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Click here to return to main page of Annual Policy Statement 2007-08

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

II. Financial Markets

117.The institutional framework for financial markets is undergoing significant changes in terms of participants, instruments and processes. This ongoing transformation has led to a sharpening of focus in the Reserve Bank’s operations in money, Government securities and foreign exchange markets with a view to improving functional assignment and operational effectiveness. Simultaneously, the orderly functioning and soundness of financial markets are being pursued through regulatory initiatives.

118.In the context of financial deepening and development, the Reserve Bank has pursued a policy of gradual development of financial markets, in particular, the money markets, the Government securities market and the foreign exchange market. With the increasing openness of the economy and the growing integration of domestic market segments with international financial markets, this process needs to be taken forward.

Government Securities Market

119.The implementation of the Fiscal Responsibility and Budget Management Act, 2003 has necessitated introduction of several structural and developmental measures for deepening and widening the Government securities market in terms of participants, instruments and market practices.

(a)State Government Borrowings

(i)Buy-back of State Development Loans

120.Faced with the accumulation of surplus cash balances and a negative spread earned on the investment of such balances, some State Governments had approached the Reserve Bank to arrange for the buy-back of their outstanding State Development Loans (SDLs). Accordingly, the Reserve Bank formulated a general scheme for the buy-back of SDLs with the concurrence of the Government of India. So far, buy-back auctions have been conducted for two State Governments (viz., Orissa and Rajasthan) and a total amount of Rs.479.07 crore of SDLs has been bought back.

(ii)Introduction of Indicative Calendar for Market Borrowings of States

121.The Annual Policy Statement of April 2006 had indicated that States, at their discretion and initiative, would be encouraged to develop an advance indicative open market borrowing calendar, with a view to helping investors to plan their investments in advance and, in turn, to avoid undue liquidity pressure in the system. Following discussions with the State Governments, the operational modalities for introduction of an indicative calendar are being finalised.

(iii)Non-Competitive Bidding Scheme in the Auctions of State Development Loans

122.The Annual Policy Statement of April 2006 had proposed to extend the facility of non-competitive bidding (currently limited to Central Government dated securities) to the primary auction of SDLs, with a view to widening the investor base and enhancing the liquidity of SDLs. Following discussions with State Governments, a ‘Non-Competitive Bidding Scheme’ in the auctions of SDLs would be introduced in the financial year 2007-08. The modalities for operationalisation of the scheme are being finalised.

(iv)Re-issuance of State Government Securities

123.Reissuance of SDLs has been favoured with a view to building up a critical mass and thereby improving the secondary liquidity of such securities. The Reserve Bank is in consultation with the State Governments to introduce a system of reissuances.

(v)Power Bonds

124.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. A few State Governments have exercised the call option to prepay their entire or part of their outstanding power bonds. Accordingly, as on April 1, 2007 the outstanding amount of power bonds in respect of 25 State Governments amounted to Rs.26,051 crore.

(b)Central Government Securities

(i)Floating Rate Bonds

125.With a view to simplifying the methodology for pricing of floating rate bonds (FRBs) in the secondary market, it is proposed to use the average cut-off yield on 182-day Treasury Bills, instead of the yield on 364-day Treasury Bills as a benchmark rate for the FRBs to be issued in future. The base rate for the new FRBs would be the average implicit cut-off yield emerging in the last three auctions of 182-day Treasury Bills held before the coupon reset date. The change in valuation methodology is also being examined in consultation with Fixed Income Money Market and Derivatives Association (FIMMDA)/Primary Dealers’ Association of India (PDAI).

(ii)Active Consolidation in Central Government Securities

126.The Annual Policy Statement of April 2006 stated that there is a need to enlarge the number of actively traded Central Government securities in order to enhance liquidity and improve pricing in the market. Accordingly, it was proposed to consolidate and build up large volumes of liquid securities while continuing with the programme of reissuances. The modalities for undertaking active consolidation of Central Government securities have already been finalised in consultation with the Government of India. In the Union Budget 2007-08, a budgetary provision of Rs.2,500 crore has been made towards premium payments for consolidation. The exercise would commence shortly.

