995-96, 1996-97, 1997-98. 3. Report on Currency and Finance - 1992-93, 1993-94, 1994-95, 1995-96, 1996-97, 1997-98. 4. CMIE Monthly Report - Nov 1998. 5. Book - Financial Institutions and Markets: Structure, Growth and Innovations
  • 24. TREASURY BILLS 24 APPENDIX Yield on Treasury Bills Period 14 days 91 days 364 days 1994-95 9.16 10.15 1995-96 12.67 12.87 1996-97 4.95 9.67 11.67 1997-98 6.68 8.68 Treasury bills auction (Till Nov - 98) - (Bids in Rs Crore) Period 364 day T-bill auction 91 day T-bill auction 1998 Bids Received Bids Accepted Bids Received Bids Accepted Jan 27 0 950 800 Feb 172 19 604 400 Mar 150 50 420 400 Apr 200 200 1931 1850 May 211 200 850 850 Jun 202 200 856 710 Jul 1164 500 2806 1987 Aug 893 800 2970 2445 Sep 705 600 1955 1760 Oct 1219 800 2999 1805
  • 25. TREASURY BILLS 25 Nov 2631 900 3815 2350
  • 26. TREASURY BILLS 26 nov 13 Central bank sells treasury bills worth Rs 30 billion through open market operations in 10 days Our Banking Bureau in Mumbai The central bank - the Reserve Bank of India (RBI) - has sold close to Rs 3,000 crore (Rs 100 crore = Rs 1 billion) of treasury bills of varying maturities and dated government securities through its open market operations in the past ten days. Going by the subsidiary general ledger (SGL) account trasactions at the RBI, there has been demonetisation to the extent of around Rs 1,800 crore during this period, as it has sold around Rs 800-900 crore of dated securities and around Rs 960 crore of 364-day treasury bills. The balance sold through the open market operation window was 91 day treasury bills, which would have matured before the end of the current fiscal thereby not affecting the year end monetisation figure. According to market sources, the central bank has sold around Rs 2,000 crore of treasury bills in total and most of the stock of t-bills
  • 27. TREASURY BILLS 27 that devolved on the RBI this fiscal has been offloaded in the market. Besides this, around Rs 700 crore of the 11.40 per cent 2000 stock which was privately placed with the central bank for Rs 3,000 crore has been offloaded. Consequent to the outflows from the system on account of the open market operations, outstanding amount in the RBI fixed rate repos has declined. This stands at around Rs 3,465 crore as of date, compared to around Rs 7,400 crore in the beginning of the previous week. However, liquidity levels are still comfortable, say market participants. In spite of this, prices of government securities in secondary market which showed signs of picking up consistently through last week, have been capped at the current levels. “The rally is not being sustained because of RBI’s presence in the market at the current levels,” said dealers. Thursday, the secondary market price of 11.40 per cent 2000 touched the RBI price of Rs 100.10. However, a section of the market feels the RBI may decide to hold its price if it intends to suck out liquidity and control money supply growth. The RBI may
  • 28. TREASURY BILLS 28 also revise its price upwards after setting off a lower cut off yield at the t-bill auctions today, other market players said. The RBI revised the price of this security to Rs 100.10 last Friday when the secondary market price crossed its earlier OMO price of Rs 100.05. This had the effect of capping the rise of prices in the shorter end and the rally began to peter out this week. Moreover, the RBI put the 13.75 per cent 2001 on the sale list at Rs 104.83, or an yield of 11.50 per cent, which resulted in a fall in prices of other three year maturities. ------------------------------------------------------------------------------------------------------------------- ---------------------------- Saturday, June 20, 1998 Central bank to float 28-day treasury bills on auction basis
  • 29. TREASURY BILLS 29 Sowmya Sivakumar in Mumbai The Reserve Bank of India (RBI) -- the central bank -- will shortly hit the market with 28-day treasury bills on an auction basis, around eight months after announcing its intention to introduce it in the credit policy of October. However, it has not yet been finalised whether the auctions will be held on a weekly or fortnightly basis, said sources. The decision to implement the measure now can be seen in the light of the recent repo rate cut which has made the short maturity T-bills more attractive. According to sources, “One of the intentions of the RBI to lower repo rate was to induce investors to get into treasury bills.” Last week, the RBI lowered the repo rate from 6 per cent to 5 per cent. The implicit cut off yield at the auction of 14-day Treasury bills is now at 6.01 per cent, while that on 91 day T-bills is 7.35 per cent. Taking this into account, the 28 day T-bill will probably be offered at an yield of around 6.25-6.50 per cent in the primary market. This means a subscriber gets over 100 basis points more for money lent in 14-day or 28-day treasury bills than what he earns on a three or four day repo.
