Debt Market Set For Another Makeover, Reforms To Continue

Updated: Oct 28 2002, 05:30am hrs
Its again time for taking stock of Indias macro-economic situation and to carry forward reforms for Reserve Bank of India (RBI) governor Bimal Jalan. The countrys banking sector has witnessed a sea-change from the time Dr Jalan took over from Dr C Rangarajan.

Over the last few years, the inter-bank market has developed real thick and fast. And with the setting up of Clearing Corporation of India Ltd (CCIL) and the introduction of negotiated dealing system (NDS), the markers have been laid for a truly developed market. In terms of market development, the Indian debt market is arguably ahead of most global markets except for a few like the US, Japan and Italy. And with RBIs willingness to introduce new instruments like STRIPS along with a state-of-the-art trading and settlement systems, the future is, to say the least, bright.

These structural changes make experts believe that the turnover in debt market is likely to witness a significant increase and is expected to exceed Rs 20 lakh crore by 2003. In India, the G-Secs market is the overwhelming part of the overall debt market, in terms of both outstanding securities and traded volumes. The total outstanding debt amounts to Rs 8,500 billion and forms 37 per cent of GDP. Of this, the central government dated securities as on March 31, 2002, amounted to 23 per cent of GDP and that of state governments at 4.5 per cent of GDP. Among G-Secs, a large bulk of volume is accounted for by central government papers. The turnover ratio (total transaction volume during the year as a multiple of outstanding stock) was about 2.7 for the year 2001-02, as compared with 1.6 in 2000-01 and 0.8 in 1995-96.

The RBI is expected to keep the pace of the development by addressing the issues at hand. Says Fixed Income Money Market and Derivatives Association of Indias (FIMMDA) newly-appointed chairman Sudhir M Joshi: "The thick of the issue is to make the repo market a vibrant one. The standardised accounting and documentation will come sooner or later." FIMMDA, on RBIs request, had already submitted its proposal. The RBI recently circulated the draft standardised accounting norm among select banks and primary dealers for their feedback. But the formal approval is still awaited.

The G-Secs market can now demand respectability on the global stage. In the pre-1990 era, the secondary market for G-Secs remained dormant. Artificial yields on G-Secs affected the yield structure of financial assets in the system. Driven by these compulsions, the RBIs monetary management was dominated by a regime of administered interest rates, and rising cash reserve ratio (CRR) and statutory liquidity ratio (SLR) prescriptions. High CRR and SLR left little room for monetary manoeuvering. It is against this backdrop and in the context of the overall economic reforms, that the development of the G-Secs markets was initiated in the 1990s.

With the initial development of the Indian debt market, and with the overall macroeconomic and foreign exchange positions now comfortable, the time is just right for RBI to address major structural issues.

While there is a view that SLR, at 25 per cent, may need to be brought down, the central bank will take a closer look at the related issue of RBIs role as the lender of last resort. "It will have to be examined carefully, since banks may then approach the RBI later, when in trouble, since the central bank is the lender of last resort," sources in the know of the exercise had earlier said.

The SLR has, over the years, been brought down considerably, freeing up banks resources. The SLR is now at 25 per cent: since October 25, 1997, when it was brought down from 31.50 per cent. At the start of the reform process, it was at 38.50 per cent.

But the structural issues relating to a further review of the SLR situation will need to take into account a host of factors. On the CRR front, for instance, RBI has already made its intention clear of eventually bringing down the CRR to the minimum of three per cent. CRR currently stands at five per cent.

On the issue of non-SLR securities too, the package is expected to take a close look. There is a move on the part of the RBI to cap the overall exposure of banks to unrated paper within the non-SLR securities category at 10 per cent of the overall portfolio. This was supposed to have been adhered to by end-September this year. There is, however, no formal operational circular from RBI on this cap yet.

One can also expect a formal announcement from the RBI on CCIL chairman RH Patils brainchild CBLO (collateralised borrowing & lending obligation), where players will do repos for various durations and that could be available for liquid instruments. As of now, repos are bilateral. CBLO will get in lots of liquidity into the market. With the CBLO coming in, the repos market is set to get a fillip.

Even as the CCIL and NDS present a golden opportunity for taking the debt market to the individual investors, retailing of G-Secs has not been gaining momentum. And some moves are expected in the policy. It is important that dated stocks are listed on the stock exchanges so as to gain individual investor attention and confidence.

The debt market has witnessed exponential growth over the last few years with the participation of mutual funds (MFs), primary dealers, insurance companies and entry of other non-bank players. The debt market is predominantly a G-Secs market constituting 69 per cent of the total issuance and 96 per cent of the secondary market volumes. And on top of all this, no one can forget the burgeoning size of the Centres borrowing programme.

Here comes the question of a rate cut. Rate cut or no rate cut is the domain talk for market players, especially before a policy announcement. Though the days are gone when all measures are taken only in the credit policy, hopes abound for a Bank Rate cut.

Conventional wisdom says that with the prevailing liquidity slosh in the market, along with in-control inflation rates, the stage now may be perfect for a Bank Rate reduction. But "who is going to benefit from a Bank Rate cut Who will bear the cost" ABN Amro Bank chief economist Dr Ajit Ranade had told the FE. "I doubt whether a Bank Rate reduction could help bank credit offtake growth. Lending in housing sector has been good. That means banks are doing fine in retail lending, but the moot question is whether a Rate cut could lead higher credit deliveries to corporates," he asked.

"Interest rates will not pose any hurdle for credit growth," he quipped, adding that "the elasticity of credit in response to Bank Rate reduction is not very strong." His views reflect the last fiscals scenario, where a 100 basis points reduction in the Bank Rate seemingly had little impact on the economy. It may be also recalled that banks have slashed their deposits rates in recent times. However, they did not effect any revision in their prime lending rates. Seconded Mr Joshi: "A reduction in the Bank Rate would have no impact on the credit offtake."

However, some treasury heads have some contrasting views. They pointed out the prevailing anomalies in the interest rate front. "If you see the overnight call money rates, which are market determined, rates are hovering below the repos rate of 5.75 per cent. This clearly indicates the scope for rate reductions." Even some bankers pointed out the possibilities of arbitrage in the prevailing scenario.

Economists, however, argue that the low yields on G-Secs are only due to the flush in liquidity. "It is dangerous. Market rates could go below the cost of funds," they feel.

Though Dr Jalan recently expressed his comfort with falling yields, bankers point out that a reduction in lending rates could be a costly proposition for banks. "The cost will be too high for banks, and that will increase their vulnerability. The only beneficiary is the government with a reduction in the cost of borrowings," some point out. But as the borrowing programme is almost over, the RBI might postpone the Rate cut announcement for the time-being.