(c)Measures for Development of Market Infrastructure

(i)Repos in the Corporate Bond Market

127.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 reporting platforms for corporate bonds have already been established by stock exchanges as per the Securities and Exchange Board of India (SEBI) guidelines. The FIMMDA is also in the process of setting up a reporting platform for over-the-counter (OTC) trades in corporate bonds and providing a consolidated ticker service for reporting all trades in corporate bonds. Widening of the repo market to include corporate bonds will be considered after the proposed trading platforms stabilise and robust clearing and settlement systems (Delivery versus Payment system) are established.

(ii)Reporting Platform for Interest Rate Swaps

128.The Reserve Bank has recently issued comprehensive guidelines in respect of interest rate derivatives, incorporating the broad regulatory framework for undertaking derivative transactions. In respect of OTC derivative transactions, it has become necessary to have a mechanism for transparent capture and dissemination of trade information as well as an efficient post-trade processing infrastructure to address some of the attendant risks. To begin with, the CCIL is being advised to start a trade reporting platform for Rupee Interest Rate Swaps (IRS). This reporting module would be functional by August 31, 2007 and will thereafter be available to all market participants.

(iii)Interest Rate Derivatives

129.An anonymous order driven system for trading in Interest Rate Derivatives (IRDs) had been introduced on exchanges in 2003. Banks were allowed to hedge the risk in their underlying investment portfolio while Primary Dealers (PDs) were also permitted as market-makers. Since then, the Government securities market has undergone numerous developmental measures, including the introduction of short selling and when-issued markets. Recognising the need for a robust interest rate futures market as an effective instrument for management of interest rate risk, on the recommendation of the Reserve Bank’s Technical Advisory Committee on Money, Foreign Exchange and Government Securities Markets, a Working Group is being set up to go into all the relevant issues and to suggest measures to facilitate the development of interest rate futures market.

Foreign Exchange Market

130.The Reserve Bank has taken several initiatives to provide a more conducive environment for the conduct of foreign exchange business. The prime concern has been to provide prompt and efficient customer service by progressively liberalising foreign exchange related transactions, removing restrictions and simplifying procedures. Concomitantly, powers have been delegated to authorised dealers with a view to improving ease of transactions for the common person.

131.Keeping in view the recommendations of the Committee on Fuller Capital Account Convertibility (CFCAC), the following measures are proposed towards liberalisation of foreign exchange facilities with operational instructions being issued separately:

(a)Rationalisation of Overseas Investment

(i)Investment in Joint Ventures (JVs)/Wholly Owned Subsidiaries (WOS) Abroad

132.In order to provide greater flexibility to Indian companies for investments abroad and to rationalise the existing facilities, it is proposed:

•to enhance the overseas investment limit (total financial commitments) for Indian companies from the existing limit of 200 per cent of their net worth to 300 per cent of their net worth, as per the last audited balance sheet.

•to reckon the amount of guarantee at 100 per cent of the amount instead of the current conversion factor of 50 per cent for determining the total financial commitments.

133.Along with liberalisation, it is also imperative to put in place a robust information system for monitoring capital flows. The current reporting system does not capture data comprehensively on costs and means of funding overseas acquisitions and performance indicators. It has, therefore, been decided to:

•introduce a revised reporting framework on overseas investments.

(ii)Portfolio Investment Overseas

134.At present, listed Indian companies have a separate limit of 25 per cent of net worth for portfolio investment abroad in listed overseas companies. It has been decided:

•to enhance this limit to 35 per cent of net worth.

(iii)Overseas Investment by Mutual Funds

135.At present, the aggregate ceiling on overseas investment by mutual funds is US $ 3 billion. With a view to providing greater opportunity to mutual funds for investment overseas, it is proposed:

•to increase the ceiling to US $ 4 billion.

(b)External Commercial Borrowing

136.With a view to providing greater flexibility to corporates in managing their liquidity and interest costs, it is proposed:

•to allow prepayment of external commercial borrowings (ECBs) up to US $ 400 million as against the existing limit of US $ 300 million by authorised dealer banks without prior approval of the Reserve Bank, subject to compliance with stipulated minimum average maturity period as applicable to loans.

(c)Facilities for Individuals: Liberalised Remittance Scheme

137.In order to further liberalise the Scheme, it is proposed:

•to enhance the present limit of US $ 50,000 to US $ 100,000 per financial year for any permitted current or capital account transaction or a combination of both.


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