  • 30. TREASURY BILLS 30 The introduction of a shorter dated instrument such as the 28-day T-bill, rather than, say, a 182 day T-bill which was announced in this April credit policy, will find more takers since treasury bill yields at the shorter end are aligned to secondary market yields but those at the longer end still remain distorted. It is for this reason that there has been a fall in interest in T-bills. For instance, the cut off yield on the 364 day T-bill is 7.99 per cent, while a paper of one year maturity is currently traded in the secondary market at an yield of around 9 per cent. This has resulted in lack of interest in 364-day T-bills, evident in the last auction held on Wednesday which almost entirely devolved on the RBI. “The 28-day T-bill will generate interest if market related yields are given. However, the RBI may not be able to hold the yields at the current levels if the notified amount is small, against a backdrop of surplus liquidity. Bidders will also lower their expectations in the light of the repo rate cut,” said Chandan Sinha, chief dealer, STCI. Sources say that the auction amount will be notified, as it is presently done for other T-bills, but the amount will be subject to change, depending on the response.
  • 31. TREASURY BILLS 31 The amount raised through this instrument will also not make a difference to the government borrowing programme, as it is extinguished in the course of the year. However, temporary mismatches can be met by raising money through short dated T-bills rather than rely on ways and means advances from the RBI. ------------------------------------------------------------------------------------------------------------------- ---------------------------- Monday, November 23, 1998 Cut-off yields of treasury bills increasingly closer to market rates Our Banking Bureau in Mumbai
  • 32. TREASURY BILLS 32 Implicit cut-off yields fixed by the Reserve Bank of India (RBI) -- the central bank -- at the primary auctions of treasury bills (T-bills) are becoming increasingly market-related. Hence, they can be considered more an indicator of where the market perceives short-term interest rates to be rather than a signal by the apex bank on the direction of rates. The only instance when the implicit cut-off yields on T-bills can be read as RBI's signal is when it decides to retain a particular level at the cost of taking a devolvement on itself, said money market dealers. At the last auction of 14- and 91-day T-bills, these were hiked to 8.63 per cent and 9.48 per cent from 8.11 per cent and 9.35 per cent, respectively. Bidders would have bid at a slightly lower price (and hence a higher yield) as a result of a drain in liquidity which took place in the form of open market operations by the RBI, they said. Besides, a one paise reduction in the cut-off price results in a 26 basis points hike in the case of 14-day T-bills and a 4 basis points hike in 91-day T-bills. This means by fixing a cut-off which is merely two paise less than
  • 33. TREASURY BILLS 33 the previous auction, the yield on 14-day T-bills is taken up by 52 basis points, as in the case of the last auction. Hence, the hike in the 14-day T-bill yields cannot be construed as RBI's signal of higher rates. An analysis of T-bill auctions results pre and post-mid term review of the credit policy reveals that barring the auctions just prior to the announcement of the review, there has been no devolvements on the RBI or primary dealers. In the case of 14-day T-bills auction on October 16 and 91-day T-bills auction on October 23, there was a 77.6 per cent and 97.4 per cent devolvement, respectively, on the RBI. The RBI retained the implicit yields at these auctions at 8.89 per cent and 10.07 per cent, respectively. The devolvement could be attributed to the higher notified amounts at Rs 500 crore (Rs 5 billion) each at these auctions which did not go down well in the market prior to the credit policy review due to the uncertainty regarding interest rates. The reduction in notified amounts to Rs 100 crore and Rs 200 crore, respectively, from the next auction onwards, coupled with factors such as status quo on interest rate indicators at the credit policy, followed by a private placement with the RBI for Rs 5,000
  • 34. TREASURY BILLS 34 crore, have resulted in enthusiastic bidding responses at the auctions. In addition, there was a switchover to the uniform price auction system for 91-day T-bills. ------------------------------------------------------------------------------------------------------------------- ---------------------------- Monday, January 5, 1998 Central bank approves foreign funds to invest in treasury bills; capital market regulator to frame the guidelines shortly Denny Thomas in Mumbai The Reserve Bank of India (RBI) -- the central bank -- has decided in principle to permit foreign institutional investors (FIIs) to invest in treasury bills, indicating governor
