US and us

Indian stockmarket is closely linked to the US markets

The boom in technology stocks in the year 2000 meant sleepless nights for many traders and investors in more ways than one "" the high correlation of technology stocks with the Nasdaq had them following the US markets at midnight. After the rally went bust, the tracking of the US markets came down to a large extent.

But does that mean the Indian markets are no longer co-related to the movements in the US markets? According to National Stock Exchange (NSE) data for January, correlation between the Nifty and the Dow Jones Industrials was as low as 0.26 and with the Nasdaq Composite, it was 0.41.

True, the two markets may not tread the same path on a day-to-day basis, but in terms of broad trends, the movement of the two markets is pretty much in line.

The chart alongside clearly shows that since early 2000 both the US and Indian markets trended downward and the rally in the Indian markets in mid-2003 started only after the recovery was already underway in the US. For simplicity, the chart uses only month-end levels for each of the three indices.

The reason the Indian markets track the trend in the US is simple. Much of the rally is supported by funds pumped in by FIIs, who have traditionally done so only when the going has been good in their respective markets.

So the next time one is feeling good about Indian equities, it makes sense to first check if there has been a feel good factor in the US markets as well.

Stabilisation bonds

The Reserve Bank of India has finally announced the calendar for issuing market stabilisation bonds and treasury bills (MSBs), replaced the one day repo with 7-day repo and merged the refinance facilities into one standing facility.

These changes had been heralded in December, but there's one crucial difference. At that time, a standing deposit type facility had been proposed, but there's no mention of that in the recent RBI notifications.

That's because such a facility would tantamount to RBI borrowing on a clean basis, which is prohibited by the RBI Act. Nor does it make sense to have a collateralised deposit facility, because that would require the backing of government securities, which the central bank is short of.

Hence, the temporary compromise, and the standing deposit facility is likely to be introduced as soon as the necessary changes in legislation are made.

Does the new arrangement realise all the RBI's aims? The MSBs give the RBI much needed ammunition for conducting open market operations. That should take much of the weight of money off repos.

With much of the liquidity neutralised by the MSBs, the RBI will be in a position to reposition repos as a pure signalling mechanism, rather than as a sterilisation instrument.

With the repo being for 7 days, the overnight call money market will be revitalised, as will market repos and perhaps the collateralised lending and borrowing obligation as well. Banks will have to think through their funds position before committing money to the repo market now.

Although theoretically the call money market rate should be lower than the 7-day repo rate, in Europe the call money rate is generally slightly higher than the repo rate because of the risk premium due to its uncollaterised nature.

With the new instruments at its command, the RBI will also be in a position to target the call money rate, and it is likely to straighten out the inverted yield curve at the short end, where the yield on 91-day T-bills is ruling below the repo rate.

Where do the new measures fall short of the initial recommendations made in December? The repo rate will still be at the floor of the LAF corridor.

It will continue to be instrument where banks dump funds as a last resort, although with more manageable volumes, some bids could be rejected. A standing deposit facility is therefore essential.

What will be the effect on yields? Due to the glut in supply of shorter term instruments (the stabilisation instruments are treasury bills and one-year securities) , there will be natural firming up of yields in the short terms while on the longer side of the curve, supply constraints will make prices go up and yields come down.

The flatness in the yield curve remains. So far as next fiscal's borrowing calendar is concerned, the combination of new government borrowing, MSBs and state swaps this year will be much higher than borrowings in the first quarter of last year. On the other hand, of course, there are huge amounts parked in repos.

With contributions from Mobis Philipose and Anindita Dey