AMITY UNIVERSITY,NOIDA

RECENT DEVELOPMENT IN MONEY MARKET

FINANCIAL MARKETS INSTITUTIONS and FINANCIAL SERVICES

AMITY COLLEGE OF COMMERCE AND FINANCE

SUBMITTED BY: YOGESH SINGLA A3104609020 B.COM(HONS)III

MONEY MARKET

The money market is a component of the financial markets for assets involved in short-term borrowing

and lending with original maturities of one year or shorter time frames. Trading in the money markets

involves Treasury bills, commercial paper, bankers' acceptances, certificates of deposit, federal funds, and

short-lived mortgage- and asset-backed securities It provides liquidity funding for the global financial

system.

GROWTH OF MONEY MARKET IN INDIA

While the need for long term financing is met by the capital or financial markets, money market

is a mechanism which deals with lending and borrowing of short term funds. Post reforms period

in India has witnessed tremendous growth of the Indian money markets. Banks and other

financial institutions have been able to meet the high expectations of short term funding of

important sectors like the industry, services and agriculture. Functioning under the regulation and

control of the Reserve Bank of India (RBI), the Indian money markets have also exhibited the

required maturity and resilience over the past about two decades. Decision of the government to

allow the private sector banks to operate has provided much needed healthy competition in the

money markets, resulting in fair amount of improvement in their functioning.

Money market denotes inter-bank market where the banks borrow and lend among themselves to

meet the short term credit and deposit needs of the economy. Short term generally covers the

time period upto one year. The money market operations help the banks tide over the temporary

mismatch of funds with them. In case a particular bank needs funds for a few days, it can borrow

from another bank by paying the determined interest rate. The lending bank also gains, as it is

able to earn interest on the funds lying idle with it. In other words, money market provides

avenues to the players in the market to strike equilibrium between the surplus funds with the

lenders and the requirement of funds for the borrowers. An important function of the money

market is to provide a focal point for interventions of the RBI to influence the liquidity in the

financial system and implement other monetary policy measures.

Quantum of liquidity in the banking system is of paramount importance, as it is an important

determinant of the inflation rate as well as the creation of credit by the banks in the economy.

Market forces generally indicate the need for borrowing or liquidity and the money market

adjusts itself to such calls. RBI facilitates such adjustments with monetary policy tools available

with it. Heavy call for funds overnight indicates that the banks are in need of short term funds

and in case of liquidity crunch, the interest rates would go up.

Depending on the economic situation and available market trends, the RBI intervenes in the

money market through a host of interventions. In case of liquidity crunch, the RBI has the option

of either reducing the Cash Reserve Ratio (CRR) or pumping in more money supply into the

system. Recently, to overcome the liquidity crunch in the Indian money market, the RBI has

released more than Rs 75,000 crore with two back-to-back reductions in the CRR.

In addition to the lending by the banks and the financial institutions, various companies in the

corporate sector also issue fixed deposits to the public for shorter duration and to that extent

become part of the money market mechanism selectively. The maturities of the instruments

issued by the money market as a whole, range from one day to one year. The money market is

also closely linked with the Foreign Exchange Market, through the process of covered interest

arbitrage in which the forward premium acts as a bridge between the domestic and foreign

interest rates.

Determination of appropriate interest for deposits or loans by the banks or the other financial

institutions is a complex mechanism in itself. There are several issues that need to be resolved

before the optimum rates are determined. While the term structure of the interest rate is a very

important determinant, the difference between the existing domestic and international interest

rates also emerges as an important factor. Further, there are several credit instruments which

involve similar maturity but diversely different risk factors. Such distortions are available only in

developing and diverse economies like the Indian economy and need extra care while handling

the issues at the policy levels.

Diverse Functions

Money markets are one of the most important mechanisms of any deve-loping economy. Instead

of just ensuring that the money market in India regulates the flow of credit and credit rates, this

mechanism has emerged as one of the important policy tools with the government and the RBI to

control the monetary policy, money supply, credit creation and control, inflation rate and overall

economic policy of the State.

Hence, the first and the foremost function of the money market mechanism is regulatory in

nature. While determining the total volume of credit plan for the six monthly period, the credit

policy also aims at directing the flow of credit as per the priorities fixed by the government

according to the needs of the economy. Credit policy as an instrument is important to ensure the

availability of the credit in adequate volumes; it also caters to the credit needs of various sectors

of the economy. The RBI assists the government to implement its policies related to the credit

plans through its statutory control over the banking system of the country.

Monetary policy, on the other hand, has longer term perspective and aims at correcting the

imbalances in the economy. Credit policy and the monetary policy, both complement each other

to achieve the long term goals determined by the government. It not only maintains complete

control over the credit creation by the banks, but also keeps a close watch over it. The

instruments of monetary policy, including the repo rate, cash reserve ratio and bank rate are used

by the Central Bank of the country to give the required direction to the monetary policy.