  • 35. TREASURY BILLS 35 Bimal Jalan's resolve to proceed with the capital account convertibility schedule suggested by the Tarapore Committee. According to Reserve Bank sources, FIIs will be allowed to invest in T-bills within the current fiscal. The central bank will soon be issuing a circular to this effect. The decision was taken at a high-level RBI meeting in Mumbai recently. FIIs are already allowed to invest in dated government securities. The Tarapore committee had recommended that FIIs be allowed to invest in T- bills in the first phase of CAC (1997-98). The committee had suggested that maturity restrictions on investment in debt instruments (including T-bills) be removed. It had added that foreign institutional investment in rupee debt securities should be kept outside the external commercial borrowings ceiling, but could be limited by a separate ceiling. However, RBI sources said the bank is unlikely to place any restrictions on the quantum of
  • 36. TREASURY BILLS 36 investment FIIs can make in T-bills. After the notification is issued, the Securities and Exchange Board of India will have to frame operative guidelines for FII investments in this instrument, as it does for all the segments in which FIIs are allowed to invest funds, pointed out RBI sources. The opening up of T-bills to foreign institutions is expected to result in increased portfolio investment in India. According to RBI sources, some of the FIIs had earlier approached the central bank requesting it to open up this segment. The Reserve Bank's move is significant as it implies a shift in the financing of the government. Apart from enabling the government to borrow foreign funds at cheap rates, the move will also help align short-term rates in India with international rates. The central bank took the decision after studying the pattern of portfolio investment in India during the past few months. Earlier, the Reserve Bank wanted to take a decision based on foreign fund allocation in the first quarter. However, the plan was dropped as it was felt that the figures for the first quarter were exceptionally high.
  • 37. TREASURY BILLS 37 The Reserve Bank's decision marks an end to a heated internal debate. It was argued that allowing FIIs to participate in the T-bills segment would lead to excessive volatility. This, in turn, would mean that interest rates would be influenced by the extreme volatility. Hence, the central bank had earlier not opened up this particular segment for FII investment. In the course of the debate, several proposals were put forward to minimise the risk of volatility if FIIs were allowed to invest in T-bills. One proposal was to put a ceiling on the total exposure that FIIs could take in this segment. However, the Reserve Bank has now decided that such restrictions may not be required and the proposal is unlikely to be implemented. ------------------------------------------------------------------------------------------------------------------- ---------------------------- Thursday, April 30, 1998
  • 38. TREASURY BILLS 38 EXPERT OPINION Shaun Browne, CEO, HSBC Capital Markets India holds the opinion that the foreign funds rush into the treasury bills segment is unlikely The markets were expecting some crucial measures in the form of CRR cuts. The bank and repo rates are down by one per cent, but one would have to keep in mind the yields on rupee bonds at this stage. There is a huge borrowing programme from the government and this may not have come out as a positive development to the markets at this stage until there is a signal of fresh liquidity coming into the system. The RBI has however sent the signals that the liquidity in the system is at comfortable and adequate levels. The RBI governor Bimal Jalan has given himself time to reduce the CRR, if required and the door has been kept open to cut the CRR if liquidity comes under pressure. The move to allow FIIs to purchase/sell treasury bills was also announced. We do not think that there will be a large turn-out and the rush from FIIs may not be seen. This is because the yields are currently too low (at 7 per cent against 10 per cent on the longer end). Thus these operations would be resorted to for pure trading purposes and keeping short-term liquidity in mind
