Indian Economy, 5th edition (55 page)

1.
Unorganised Money Market

2.
Organised Money Market

1. Unorganised Money Market

Before the Government started the organised development of the money market in India, its unorganised form had its presence since the ancient times—its remnant is still present in the country in its same form. Their activities are not regulated like the organised money market. The unorganised money market in India may be divided into three differing categories:

(i) Unregulated Non-Bank Financial Intermediaries

Unregulated Non-Banking Financial Intermediaries
are functioning in the form of
chit funds, Nidhis
(operate in South India which lend to only their members) and loan companies. They charge very high interest rates (i.e. 36 to 48 per cent per annum) thus are exploitative in nature and have selective reach in the economy.

(ii) Indigenous Bankers

Indigenous Bankers
receive deposits and lend money in individual or private firms’ capacity. There are basically four such bankers in the country functioning individually as non-homogenous groups:

(a)
Gujarati Shroffs
They operate in Mumbai, Kolkata as well as industrial, trading and port cities in the region.

(b)
Multani or Shikarpuri Shroffs
They operate in Mumbai, Kolkata, Assam tea gardens and North Eastern India.

(c)
Marwari kayas
They operate mainly in Gujarat with a little bit of presence in Mumbai and Kolkata.

(d)
Chettiars
They are active in Chennai and at the ports of southern India.

(iii) Money Lenders

They constitute the most localised form of money market in India and operate in the most exploitative way. They have their two forms:

(a)
The professional money lenders who lend their own money as a profession to earn interest income.

(b)
The non-professional money lenders who might be businessmen and lend their money to earn interest income as a subsidiary business.

Today, India has seven organised instruments of the money market which are used by the prescribed firms in the country but the unorganised money market also operates side by side. The main reason behind this reality could be summed up
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in the following points:

(i)
Indian money market is still under-developed.

(ii)
Penetration and presence of the instruments of the organised money market is still half-hearted.

(iii)
There are many needful customers in the money market who are not taken care of by the organised money market.

(iv)
Entry to the organised money market for its customer is still restrictive in nature—not allowing small businessmen.

(v)
This is why the vacuum is filled up by the unorganised money market.

2. Organised Money Market

Since the Government started developing the organised money market in India (mid-1980s), we have seen the arrival of a total number of
seven instruments
designed to be used by different categories of business and industrial firms. A brief description of these instruments follows:

(i) Treasury Bills (TBs)

This instrument of the money market though present since indepence got organised in 1986. They are used by the Central Government to fulfill its short-term liquidity requirement upto the period of 364 days. There developed
five types
of the TBs in due course of time:

(a)
14-day (Intermediate TBs)

(b)
14-day (Auctionable TBs)

(c)
91-day TBs

(d)
182-day TBs

(e)
364-day TBs

Out of the above five variants of the TBs, at present only the
91-day TBs
,
182-day TBs
and the
364-day TBs
are issued by the Government—other three variants were discontinued in 2001.
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The TBs other than providing short-term cushion to the Government, also function as short-term investment avenues for the banks and financial institutions, besides functioning as requirements of the CRR and SLR of the banking institutions.

(ii) Certificate of Deposit (CD)

Organised in 1989, the CDs are used by the
banks
and issued to the depositors for a specified period less than one year—they are negotiable and tradable in the money market. Since 1993 the RBI allowed the financial institutions to operate in it - IFCI, IDBI, ICICI, IRBI (IIBI since 1997) and the Exim Bank—they could issue CDs for the maturity periods above one year and upto three years.

(iii) Commercial Paper (CP)

Organised in 1990 it is used by the
corporate houses
of India (which should be a listed company with a working capital of not less than 5 crore). The CP issuing companies need to obtain a specified credit rating from an agency approved by the RBI (such as CRISIL, ICRA).

(iv) Commercial Bill (CB)

Organised in 1990, the CBs are issued by the All India Financial Institutions (AIFIs), Non-Banking Finance Companies (NBFCs), Scheduled Commercial Banks, Merchant Banks, Co-operative banks and the Mutual Funds. It replaced the old Bill Market available since 1952 in the country.

(v) Call Money Market (CMM)

This is basically an
inter-bank
money market where funds are borrowed and lent for one day. Also known as
over-night borrowing
(called as
money at call
) and for a period upto 14 days (called
short notice
). No collateral is required to borrow from this market. Funds are usually raised from this market upto three days—the higher the interest, the longer the period for which the funds have been borrowed.

The scheduled commercial banks, co-operative banks operate in this market as both the borrowers and lenders while LIC, GIC, UTI, IDBI and NABARD are allowed to operate as only lenders in this market. The interest rate in this market depends upon the demand and supply of the funds on a particular day which is market determined.

(vi) Money Market Mutual Fund (MF)

Popular as Mutual Funds (MFs) this money market instrument was intorduced/organised in 1992 to provide short-term investment opportunity to the
individuals.

The initial guidelines for the MF have been liberalised many times. Since March 2000, the MFs have been brought under the preview of the SEBI besides the RBI. At present, a whole lot of financial institutions and firms are allowed to set up the MF—commercial banks, public and private financial institutions and private sector companies. At present 35 MFs are operating in the country—managing a corpus of 3,41,378 crore.