Inflation is one of the serious economic problems that all the developing economies have to face

every now and then. Cyclical fluctuations do affect the price level differently, depending upon

the demand and supply scenario at the given point of time. Money market rates play a major role

in controlling the price line. Higher rates in the money markets reduce the liquidity in the

economy and have the effect of reducing the economic activity in the system. Reduced rates, on

the other hand, increase the liquidity in the market and bring down the cost of capital

substantially, thereby increasing the investment. This function also assists the RBI to control the

overall money supply in the economy. Such operations supplement the efforts of direct infusion

of newly printed notes by the RBI.

Future of Open Markets

Financial openness is said to be a situation under which the residents of one country are in a

position to trade their assets with residents of another country. A slightly mild definition of

openness may be referred to as financial integration of two or more economies. In recent years,

the process of globalization has made the money market operations and the monetary policy

tools quite important. The idea is not only to regulate the economy and its money markets for the

overall economic development, but also to attract more and more foreign capital into the country.

Foreign investment results in increased economic activity, income and employment generation in

the economy. Free and unrestricted flow of foreign capital and growing integration of the global

markets is the hallmark of openness of economies.

Indian experience with open markets has been a mixed one. On the positive side, the growth rate

of the country has soared to new levels and the foreign trade had been growing at around 20 per

cent during the past few years. Foreign exchange reserves have burgeoned to significantly higher

levels and the country has achieved new heights in the overall socio-economic development. The

money market mechanism has played a significant role in rapid development of the country

during the post-reforms era.

On the flip side, the post-reforms period has witnessed relatively lesser growth of the social

sector. Money market mechanism has kept the markets upbeat, yet the social sector needs more

focused attention. With the base of the economy now strengthened, the money market

mechanism must also focus on ensuring that proper direction is provided to the credit flows so

that the poorest sections of the society also gain.

Interesting developments in money market

The Finance Ministry would appear confident of preventing an enlargement of the fiscal deficit even with an increase in non-plan expenditure, as tax receipts have been quite heartening with a spurt in revenues from direct taxes.

THE MONEY market has been passing through an interesting phase in recent months with contrary forces at work and speculation about the trend of interest rates.

The Prime Minister has observed that there will not be any change in interest rates despite the sharp rise in the inflation rate. This prognosis is presumably due to the impression that the accentuation of inflationary pressures has been mainly on account of external factors and that there may be an improvement in the price situation within the country with the kharif harvests from the middle of October.

Though the kharif foodgrain estimate will come down to 100.29 million tonnes from 108 million tonnes, the rabi performance is expected to be satisfactory and the output of fine and coarse cereals and pulses for the whole year may not be lower than 195 million tonnes. On the other hand, the cotton crop is placed at an all time record level of 213 lakh bales while oilseeds production too may be higher this season.

As world prices for crude also have been fluctuating in wide limits, though below the peak level touched a few weeks ago, the impression is gaining ground that they will come down in the coming months and their inflationary impact may be less pronounced.

GDP to grow at 6.5-7 p.c.

With the gross domestic product likely to rise by 6.5-7 per cent in 2004-05 and high liquidity in the banking system despite efforts to immobilise surplus funds to a certain extent through operations of the Market Stabilisation Scheme and a hike in cash reserve ratio, quite a few bankers seem to be of the view that interest rates will remain stable with even a downward bias. But other bankers have been raising interest rates on housing loans and issuing new loans on a floating rate basis.

Will interest rates go up?

The question now is for how long the prevailing low interest rates will continue and whether they will tend to harden as the months pass by. It has also to be borne in mind that interest rates in developed countries are on the rise though the U.S. Federal Reserve is inclined to be cautious when taking decisions about further rise in its discount rate.

While it remains to be seen how the changes in interest rates elsewhere impact the structure of interest rates in India, there has been a noticeable slowdown in the growth of forex reserves in recent months. However, the outgo of $4.6 billion in five weeks in July-September should be ascribed to an outflow of interest bearing obligations, particularly NRI deposits. On the other hand, inflow of non-debt resources has been quite sizable. After a pause, FII inflows have been increasing with purchases of equities on the bourses and support to new issues.

BoP comfortable

Thus, even with foreign exchange assets rising at a slower rate by $5.37 billion upto September 10, against $12.24 billion a year ago, the rupee has not come under any pressure. So long as the secular trend is observed and the Balance of Payments position gets strengthened with a reduction in interest bearing obligations and larger inflows of invisible receipts, the rupee will remain fairly steady and the variations may be due to a strengthening of the U.S. dollar and other currencies.

High liquidity of banks

The money market has not witnessed any diversion of funds to the forex market as there has been no volatility in rupee parity. Besides, additions to money supply will be satisfactory even though at a slower rate.