  • 39. TREASURY BILLS 39 and used between buying/ selling instruments. It would however be a positive development from a sentiment point of view. ------------------------------------------------------------------------------------------------------------------- ----------------- Friday, September 25, 1998 J P Morgan unveils constant duration treasury bill index Our Banking Bureau in Mumbai J P Morgan has launched a constant duration treasury bill index, which will be the first index for the domestic market that captures returns of short term money market instruments. The JP Morgan Treasury Bill Index (JPM TBI) will be a composite index derived from equally weighted sub-indices. "The sub-indices will track returns on outstanding treasury bills divided into four buckets based on residual maturities- less than and equal to 60 days, 61-120 days, 121-240 days and 241-364 days," explained Amit
  • 40. TREASURY BILLS 40 Agarwal, associate, market research, JP Morgan, at the launch of the index here. The returns on investments at the mid-point of each of these buckets - 30 days, 90 days, 180 days and 300 days, which will constitute the benchmark instruments for the composite index, will be captured in the index. To avoid the problem of duration drift which makes it difficult to compare the index over different points of time, the JPM TBI has been based on a constant duration model. "The index, which reflects returns on a passive portfolio, will be invested fully in the four benchmark instruments and rolled over daily. The daily returns on the index will be reinvested equally across the four buckets," said Agarwal. The base date of the index has been taken as April 1, 1996, and the index value as on that date as 1000. The index on September 15, 1998, had a value of 1283.10. The index will provide returns in terms of both the rupee and the US dollar. The index will use secondary market traded data from the subsidiary general ledger (SGL) released by the Reserve Bank of India. On days when there is scant trading or illiquidity, the mid of the bid-offer quotes provided by Reuters would be used, said Agarwal.
  • 41. TREASURY BILLS 41 "The index is expected to be a significant input in the monetary composite index (MCI) proposed by the Reserve Bank of India," said Aashish Pitale, head of market research, JP Morgan. The index will hopefully evolve as a performance benchmark for banks, money market mutual funds and foreign institutional investors, he added. It will basically provide a benchmark to guage performance of funds and test investment strategies. It can also be used for asset allocation decisions, said Agarwal. JP Morgan intends to make this a real time index once screen-based trading is introduced. Initially, it will be available through publications of the company. ------------------------------------------------------------------------------------------------------------------- ----------------- Monday, February 23, 1998 Central bank's move of not offering higher yields on T-bills baffles market
  • 42. TREASURY BILLS 42 Our Banking Bureau in Mumbai The decision by the Reserve Bank of India (RBI) -- the central bank -- to accept surplus funds of the banking system at 9 per cent through repos and not hike the cut off yield at the auction of 14-day and 91-day treasury bills from the present level of 7.23 per cent and 7.35 per cent respectively has virtually killed the treasury bills market. Competitive bidders have preferred to park money with RBI through repos rather than invest in treasury bills. At the same time, they have not reinvested the proceeds from the maturing of existing stock of treasury bills. The RBI has not raised any resources at the last three auctions of 364-day treasury bills. Consequently, the outstanding stock of 364-day treasury bills has declined from Rs 17,517 crore (Rs 100 crore = Rs 1 billion) on January 14 to Rs 16,771 crore by February 13. At the auction of 91-day treasury bills, since primary dealers have shied away from underwriting, the devolvement has been on the central bank. The stock of 91-day treasury bills
  • 43. TREASURY BILLS 43 with RBI has gone up from Rs 244 crore to Rs 466 crore. The outstanding stock of 91-day treasury bills has declined by Rs 600 crore to Rs 2850 crore. The measures which the central bank announced on January 16 were undoubtedly justified. "However, the decision not to offer higher yields on 14-day, 91-day and 364-day treasury bills is baffling," says S R Kamath, deputy general manager, STCI. Since the Bank Rate was hiked by 2 per cent and cash reserve ratio by 50 basis points, Kamath's logic is that RBI should be offering at least 9.25 per cent on 14-day, between 9.50 - 9.75 per cent on 91-day and at least 10 per cent on 364-day treasury bills. This would ensure that competitive bidders do not go for the soft option of parking funds in repos. "This time around, the money and securities market has paid a heavy price in order to rein in volatility in the forex market. It remains to be seen when the market would recover," says a primary dealer. Strange are the ways of RBI for it offers a commission of 12 paise to the primary dealers. While the successful competitive bidders get a yield of 7.32 per cent, the primary
