treasury bills market
TRANSCRIPT
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)
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 THE INTERNATIONAL MARKETS .............................................................................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
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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.
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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.
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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.
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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.
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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.
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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
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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
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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
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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
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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
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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.
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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
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• 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
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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.
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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
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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
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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.
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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 yie lds 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.
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.
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.
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
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
TREASURY BILLS
25
Nov 2631 900 3815 2350
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
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
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.
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----------------------------
Saturday,
June 20, 1998
Central bank to float 28-day treasury bills on auction
basis
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.
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.
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.
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----------------------------
Monday, November 23, 1998
Cut-off yields of treasury bills increasingly closer to
market rates
Our Banking Bureau in Mumbai
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
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
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
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
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.
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
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
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
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.
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
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
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
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
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.
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.
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.
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Thursday,
April 30, 1998
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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.”
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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
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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
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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.
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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
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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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