PDs may not get forex, commodities entry

New norms to open up only equity trading.

Reserve Bank of India (RBI) is unlikely to allow primary dealers to enter into commodity and foreign exchange trading business immediately, as requested by some, a central bank official said on Monday.

New norms for primary dealers, likely to be released in two weeks, may allow them to foray only into equity trading, he said.

The central bank will announce two sets of guidelines for primary dealers, one for standalone primary dealers and the other for bank-primary dealers, he said.

RBI recently allowed banks to undertake PD business directly. Earlier, banks had to set up subsidiaries to undertake this business.

Primary dealership system was started a decade ago to underwrite government bond auctions and to provide liquidity in secondary gilt market.

PDs' role is set to gain prominence from April 1, when RBI stops participating in primary gilt market.

As per the Fiscal Responsibility and Budget Management Act, from April 1, RBI can't support government borrowing by taking private placements or buying gilts that are not subscribed at auctions.

It can only buy or sell gilts in the secondary market.

As a result, primary dealers will have to support the government borrowing programme by underwriting 100 per cent of the auction, as against the current allowance of part-underwriting.

Primary dealers have been asking RBI to allow them to trade and invest in other instruments such as foreign exchange, equities, and commodities because rising interest rates have dented their profitability from bonds.

The central bank official, however, said the diversification of primary dealership activity could be limited to only equities at this juncture.

According to industry officials, some primary dealers with large capital are planning to spin off their PD business into separate subsidiaries so that they have freedom to diversify into other businesses.

Primary dealers with low capital, however, can't expand the domain of their business. Some primary dealerships founded by banks are likely to merge back into their parent banks.

"I think some PDs set up by foreign banks are planning to merge back. Some will remain. Let's see what the guidelines will be," a primary dealer said.

Primary dealers are bracing themselves for a difficult financial year ahead because the interest rates have been rising, liquidity has been tight, and the government's borrowing target is very large.

The government plans to issue Rs 1.53 trillion of gilts on a gross basis in 2006-07 (April-March).

"Except for Life Insurance Corporation and some provident funds, there are no investors in the market. Banks are selling bonds to meet their credit offtake. I think it is going to be very difficult for primary dealers in the next year," said the chief executive of a primary dealership firm founded by a foreign bank.