Mid-Term Review of the Annual Policy Statement for 2007-08, RBI Credit Policy, Reserve Bank of India: Banknet India

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Part II. Mid-term Review of Annual Statement on Developmental and Regulatory Policies for the Year 2007-08

I. Financial Markets

114. The Reserve Bank has consistently emphasised the importance of developing financial markets as well as operational flexibility for market participants in various segments in an environment secured by effective regulation and oversight.

115. The Technical Advisory Committee (TAC) on Money, Foreign Exchange and Government Securities Markets has provided valuable guidance to the Reserve Bank in the context of its developmental and regulatory role vis-à-vis financial markets. The Committee has met three times since the announcement of the Annual Policy Statement in April 2007.

Government Securities Market

116. The Reserve Bank has endeavoured to broaden and deepen the Government securities market in terms of participants, instruments and processes. Consequent upon the implementation of the Fiscal Responsibility and Budget Management (FRBM) Act, 2003 and withdrawal of the Reserve Bank from the primary segment, development of the Government securities market has assumed vital importance.

(a) State Government Borrowings

(i)Market Borrowings of States: Information Dissemination

117. In consultation with State Governments, the information on gross allocation inclusive of net allocation, additional allocation and repayments during 2007-08 and the amount that could be raised during the remaining period of 2007-08 as market borrowings by State Governments was disseminated through a press release in September 2007.

(ii) Non-Competitive Bidding Scheme in the Auctions of State Development Loans: To be Operationalised

118. The Annual Policy Statement of April 2007 proposed to introduce a ‘Non-Competitive Bidding Scheme’ in the auctions of State Development Loans (SDLs) in the financial year 2007-08 following discussions with State Governments. Accordingly, a scheme for Non-Competitive Bidding Facility was incorporated in the Revised General Notification issued by all State Governments on July 20, 2007. The scheme would be operationalised by March 31, 2008.

(iii) Reissuance of State Government Securities

119. Reissuance of SDLs has been favoured with a view to building up a critical mass of stock in the gilt market thereby improving the secondary liquidity of such securities. The Reserve Bank, in consultation with State Governments, has proposed to introduce a system of reissuances. Responses received from State Governments in this regard are being examined and it is proposed to re-issue SDLs in the second half of 2007-08.

(iv) Power Bonds

120. Under the scheme for one-time settlement of outstanding dues of the State Electricity Boards (SEBs) to Central Public Sector Undertakings (CPSUs), power bonds for an aggregate amount of Rs.31,581 crore were issued by 27 State Governments. The repayment of these power bonds started from the year 2006-07. State Governments could exercise the call option for full or part prepayment of their outstanding power bonds on April 1, 2008 as per the terms and conditions of the respective Notifications.

(b) Central Government Securities

Floating Rate Bonds

121. With a view to simplifying the methodology for pricing of floating rate bonds (FRBs) in the secondary market, the Annual Policy Statement of April 2007 had proposed to examine the change in valuation methodology in consultation with Fixed Income Money Market and Derivatives Association (FIMMDA)/Primary Dealers’ Association of India (PDAI). Accordingly, a new issuance structure for FRBs has been approved by the TAC on Money, Foreign Exchange and Government Securities Markets and the facility to handle the new issuance structure is being built into the new Negotiated Dealing System (NDS) auction system being developed by the Clearing Corporation of India Limited (CCIL). This is expected to be completed by March 31, 2008.

(c) Development of Market Infrastructure

(i)Repos in the Corporate Bond Market

122. The High Level Expert Committee on Corporate Bonds and Securitisation (Chairman: Dr. R.H. Patil) had recommended, inter alia, the establishment of a trade reporting platform for better price discovery. The Securities and Exchange Board of India (SEBI) has since operationalised the reporting platforms managed by the two exchanges, namely, the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE), as well as the industry body, the FIMMDA. As the corporate debt markets develop and the Reserve Bank is assured of availability of fair prices, and an efficient and safe settlement system based on delivery versus payment (DvP) III and Straight Through Processing (STP) is in place, the Reserve Bank is committed to permitting market repos in corporate bonds.