  • 44. TREASURY BILLS 44 dealers get a yield of 10.47 per cent. However, primary dealers in general have stayed clear of underwriting the issues. It is in the interest of RBI to ensure that a conducive interest rate regime is created ahead of the next year's borrowing programme of the government. At the same time, the interest of banks in treasury bills has to be regenerated. For, in April, over Rs 4,800 crore worth 364- day treasury bills are maturing, and the government would rather have them reinvest it. ------------------------------------------------------------------------------------------------------------------- ----------------- Thursday, April 30, 1998 Reintroduction of 182-day treasury bills may provide fillip to trading activity in secondary market The decision by Reserve Bank of India (RBI) to reintroduce the 182-day treasury bill and review the frequency of auction of treasury bills is expected to deepen and broaden the market for treasury bills. The RBI has reintroduced the auction of 182-day treasury bills on a
  • 45. TREASURY BILLS 45 fortnightly basis. Interestingly, the 182-day treasury bills were introduced in 1986 on the recommendation of the Sukhomoy Chakravarty Committee, but later discontinued in 1992 because of lack of investor interest. S R Kamath, deputy general manager, Securities Trading Corporation of India Ltd, is of the view that the re-introduction of the 182-day treasury bills will provide a fillip to trading activity in the secondary market. Market watchers point out that RBIs efforts will come to a naught if it continues to set the implicit cut-off yields at the auctions which are out of sync with the secondary market yields. During the last 12 months there has been a decline in interest in this instrument precisely because of this reason. "The reduction in the periodicity of conducting 364-day treasury bills auctions to a monthly basis instead of conducting every fortnight would avoid the bunching up of auctions," said Kamath. "The reintroduction of auction of 182-day treasury bills will provide a medium instrument that will meet the requirements of many players," feels S K Mukherji, managing director of the Discount and Finance House of India. It has also permitted foreign institutional investors (FII) to purchase and sell treasury bills within the overall approved debt ceilings. Outlining the rationale behind the move, RBI officials said that they expect the FIIs to use this instrument for parking short-term surpluses. They do not expect any significant investment by FIIs in treasury bills.
  • 46. TREASURY BILLS 46 Currently the RBI conducts auctions of 14-day and 91-day treasury bills on a weekly basis and of 364-day treasury bills on a fortnightly basis. The RBI has adopted a strategy of revamping the treasury bills market and introduced the system of notifying amounts for 14- and 364-day bills. The decision to introduce 28-day bills on auction basis is yet to see the light of the day. ------------------------------------------------------------------------------------------------------------------- ----------------- Thursday, April 30, 1998 Mixed reaction to FII participation in t-bills While there has not been any enthusiastic response for the RBI move to allow participation by foreign institutional investors in treasury bills (T-Bills), those active in the debt market welcomed the move. Credit Suisse First Boston is a very active player in the debt market. K R Bharat, managing director, CSFB, was upbeat. He indicated that they would immediately take a look at t-bills. "It is a very positive move. We are already active in government securities through our fixed income operations. We will certainly include t-bills in our portfolio," he said. Shaun Browne, chief executive officer, HSBC Capital Markets India, felt that there may not be too may FIIs enthusiastic to put funds in t-bills. "We do not believe that there would be a huge rush for the t-bills segment considering that yields are still low. It is a sentiment-driven move," he said. However, RBI sources said that the move is not only for inducing FII investment in t-bills. It is also aimed at providing FIIs a risk-free, short-term investment avenue. This is expected to curtail volatility in the forex market due to sudden repatriation of funds from equities.
