Development of Financial
Markets in India
Rakesh Mohan
Deputy Governor
Reserve Bank of India
Lecture at
the First Indian-French Financial Forum
at Mumbai, May 16, 2007
1
Scheme of the Presentation
 Role of Financial Markets
 Money Market
 Government Securities Market
 Foreign Exchange Market
 Financial Market Integration
2
Role of Financial Markets
 Intermediate between savers and investors
 Generate resources for investment and growth
 Allocate resources efficiently
 Improve the efficacy of the transmission
mechanism of monetary policy
3
Financial Markets in Pre-reform Period –
Major Problems
 Administered Interest rates
 Limited Instruments
 Restrictions on Participation
 Segmentation of Markets
4
Money Market

Role of the Money Market


Key role in the transmission of monetary policy
impulses
Major Reforms Introduced




Development of the Liquidity Adjustment Facility
Development of collateralised instruments – CBLO and
Market Repo
Modification in issuance norms and maturity profile of
CD and CP
Setting up of central counter party – Clearing
Corporation of India Ltd. (CCIL)
5
Money Market
Impact – Increase in Activity
(Rupees crore)
Average Daily Turnover
Year
Outstanding Amount
Call
Money
Market
Market
Repo
(Outside
the LAF)
Collateralised
Borrowing and
Lending
Obligation
(CBLO)
Term
Money
Market
Money Market
- Total (2 to5)
Comme
rcial
Paper
Certificates
of Deposit
2
3
4
5
6
7
8
1997-98
22709
-
-
-
22709
1500
14296
1998-99
26500
-
-
-
26500
4770
3717
1999-00
23161
6895
-
-
30056
7014
1908
2000-01
32157
10500
-
-
42657
6751
1199
2001-02
35144
30161
-
195
65500
7927
949
2002-03
29421
46960
30
341
76752
8268
1224
2003-04
17191
10435
515
519
28660
7835
3212
2004-05
14170
17135
6697
526
38528
11723
6052
2005-06
17979
21183
20039
833
60034
17285
27298
2006-07
21725
33676
32390
1012
88803
21478
64954
1
6
Money Market
Impact – Decline in Volatility
LAF Corridor and Call Rate
25
15
10
5
Call Rate
Reverse Repo Rate
20-Jan07
14-Jun06
6-Nov05
31-Mar05
23-Aug04
16-Jan04
10-Jun03
2-Nov02
27-Mar02
19-Aug01
11-Jan01
0
5-Jun-00
Per cent
20
Repo Rate
7
Coefficient of variation
1.0
0.9
0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0.0
2006-07
2005-06
2004-05
2003-04
2002-03
2001-02
2000-01
1999-00
1998-99
1997-98
1996-97
1995-96
1994-95
1993-94
Money Market
Impact – Decline in Volatility
Variation in Call Money Rates
8
4/1/2004
5/20/2004
7/2/2004
8/13/2004
9/27/2004
11/6/2004
12/15/2004
1/19/2005
2/25/2005
4/6/2005
5/16/2005
6/21/2005
7/29/2005
9/5/2005
10/11/2005
11/19/2005
12/24/2005
1/31/2006
3/8/2006
4/18/2006
5/25/2006
6/29/2006
8/3/2006
9/8/2006
10/16/2006
11/23/2006
12/29/2006
2/7/07
Per cent
Money Market
Impact – Improvement in Efficiency
Bid-Ask Spread in the Call Money Mark et
1.50
1.25
1.00
0.75
0.50
0.25
0.00
-0.25
-0.50
Bid-Ask Spread
Mean
Mean + 2SD
Mean - 2SD
9
Government Securities Market
 Significance of the G-Sec. Market



Enables smooth raising of government
borrowings
Risk free rupee yield curve provides a benchmark
for pricing other debt instruments
Plays a key role in the monetary policy
transmission mechanism
10
Government Securities Market
 Major Reforms in the G-Sec Market








Auction system for issuance of government securities
Primary Dealer (PD) system
New instruments
Widening of investor base
Debt consolidation – re-issuance of securities
Introduction of short-selling
When issued market allowed
Strengthening of trading and settlement infrastructure
11
Government Securities Market - Impact
Turnover in Government Securities Market
120
400
100
350
300
80
250
60
200
150
40
100
20
50
0
0
1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07
Per cent of GDP
Per cent of Stock (right scale)
12
Government Securities Market
Reasons for the Recent Decline in Activity
Yield and Annual Turnover (market value)
16
14
3000000
12
10
Rs. crore
2500000
2000000
8
6
4
1500000
1000000
500000
2
0
0
1996- 1997- 1998- 1999- 2000- 2001- 2002- 2003- 2004- 2005- 200697
98
99
00
01
02
03
04
05
06
07
Annual Turnover
Yield on 10-year security (end-March)
13
Per cent
3500000
Government Securities Market
Emergence of Yield Curve
Yield Curve Movement - SGL Transactions
14
Per cent
12
10
8
6
4
1
3
5
7
9
11
13
15
17
19
21
23
25
27
29
Years to maturity
Mar-97
Mar-00
Mar-03
Mar-04
Mar-05
Mar-06
14
Foreign Exchange Market
 Major Reforms