(ii) Reporting Platform for Interest Rate Swaps

123. In the Annual Policy Statement of April 2007, it was announced that the CCIL would develop a trade reporting platform for Rupee Interest Rate Swaps (IRS). The platform has since been operationalised on August 30, 2007 and banks and Primary Dealers (PDs) have started reporting the IRS and Forward Rate Agreements (FRAs) trades on the platform on a daily basis.

(iii)Interest Rate Derivatives

124. Interest rate futures were introduced in India in June 2003. In the context of continued financial market developments, the Annual Policy Statement of April 2007 had proposed to set up a Working Group under the aegis of the TAC on Money, Foreign Exchange and Government Securities Markets to study and suggest measures to facilitate the development of the interest rate futures market. Accordingly, the Reserve Bank has constituted a Working Group on Interest Rate Futures (Chairman: Shri V.K. Sharma) which would review the experience gained so far with interest rate futures with particular reference to product design issues and make recommendations for activating the instrument. The Group would also revisit the recommendations of the earlier Committees in this area and examine regulatory requirements as well as the scope and extent of participation of non-residents while making its own recommendations. The report would be placed on the Reserve Bank’s website within three months (by December 31, 2007) after further discussions with the TAC on Money, Foreign Exchange and Government Securities Markets.

(iv) Market Stabilisation Scheme:Revision of Ceiling

125. A Memorandum of Understanding (MoU) was signed between the Government of India and the Reserve Bank on March 25, 2004 detailing the rationale and operational modalities of the MSS. The Government of India, in consultation with the Reserve Bank, has periodically raised the ceiling on the outstanding obligations of the Government of India by way of issuance of bills/securities under the MSS for the year 2007-08 to the level of Rs.2,00,000 crore as on October 4, 2007. The Reserve Bank announces the auctions under the MSS, if any, for the succeeding week every Friday.

(v) Guidelines on ‘Short Sales’ and ‘When Issued’ Transactions

126.Currently, ‘Short sale’ and ‘When Issued’ transactions are undertaken on the Negotiated Dealing System - Order Matching (NDS-OM) system only. In order to provide further flexibility to participants, it is proposed:

• to permit covering of ‘Short-sale’ and ‘When Issued’ transactions outside the NDS-OM system.

127. Guidelines in this regard would be issued in consultation with the FIMMDA and the PDAI.

(vi) CSGL Option on NDS-OM

128. The screen-based order driven anonymous NDS-OM module was operationalised in August 2005 for trading in Government securities. Access to the module was initially extended to banks and PDs and later to other NDS members including insurance companies, mutual funds and bigger provident funds for their proprietary deals. Constituent trading on the NDS-OM was enabled from May 2007 and access to the system was extended to certain ‘qualified entities’, including deposit taking non-banking financial companies (NBFCs) maintaining gilt accounts with NDS members. It is now proposed:

• to include systemically important non-deposit taking NBFCs (NBFC-ND-SI) as ‘qualified entities’ for accessing the NDS-OM using the CSGL route.

Foreign Exchange Market

129. The Reserve Bank has taken several initiatives to rationalise and simplify the procedures in the conduct of foreign exchange transactions with a view to facilitating prompt and efficient customer service. Keeping in view the recommendations of the Committee on Fuller Capital Account Convertibility (CFCAC), a number of measures were taken towards liberalisation of foreign exchange transactions.

130. The pace of implementation of the recommendations of CFCAC was accelerated with regard to foreign exchange outflows. These measures include: (i) permitting Indian companies as well as registered partnership firms to invest in overseas joint ventures (JV)/wholly owned subsidiaries (WOS) up to 400 per cent of the their net worth under the automatic route; (ii) increasing the existing limit of 35 per cent of the net worth for portfolio investments by listed companies to 50 per cent of the net worth and dispensing with the requirement of 10 per cent reciprocal share holding in the listed Indian companies by overseas companies; (iii) increasing the existing limit for prepayment of external commercial borrowings (ECBs) without the Reserve Bank’s approval from US $ 400 million to US $ 500 million, subject to compliance with the minimum average maturity period; (iv) increasing the aggregate ceiling for overseas investments by mutual funds registered with the SEBI from US $ 4 billion to US $ 5 billion while continuing with the existing facility of investing up to US $ 1 billion in overseas Exchange Traded Funds that may be permitted by the SEBI; and (v) enhancing the existing limit under the Liberalised Remittance Scheme (LRS) for resident individuals from US $ 100,000 to US $ 200,000 per financial year.