  • 47. TREASURY BILLS 47 Fund managers said that most investors would like to park their funds in fixed income. However, they believed nobody would come to India to specifically invest in t-bills. "It is good for FIIs to park their funds in t-bills rather than converting it into dollars. One has to incur cost of conversion. However, as an investment avenue, it is a very low yielding instrument," Richard Overton, managing director, ITC Threadneedle Mutual Fund, said. Market players expressed satisfaction at the decision. "We expected the decision for allowing foreign investors in t-bills. It was a policy decision put off for a while," said Brian Brown, managing director, W I Carr Securities. Nimesh Kampani, chairman, JM Financials, felt that the facility has been extended to FIIs to manage liquidity. "There may not be any substantial increase in volume in t-bills as it is not an attractive investment due to 6-7 per cent forward cost that one has to incur," he said. Dileep Madgavkar, who heads fixed income at Prudential ICICI AMC, said that the impact may not be visible soon. "We have to wait and watch the impact of allowing FIIs to invest in t-bills. It remains to be seen if there can be any demand for the instrument," he said. A section of market players felt that increased volume in t-bills due to FII investment would mean liquidity in these instruments. However, on the flip side, it may also result in an increase in volatility in the short-term interest rates. Vishnu Deuskar, country treasurer, ABN AMRO Bank, feels that there will be hardly any impact on volumes of FII investment in fixed income securities as it is within the overall approved debt ceilings. According to details provided by Sebi, as on March 31, 1998, 17 approvals have been given for 100 per cent debt investment for a total allocation of US $ 2.5 billion. Of these, as on April 26, 4 FIIs have become active, and have made cumulative net investment of $ 143.4 million. ------------------------------------------------------------------------------------------------------------------- ----------------- Thursday, April 30, 1998
  • 48. TREASURY BILLS 48 Jalan signals lower interest rates; cuts bank rate to 8 per cent, frees interest rates on small loans and allows foreign funds to invest in T-bills Our Banking Bureau in Mumbai The Reserve Bank of India has cut the Bank Rate by one percentage point to 9 per cent, introduced one-day repos, freed interest rates on small loans, promised to cut the cash reserve ratio if the situation warrants in future and said the capital adequacy ratio for banks would be hiked in the near future. Talking to Business Standard after unveiling the monetary and credit policy for the first half of 1998-99 fiscal, Reserve Bank governor Bimal Jalan said “credit will not be a constraint this year.” The policy broadly divided into structural measures and credit measures also cut the export credit rate by 1 per cent point to 11 per cent and doubled the export refinance limit to 100 per cent of the incremental outstanding credit. As per the Narasimham committee recommendations, the RBI plans to hike capital adequacy ratio for banks, Jalan said. Announcing the targets for 1998-99, he pegged money supply growth in the range of 15-15.5 per cent, the same as last year. The aggregate deposit growth at 15.5 per cent is lower than the actual growth of 18.9 per in 1997-98 and the increase in funds flow to the corporate sector at 19 per cent is higher than the actual growth of 17.6 per cent in 1997-98. The GDP growth has been pegged at 6.5-7 per cent and the governor has stated that inflation should be reined in between 5 and 6 per cent. The policy unveiled Wednesday had four major thrust: * development of the markets; * curbing volatility in the markets; * freeing interest rates; and * creating new instruments of monetary control and signalling lower interest rates. Jalan said, “I would not like to describe the policy in one word whether it is expansionary or not. I think it is the right policy for this time. Concerns about inflation have receded a bit. Concerns about growth are predominant now. The policy tries to project that credit availability is not going to be a constraint on growth.”
