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IDFC AMC

Open Market Operations

By: Punam Sharma

  • Open Market Operation (OMO) is buying or selling of government securities conducted by RBI to manage the liquidity conditions in the market and may support government market borrowing.
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  • It’s one of the major instruments of monetary policy by which the RBI infuses liquidity in the market and can be used in sterilization of capital flows (managing excess inflow of capital).
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  • Effective instruments for OMOs are Liquidity Adjustment Facility (LAF) to manage liquidity and Market Stabilization Scheme (MSS) to manage long term excess liquidity.
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  • Two rates constitute the LAF system, Repo and Reverse Repo rate. Repo rate is used for daily injection of liquidity and reverse repo is used for daily absorption of securities.
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  • Securities purchased and sold in OMOs are dated securities, T bills.
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  • Presently because of the liquidity deficit RBI is resorting to purchasing bonds from the market.
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How is it conducted?
 

  • When there is excess liquidity in the market, RBI sells bonds to absorb liquidity and when there is liquidity deficit, it buys bonds to inject liquidity in the market.
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  • RBI could support government borrowing through OMOs by injecting liquidity in the market by buying back bonds from banks. This in turn could lower Gsec yields because of improved liquidity.
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What are OMO effects on the market?
 
When RBI buys back bonds the effects are:
 

  • Increases liquidity.
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  • Could lower Gsec yields
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  • Tends to reduce interest rates.
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  • It may tend to be inflationary.
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When RBI sells bonds and absorbs liquidity, the effects are reversed.
 
Statistics
 
RBI for FY12 has conducted 5 OMO purchases for total amount of 60,000cr out of which 54,573 cr has been accepted. Table below shows the OMO purchases accepted in various dated securities on date it was conducted.
 

 
The graph below shows the 10 year Gsec yields and the OMO purchases conducted by RBI.
 

Source: RBI
 

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IDFC AMC

State Development Loans

By: Punam Sharma

What is State Development Loans (SDL)?
 

  • To fund their fiscal deficits, States issue SDL.
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  • SDLs are debts issued by State Governments, where in the actual process of selling the security is coordinated by BI. Each State is allowed to issue securities up to a certain limit each year.
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  • The coupon rates are generally higher than Gsecs issued for the same maturity.
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  • Normally SDLs are issued for 10 year maturity.
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  • SDLs are normally sold through auction process, similar to Gsecs.
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  • SDLs qualify as approved SLR security and LAF-Repos.
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  • As per the Twelfth Finance commission, Centre’s contribution to aide States to finance their deficits has been discontinued leading to additional issuance of SDLs to finance the same.
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  • National Small Savings funds (NSSF) like postal deposits, savings certificates, social security schemes formed a major source for financing state deficits. However, NSS collections have declined and there has been out flows last year. Therefore NSS contribution towards State deficits has declined from 18% FY11 to 9% FY12.
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  • As an alternative to NSS, States have been issuing SDLs for financing its deficits.FY12 SDL contribution towards financing state deficits has increased from 51% FY11 to 72% in FY12.
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Who are the Participants?
 

  • As SDLs qualify as SLR status, participants are mainly banks.
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  • Other participants include insurance companies, provident and pension funds, mutual funds.
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Why they invest in SDL?
 

  • To meet their SLR requirement, banks invest in SDL.
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  • SDLs are seen as a buy and hold instrument rather than instruments to be traded and are quoted at a premium to Gsecs. Insurance companies, mutual funds, provident and pension funds invest for the higher yield SDLs provide over and above government bond yields.
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Statistics
 

  • State government finances are weakening along with central government finances. State governments have been running Gross Fiscal Deficits ranging from 2.9% of GDP (FY10) to 2.2% of GDP (FY12). Gross fiscal deficit for States FY12 is Rs 199720 cr.
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  • State Governments have borrowed a total of Rs 100323 cr till 20th November 2012 out of a total borrowing program of Rs 203600 cr.
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10 year Gsec & 10 year SDL yield trend

 

  • Highest spread between Gsec and SDL yield during current financial year was 77 bps in July while lowest has been 33bps in April.
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  • The low spread of 33 bps has been after the announcement of rate cut by RBI by 50 bps on 17 April 2012.
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  • The spread as per the last auction in November is 73bps.
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  • Average spread for the current fiscal (till November) is 65 bps.

 

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