The scheduled commercial banks have thus been experiencing an increasing growth in their deposits, though the additions this year upto September 3 are lower at Rs. 84,904 crores against Rs. 94,716 crores.

But in the 12 months ended September 3, the growth in deposits has been spectacular at Rs. 2,13,750 crores against Rs. 1,49,540 crores. It is interesting to note, of course, that banks have been utilising surplus funds more profitably, as incremental bank credit in the 12 months under reference has risen by 83.09 per cent of incremental deposits against 50.72 per cent comparably. Fresh investments out of incremental deposits accounted for only 42.89 per cent against 86.68 per cent.

If the UPA Government is keen on increasing credit availability to the farm sector and loans extended to borrowers in industry and trade also tend to rise, the liquidity in the banking system may slowly disappear. As the monetary authorities would seem to be keen on intensifying operations with the MSS with a view to containing inflationary pressures, the CRR is being raised to 5.0 per cent from 4.5 per cent in two stages and an amount of Rs. 8,000 crores will get

immobilised by October 2. The intention is perhaps not to increase interest rates when the Credit Policy for the busy season is announced by the end of October.

Centre's borrowing

This line of thinking is perhaps correct as the Reserve Bank has indicated that the target for the issuance of securities by MSS for 2004-05 has been raised to Rs. 80,000 crores from Rs. 60,000 crores.

The issue of new loans by MSS in the coming months may nevertheless have larger notified amounts, as Government borrowing is slated to be only Rs. 44,000 crores in October-March 2004-05 against Rs. 66,000 crores in April-September or a total of Rs. 1,10,000 crores against the target of Rs. 1,15,501 crores for net borrowing in 2004-05.

The Finance Ministry would appear confident of preventing an enlargement of the fiscal deficit even with an increase in non-plan expenditure, as tax receipts have been quite heartening with a spurt in revenues from direct taxes by 50.69 per cent upto September 15 to Rs. 27,240 crores from Rs. 18,077 crores.

What is significant is the sharp rise in income tax collections by 55.51 per cent to Rs. 17,999 crores from Rs. 11,574 crores. As the demand for various products has been rising and industrial production also has increased by 7.8 per cent in April-July against 5.9 per cent comparably, the revenues from indirect taxes too may not show any shortfall from Budget estimates.

As there has been no aggressive borrowing by the Centre and State governments also have not been securing their requirements in a big way till now, the yields on new loans have not risen noticeably, though the yields on gilt-edged securities in the open market have been rising slowly and banks with excess holdings of securities, particularly in long-term loans, fear that the income from treasury operations may not be of last year's dimensions and their net profits may not rise at the rate seen in recent years.

The happenings in the money market during the busy season may thus be on different lines and it will be interesting to watch whether MSS operations will have to be slowed down if the credit deposit ratio continues to rise impressively. It may thus not be feasible to raise the CRR further and also immobilise additional funds through as it will add to the interest burden ofo the Central Exchequer.

Reforms made in the Indian Money Market are:-

1. Deregulation of the Interest Rate : In recent period the government has adopted an interest rate policy of liberal nature. It lifted the ceiling rates of the call money market, short-term deposits, bills rediscounting, etc. Commercial banks are advised to see the interest rate change that takes place within the limit. There was a further deregulation of interest rates during the economic reforms. Currently interest rates are determined by the working of market forces except for a few regulations.

2. Money Market Mutual Fund (MMMFs) : In order to provide additional short-term investment revenue, the RBI encouraged and established the Money Market Mutual Funds (MMMFs) in April 1992. MMMFs are allowed to sell units to corporate and individuals. The upper limit of 50 crore investments has also been lifted. Financial institutions such as the IDBI and the UTI have set up such funds.

3. Establishment of the DFI : The Discount and Finance House of India (DFHI) was set up in April 1988 to impart liquidity in the money market. It was set up jointly by the RBI, Public sector Banks and Financial Institutions. DFHI has played an important role in stabilizing the Indian money market.

4. Liquidity Adjustment Facility (LAF) : Through the LAF, the RBI remains in the money market on a continue basis through the repo transaction. LAF adjusts liquidity in the market through absorption and or injection of financial resources.

5. Electronic Transactions : In order to impart transparency and efficiency in the money market transaction the electronic dealing system has been started. It covers all deals in the money market. Similarly it is useful for the RBI to watchdog the money market.

6. Establishment of the CCIL : The Clearing Corporation of India limited (CCIL) was set up in April 2001. The CCIL clears all transactions in government securities, and repose reported on the Negotiated Dealing System.

7. Development of New Market Instruments : The government has consistently tried to introduce new short-term investment instruments. Examples: Treasury Bills of various duration, Commercial papers, Certificates of Deposits, MMMFs, etc. have been introduced in the Indian Money Market.