Market-determined exchange rate in 1993
Current account convertibility in 1994
Substantial liberalisation of capital account
transactions
Greater flexibility to market participants to
undertake foreign exchange operations
Improvement in market infrastructure
15
Foreign Exchange Market
Increase in Activity
Turnover in the Foreign Exchange Market
(Turnover in US $ billion)
Year
Merchant
Inter-bank
Total
2
3
4
1997-98
210
1096
1305
1998-99
246
1057
1303
1999-00
244
898
1142
2000-01
269
1118
1387
2001-02
257
1165
1422
2002-03
325
1236
1560
2003-04
491
1628
2118
2004-05
705
2188
2892
2005-06
1220
3192
4413
2006-07 (P)
1787
4727
6514
1
16
Foreign Exchange Market
Increase in Size: Relative Terms
Size of the Foreign Exchange Market
Year
Foreign Exchange
BoP size
Col. 2
Market-Annual Turnover
($ billion)
over Col. 3
2
3
4
2000-01
1387
258
5.4
2001-02
1421
237
6.0
2002-03
1560
267
5.8
2003-04
2118
362
5.9
2004-05
2892
481
6.0
2005-06
4413
664
6.6
2006-07 (AprDec)
4646
642
7.2
($ billion)
1
17
INR
GBP
EUR
1/3/2007
9/3/2006
5/3/2006
1/3/2006
9/3/2005
5/3/2005
1/3/2005
9/3/2004
5/3/2004
1/3/2004
9/3/2003
5/3/2003
1/3/2003
9/3/2002
5/3/2002
1/3/2002
9/3/2001
5/3/2001
1/3/2001
9/3/2000
5/3/2000
1/3/2000
per cent
Foreign Exchange Market
Improvement in Efficiency
Bid-Ask Spread of Select Currencies agains US Dollar
1.6
1.4
1.2
1.0
0.8
0.6
0.4
0.2
0.0
JPY
18
19
Mar-07
Sep-06
Mar-06
Sep-05
Mar-05
Sep-04
Mar-04
Sep-03
Mar-03
Sep-02
Mar-02
Sep-01
Mar-01
Sep-00
Mar-00
Sep-99
Mar-99
Sep-98
Mar-98
Sep-97
Mar-97
Sep-96
Mar-96
Sep-95
Mar-95
Co-efficient of variation of the exchange rate of
the Rupee vis-a-vis the US $
Foreign Exchange Market
Decline in Volatility
Volatility in the Foreign Exchange Market
2.5
2.0
1.5
1.0
0.5
0.0
Financial Market Integration

Significance


For monetary policy transmission framework
Evidence of stronger integration during the recent period
(2000-2006) than the earlier period (1993-2000)





Correlation between the call rate and the reverse repo improved
from 0.35 to 0.86
Correlation between the call rate and the 364-day Treasury Bills
yield improved from 0.40 to 0.92
Correlation between the call rate and the 10-year yield improved
from 0.46 to 0.88
Correlation between the call rate and the 6-months forward premia
improved marginally from 0.61 to 0.62
Correlation between interest rates (the call rate) and the stock market
improved from -0.10 to -0.23.
20
-5
CALL
91-TBills
FR3
CP
CD
10-Year G-Sec
RREPO
EXCH
Aug-06
Oct-05
Dec-04
Feb-04
Apr-03
Jun-02
Aug-01
Oct-00
Dec-99
Feb-99
Apr-98
Jun-97
Aug-96
Oct-95
Dec-94
Feb-94
Apr-93
Interest Rates and Forward Premia (Per
cent)
40
25
30
15
20
5
10
0
21
Exchange Rate (Rs./US $)
Financial Market Integration
Interest Rates and Exchange Rate in India
50
35
Financial Market Integration
Interest Rate Spread over the Reverse Repo Rate
(Per cent)
Apr-1993 to Apr 1993 Apr 2000
Sep-2006
to
to
Mar Sep-2006
2000
1
2
3
4
Call money Rate
1.75
2.98
0.43
Certificate of Deposits Rate
3.33
5.43
1.07
Commercial Paper Rate
4.01
6.09
1.78
91 Treasury Bill Rate
1.71
2.90
0.42
364 day Treasury Bill Rate
2.13
4.18
0.75
10 year Yield on GSEC
3.50
6.21
1.84
22
Growth of Financial Markets in India – A Comparative
Picture
Table 6: Depth of Financial Markets in India – Average Daily Turnover
(Rs.crore)
Year
Money
Market
(Total)
Government
Securities Market
Foreign
Exchange
Market
Equity Market
(cash segment)
Equity
Derivatives
at NSE
2
3
4
5
6
2000-01
42,657
2,802
21,198
9,308
11
2001-02
65,500
6,252
23,173
3,310
410
2002-03
76,752
7,067
24,207
3,711
1,752
2003-04
28,660
8,445
30,714
6,309
8,388
2004-05
38,528
4,826
39,952
6,556
10,107
2005-06
60,034
3,643
56,391
9,504
19,220
2006-07
88,803
4,863
83,984
11,760
29,803
1
23
The Way Ahead - Measures Announced in the
Annual Policy Statement
G-Sec. Market
 A ‘Non-Competitive Bidding Scheme’ in the
auctions of State Development Loans (SDLs) to be
introduced.
 A system of reissuances of State Government
securities to be introduced.
 Use of 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.
 A Working Group being set up to suggest measures
for developing the interest rate futures market.
24
The Way Ahead - Measures Announced in
the Annual Policy Statement
Foreign Exchange Market
 Further liberalisation of foreign exchange facilities
in view of CFCAC




Overseas investment limit to be enhanced
Portfolio investment abroad limit to be enhanced
Increase in the existing limit for prepayment of ECBs
The limit for remittance scheme for individuals to be
enhanced
 Expanded the range of hedging tools available to the
market participants as also facilitate dynamic
hedging by the residents
 A Working Group on Currency Futures to be set up
25
Thank
You
26