131. In the context of recent global and domestic developments and with a view to giving an opportunity to small and medium enterprises to manage the challenges in global markets, the Reserve Bank, in consultation with the Government of India, permitted all exporters as a temporary measure, to earn interest on their Exchange Earners’ Foreign Currency (EEFC) accounts to the extent of outstanding balances of US $ 1 million per exporter. This facility would be valid up to October 31, 2008 and banks are free to determine the rate of interest.

132. In addition, the coverage of the interest subvention scheme in respect of rupee export credit to specified categories of exporters was widened and the validity of the scheme was extended by three months from December 31, 2007 to March 31, 2008.

(a) Expansion of Hedging Facilities

133. The range of hedging tools available to the market participants has been further expanded keeping in view the evolution of foreign exchange market.

Forward Contracts

Hedging Facility for Exporters and Importers

134. Under extant guidelines, exporters and importers are permitted to hedge on the basis of declaration of an exposure and based on past performance criteria as specified. Market participants have represented to the Reserve Bank that the facility of hedging under the past performance route may be available on a continuous basis. In order to facilitate exporters and importers to hedge their exposures on a dynamic basis, it is now proposed:

• to permit reinstatement of the eligible limits under the past performance route to the extent that supporting underlying documents are produced during the term of the hedge undertaken; and

• the reinstatement facility would not, however, be available for contracts already cancelled under the scheme.

Oil Refining and Marketing Companies

135. With a view to facilitating hedging of foreign exchange exposure in respect of oil companies, it is proposed:

• to permit oil companies to hedge their foreign exchange exposures to the extent of 50 per cent of their inventory volume as at the end of the previous quarter by using overseas over-the-counter (OTC)/exchange traded derivatives up to a maximum of one year forward.

(b) Currency Futures

136. The Annual Policy Statement of April 2007 proposed to set up a Working Group on Currency Futures to study the international experience and suggest a suitable framework to operationalise the proposal within the existing legal and regulatory framework. Accordingly, an Internal Working Group on Currency Futures (Chairman: Shri Salim Gangadharan) was set up which studied, inter alia, the experiences of some emerging market economies where currency futures exchanges have been functioning within an environment of capital controls. The Group considered the views of a wide cross section of stakeholders, including banks, industry associations, domestic and international exchanges, and has had extensive and detailed consultations with market participants in the TAC on Money, Foreign Exchange and Government Securities Markets. The Group has explored various options for the proposed currency futures exchange, particularly on aspects like participation, clearing and settlement, market intermediaries, margins, contract design and surveillance mechanism. The draft report of the Group would be placed on the Reserve Bank’s website for comments by November 15, 2007.

(c) Derivatives

137. The Reserve Bank had constituted an Internal Group for preparing consolidated guidelines on derivatives. Based on the recommendations of the Group in respect of foreign exchange derivatives, the following measures are proposed with a view to providing greater flexibility to the residents:

(i) Writing of Options

138. Currently, corporates are allowed only to purchase options on a stand-alone basis. In certain cases, corporates are permitted to write options as part of a zero cost structure. It is now proposed:

• to allow importers and exporters having foreign currency exposures to write covered call and put options in both foreign currency/rupee and cross currency and receive premia.

(ii) Running Options Book

139. In terms of extant guidelines, authorised dealers (ADs) desirous of running options books in foreign currency rupee options are permitted to do so, subject to approval by the Reserve Bank. In order to enable the ADs to manage their risks efficiently, it is proposed:

• to permit ADs to run cross currency options books, subject to the Reserve Bank’s approval.

(iii) Types of Options

140. Under extant guidelines on foreign currency rupee options, ADs are permitted to offer only plain vanilla European options. In keeping with the gradual evolution of the foreign exchange market and based on market demand, it is now proposed:

• to permit ADs to offer American options as well.

II. Credit Delivery Mechanism and Other Banking Services... Click Here For Full Text

III. Prudential Measures... Click Here For Full Text

IV. Institutional Developments... Click Here For Full Text

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