STRIPS date foreseen

MONETARY POLICY PREVIEW/ MONEY MARKETS

M S Annigeri
Chief Executive Officer
Fimmda

In recent times, management of the huge liquidity overhang in the system has engaged the attention of the Reserve Bank of India (RBI), resulting in the introduction of new instruments of sterilisation such as market stabilisation bonds and a modified liquidity adjustment facility (LAF).

In this context, we shall first look at the various instruments available to RBI for managing liquidity.

Traditionally, RBI has used the following three instruments for managing liquidity viz. the cash reserve ratio, LAF and open market operations (OMO).

The first of these instruments has been used sparingly in recent times, particularly to curb any speculative attack on the local currency.

In the current scenario, any sustained effort to speculate on the rupee is unlikely. Nevertheless, while on the subject, it may be worthwhile analysing the impact of an increase in CRR.

The first and most important aspect of a CRR hike is the uniform impact on the banking industry, being a mandatory pre-emption.

Further, unlike the case with OMO or LAF, any hike in CRR leads to a steep increase in interest rates, leading to a higher cost of borrowing in respect of new issuances by the government.

Also, at the current juncture, interest outgo for the RBI on additional CRR, if stipulated, would be at the bank rate of 6 per cent, which is very high, given the present interest rate scenario.

Given the state of liquidity, the RBI has been compelled to use the other two options almost regularly over the last couple of years. It must, however, be noted that exercise of these options on a sustained basis is possible, subject to availability of adequate stock of government securities with the RBI.

During 2003-04, OMO sales amounted to about Rs 41,000 crore and the average daily LAF deployment amounted to Rs 31,000 crore. Therefore, the issue of availability of stock to address the surging systemic liquidity has assumed a lot of importance.

MSS as a tool for sterilisation ensures that there is an explicit cost to the "fisc" rather than an implicit cost, as in the case of LAF or OMO.

As on April 30, 2004, the amount raised under MSS worked out to Rs 22,851 crore , leaving a balance of Rs 37, 149 crore that can be raised during the remaining part of this financial year, considering that the maximum amount for 2004-05 has been fixed at Rs 60,000 crore.

Alongside MSS, the RBI also changed the LAF structure from an overnight repo to a 7-day repo. Accordingly, RBI now conducts 7-day repos on a daily basis; the current outstanding amount works out to approximately Rs 76,000 crore, indicating the continuance of a large surplus liquidity in the system.

In the backdrop of excess liquidity in the system, trading in Govt. securities had been registering steadily increasing volumes. However, the market had for some time now, been asking for the facility of "same day purchase and sale".

The introduction of DVP-III has now made this possible, and in the process, reduced the price risk in the trading portfolio of market participants.

The crucial part of this exercise lies in establishing that the purchase contract preceded the sale contract, and that, therefore, there was no "short sale".

However, given the robust clearing and settlement mechanism in place, it would perhaps be worthwhile reviewing the restriction on "short sale".

Having said that, it must be mentioned that the "same day purchase and sale", facilitated by DVP-III, has contributed to a significant increase in trading volumes. As far as the bi-annual monetary policy statement is concerned, we expect no change in the key rates.

However, the statement is expected to carry a commentary on the global interest rate scenario, with special reference to the likely US Federal Reserve rate hike, and implications thereof for the Indian markets.

On the product side, one could perhaps expect some announcement on the introduction of STRIPS. Also, it is expected that there would be some facilitating change in the regulation pertaining to interest rate futures to enable a greater level of participation by banks in this area.