  • 49. TREASURY BILLS 49 Jalan said “the developments considered while framing the policy included higher than the projected growth of money supply in relation to the growth in GDP, substantial increase in financial flows from banks to the corporate sector despite the industrial slowdown, a higher government borrowing programme and uncertainty in the external currency market.” The short-term objectives of the policy were to accelerate industrial investment and output, keep inflation low, continue financial reforms, reduce interest rates and improve credit delivery mechanisms. Jalan, however, put a rider. Quite frankly, I don’t know anywhere in the world where the monetary policy per se can induce you to behave in a certain way or take long-term investment decisions. Interest rates have a role in influencing investment decisions. No body can force anybody to lend if there is no demand.” Curbing volatility The RBI has allowed foreign institutional investors to invest in treasury bills and given banks the freedom to levy penal interest rates on premature withdrawal of fixed deposits. RBI officials pointed out that whenever FIIs sell in the stock market they take the proceeds out as they do not have short-term avenues to invest in. This creates volatility in the foreign exchange market. On being allowed to invest in treasury bills, the FIIs are expected to park surplus short- term funds and not take them out of the country. The penal interest rate on premature withdrawal of deposits is expected to take volatility out of the money markets when liquidity is tight. In case, call rates shoot up, corporates with huge float funds in the fixed deposit market tend to withdraw them and invest it. This creates large dry pockets in the money market, adding volatility to the rates. With banks being given the freedom and thereby levying a high penal interest rate, premature withdrawals for investment in the call market are expected to fall. Banks have to intimate the penal interest rate to the borrowers while accepting the deposits. Creating a signalling mechanism The most significant tool introduced in Wededaypolicy was the one-day repos. Under these instruments, the RBI will do both repos and reverse repos. Market players expect this to form a floor for call market rates. In recent months, open market operations of the RBI both through outright sales of government securities and repos and reverse repos have gained considerable
  • 50. TREASURY BILLS 50 momentum. The primary objective of these operations was to absorb or provide liquidity in the market though under certain circumstances, repos have also been used to signal changes in interest rates. It is proposed to use both fixed interest and auction-based repos as appropriate. RBI sources point out that the repos being introduced, including the one day repos, will eventually replace CRR as a tool of monetary control. The cut in the Bank Rate will prompt banks to cut their prime lending rates. In fact, various banks will soon be calling their board meetings to take a view on the interest rates. However, bankers had also expected a cut in CRR, which has not happened. But even without the CRR cut, banks are drawing up plans to cut their prime lending rates. Falling interest rates Signalling a falling interest rate regime, the RBI cut Bank Rate by 1 percentage point to 9, increased export credit refinance limits and cut interest rates on export credit. The refinance limit has been hiked to 100 per cent from 50 per cent of the increase in outstanding export credit eligible for refinance over the level of such credit as on February 16, 1996, with effect from May 9 this year. The interest rates on pre-shipment export credit up to 180 days and for incentives receivable from the government covered by the ECGC guarantee in respect of pre-shipment credit up to 90 days is being reduced to 11 per cent from 12 with immediate effect. Interest rate leeway Jalan totally freed the interest rates on small loans. On the lending rate front, Reserve Bank has freed interest rates on borrowings below Rs 2 lakh. It has, however, stipulated that interest rates on these loans should not exceed the prime lending rates. Earlier, for loans up to Rs 25,000, the interest rates was capped at 12 per cent and for loans between Rs 25,000 and Rs 2 lakh, it was capped at 13.5 per cent. Advances against term deposits have been capped at the prime lending rate. On the liability side, the apex bank has allowed banks to offer differential interests on deposits depending on their size. Banks are also free to levy penal interest rates on domestic term deposits and NRE and FNCR (B) deposits. This relaxation will apply to fresh deposits and renewal of
