Infrastructure Development of the Government Securities Market

The government securities market constitutes the principal segment of the debt market. The development of any market requires the strengthening of the market infrastructure with large number of market players who have divergent perceptions about the market and who would continuously provide liquidity. One of the initiatives taken to develop the government securities market during the first stage of the reform process was the setting up of Securities Trading Corporation of India. The STCI together with Discount and Finance House of India had the task of developing an active secondary market in government securities. The Reserve Bank introduced the primary dealer system and satellite dealer system to further strengthen the market infrastructure.

Primary Dealer System:
A system of primary dealers was introduced in 1996, to further strengthen the market infrastructure and to make it more liquid and broad based. The objectives of the introduction of this system were
(i) to strengthen the government securities infrastructure;
(ii) to bring about improvements in the secondary market trading, liquidity and turnover in government securities;
(iii) to encourage a voluntary holding of government securities amongst a wider investor base; and
(iv) to make PDs an effective conduit of open market operations.

The major focus of PDs would be on increasing the turnover of government securities rather than becoming a mere repository of this system. Hence, their role would be to act as market makers by providing two-way quotes in the secondary market, thereby ensuring liquidity and support to the primary market operation. In the long run, this system would facilitate the transfer of market making activities from the Reserve Bank to primary dealers.

PDs can be subsidiaries of scheduled commercial banks, subsidiaries of all India financial institutions, companies under Companies Act, 1956 engaged predominantly in government securities market, and subsidiaries of foreign banks/securities firms. Every PD has to maintain minimum net owned funds of Rs50 crore deployed daily in the government securities market. PDs as institutional entities fall in the category of non-banking finance companies. PDs are registered with and regulated by the Reserve Bank of India, irrespective of whether they accept public deposits or not.

Obligations upon PDs and Facilities Extended to them:

In order to enable PDs to perform their role effectively, the Reserve Bank has cast certain obligations upon PDs which include an annual minimum bidding for dated securities and treasury bills with a minimum success ratio and commitment to underwrite the shortfall (gap) between the subscribed accepted amount and the notified amount. PDs have to achieve an annual turnover of not less than five times of average month-end stocks during the year in dated securities and ten times in treasury bills, within which outright transactions should be three and six times respectively.

To strengthen this system and to make PDs fulfill their obligations, the Reserve Bank extends to them various facilities like access to SGL and current account facility with the Reserve Bank, liquidity support through reverse repos linked to both bidding commitment and performance of PDs in the primary and secondary markets, freedom to deal in money market instruments, facility of transfer of funds from one centre to another under the Reserve Bank’s Remittance Facility Scheme, exclusive access to open market operations in treasury bills since February 2000 and a ‘switch facility’ to swap their medium to long-term dated government securities with 364-day treasury bills during August 2000. Routing operations in the call money market are allowed through all PDs to increase their profitability. PDs are allowed to issue commercial papers (CPs) to raise resources.

The Reserve Bank provides liquidity support to PDs through repos/refinance against central government securities under three levels. At the first level, normal refinance at bank rate is provided up to a specified amount. A backstop refinance at a variable rate up to a fixed amount is provided at the second level. Finally discretionary support is extended through liquidity adjustment facility (LAF). The total assured liquidity support for all PDs together is about Rs4,500crore for 2002-03 as against Rs6,000crore during 2001-02, of which two-third is under the normal facility and one-third under the backstop facility. If any PD in any auction of treasury bills, fails to submit the required minimum bid or submits a bid lower than its commitment, the Reserve Bank will reduce liquidity support to the extent of shortfall/failure in submission of bids for a period of three months from the date so specified by the Bank. For instance, if a bid is short by an amount of Rs10crore, liquidity support will be reduced by an amount of Rs10crore for 3 months.