(vii) Repos and Reverse Repos

In the era of economic reforms the development of
money market
and the
reverse repo money market
are considered the most dynamic and the most favored instruments of the Indian money market by the experts. ‘Repo’ is basically short form or the acronym of the
rate of repurchase.
The RBI in a span of four years, introduced this instrument of the money market—
repos
in December 1992 and
reverse repos
in November 1996.

Repos
allow the banks and the financial institutions to borrow money from the RBI for the short-term (by selling Government Securities to the RBI). In
reverse repos,
the banks and financial institutions purchase Government securities from the RBI (basically here the RBI is borrowing from the banks and the financial institutions). All the Government securities are dated and the interest for the repo or reverse repo transactions are announced by the RBI from time to time.

The provision of repos and the reverse repos have been able to serve the liquidity evenness in the economy as the banks are able to get the required amount of funds out of it, and they can park surplus idle funds through it. These instruments have emerged as important tools in the management of the monetary and credit policy in the recent years.
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(viii) Cash Management Bill (CMB)

The Government of India, in consultation with the Reserve Bank of India, decided to issue a new short-term instrument, known as Cash Management Bills, since August 2009 to meet the temporary cash flow mismatches of the Government. The Cash Management Bills are
non-standard
and
discounted instruments
issued for maturities less than 91 days.

The Cash Management Bills have the
generic character of Treasury Bills
(issued at discount to the face value); are tradable and qualify for
ready forward facility;
investment in it is considered as an eligible investment in Government Securities by banks for SLR.

It should be noted here that the existing Treasury Bills serve the same purpose but as they were put under the WMAs (Ways & Means Advances) provisions by the GoI in 1997 they did not remain a fluid route to government in meeting its short-term requirements of funds at its will (see ‘Fiscal Consolidation in India’ sub-topic in the Chapter Public Finance for details). The CBM does not come under the similar WMAs provisions.

Discount and Finance House of India (DFHI)

The Discount and Finance House of India Limited
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(DFHI) was set up in April 1988 by the RBI jointly with the public sector banks and financial investment institutions (i.e. LIC, GIC and UTI). Its establishment was an outcome of the long-drawn need of the following two types:

(i)
to bring an equilibirium of liquidity in the Indian banking system and

(ii)
to impart liquidity to the instruments of the money market prevalent in the economy.

The DFHI functions on
commercial basis.
Today, the house deals in all the instruments of the Indian money market without any ceiling, and plays the role of the ultimate body in providing stability to the liquidity in the money market as well as the banking system.

MONETARY POLICY TOOLS

Monetary policy deals with all those instruments/means by which short-term money/capital is raised in the economy, i.e., the money which is raised for a 1 to 364 days. The policy and the instruments are regulated by the Indian central bank, the RBI. The monetary policy tools used presently and their operating procedure are as given below
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:

1. Call Money Market

The call money market is an important segment of the money market where uncollateralized borrowing and lending of funds take place on
overnight basis
. Participants in the call money market in India currently include scheduled commercial banks (SCBs)- excluding regional rural banks), cooperative banks (other than land development banks), and primary dealers, both as
borrowers
and
lenders
(RBI’s Master Circular dated 1 July 2011). Prudential limits, in respect of both outstanding borrowing and lending transactions in the call money market for each of these entities, are specified by the RBI.

2. Open Market Operations (OMOs)

OMOs are conducted by the RBI via the sale/purchase of government securities (G-Sec) to/from the market with the
primary aim
of modulating rupee liquidity conditions in the market. OMOs are an effective quantitative policy tool in the armoury of the RBI, but are constrained by the stock of government securities available with it at a point in time.

3. Liquidity Adjustment Facility (LAF)

The LAF is the key element in the monetary policy operating framework of the RBI (introduced in June 2000). On daily basis, the RBI stands ready to lend to or borrow money from the banking system, as per the latter’s requirement, at fixed interest rates. The
primary aim
of such an operation is to assist banks to adjust to their day-to-day mismatches in liquidity, via
repo
and
reverse repo
operations.

Under the repo or repurchase option, banks borrow money from the RBI via the sale of securities with an agreement to purchase the securities back at a fixed rate at a future date. The rate charged by the RBI to aid this process of liquidity injection is termed as the repo rate. Under the reverse repo operation, the RBI borrows money from the banks, draining liquidity out from the system. The rate at which the RBI borrows money is the reverse repo rate. The interest rate on the LAF is fixed by the RBI from time to time (with crucial changes introduced recently in the operating procedure of Monetary Policy detailed in the next paragraph). LAF operations help the RBI effectively transmit
interest rate signals
to the market.

Recent Changes in Monetary Policy

Effective 3 May 2011, based on the recommendations of the
Working Group on Operating Procedure of Monetary Policy,
the operating framework of monetary policy has been refined with the following changes:

(i)
The repo rate has been made the only independently varying policy rate.

(ii)
A new marginal standing facility (MSF) has been instituted, under which SCBs have been allowed to borrow overnight at their discretion, up to 1 per cent of their respective NDTL, at 100 bps above the repo rate. The revised MSF reverse repo corridor has been defined with a fixed width of 200 bps with the repo rate placed in the middle of the corridor.

(iii)
The reverse repo rate has been placed 100 bps below and the MSF rate 100 bps above the repo rate.

It is expected that the fixed interest rate corridor, set by the MSF rate and reverse repo rate, by reducing uncertainty and avoiding difficulties in communication associated with a variable corridor, will help in keeping the overnight average call money rate close to the repo rate.