  • 51. TREASURY BILLS 51 existing deposits. At present, banks are not allowed to offer interest above Libor on FCNR (B) deposits. Now the RBI has increased the interest rate ceiling on FCNR (B) deposits of one year and above by 50 basis points. However, in case of deposits of maturities below one year, the rates have been reduced by 25 basis points. Banks will be allowed to fix their own overdue interest rates in respect of FCNR (B) deposits subject to these deposits being renewed. Developing the market Jalan has taken significant steps to develop the money market. The RBI has reduced the lock in for certificates of deposits and fixed deposits to 15 days from 30. It has reduced the size of operation per transaction by entities routing their lendings through primary dealers to Rs 3 crore (Rs 30 million) from Rs 5 crore. The minimum lock in for money market mutual funds have also been reduced to 15 days from 30. In order to develop the government securities market further, it has dispensed with the practice of reverse repos with primary dealers in specified securities. Instead, liquidity support against security of holdings in SGL accounts will be provided for. The 182-day treasury bills have been reintroduced, one-day repos are being introduced and the periodicity of 364-day auctions will now be monthly instead of fortnightly. FIIs have also been allowed to invest in treasury bills. In order to develop secondary market trading in government securities, the RBI has said the total investment portfolio of banks should be marked to market in the next three years. As of March 1999, 70 per cent of the bank’s investment portfolio will need to be marked to the market. The Reserve Bank has taken steps to give a composite cash credit limit to cover the farmers’ production, post harvest and household requirements, as recommended by the Gupta panel. The move is to improve credit delivery to the agricultural sector. However, the RBI has not taken any view on the Khan committee recommendations on harmonisation of the roles of banks and FIs. The rules for advances against shares has been relaxed with borrowers limit increased to Rs 20 lakh from Rs 10 lakh and the margin requirement reduced to 25 per cent from 50 per cent. ________________________________________________________________________ ____________________________________
  • 52. TREASURY BILLS 52 Saturday, April 4, 1998 Finance ministry issues notification enabling the central bank to make changes in treasury bills scheme Abhijit Doshi in Mumbai The finance ministry has issued a notification enabling the central bank - the Reserve Bank of India - to impact changes in the treasury bills scheme. The omnibus provisions in the notification, dated March 31, will remove the need for the RBI to approach the Centre every time it wants to introduce a change. The notification enables the RBI to issue bills of varying maturities with a maximum tenor of up to 364 days. The RBI will now also be able to notify the nominal amounts of bills to be sold to competitive bidders from time to time. Now that the notification has been issued, bankers expect the RBI to introduce 28-day treasury bills soon. A beginning has already been made in this direction with the RBI notifying a Rs 100 crore (Rs 100 crore = Rs 1 billion) 14-day T-bill auction on April 3. This was the first time that the Centre notified the amount ahead of the auction of treasury bills of tenor other than 91-days. Another change is the removal of non-competitive bidders from the auctions. State governments and provident funds will henceforth not take part at the auctions. The allocation for non- competitive bidders will be at the discretion of the RBI and will be outside the notified amount. According to the notification, allocation for non-competitive bidders will be at the weighted average price arrived at on the basis of competitive bids accepted at the auctions. Another provision enables the RBI to make allocations at the auctions through either ‘uniform price auction’ or ‘multiple price auction’. The method of auction will be announced by the RBI from time to time. The notification also said the RBI may participate at the auctions as a non-competitor and buy bills for either a part or the whole of the amount notified at the cut off price fixed at the auction. The minimum amount for bids has been changed to Rs 25,000 for all maturities. Till now, the
  • 53. TREASURY BILLS 53 minimum amount varied between various maturities. For example, the amount was Rs 25,000 for 91-day bills and Rs one lakh for 364-day bills. The government has allowed banks to authorise the RBI to debit their accounts for payment on allocation, thus doing away with the need to issue cheques to the central bank. ________________________________________________________________________ ________________________________

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