The government needs enormous amount if money to perform the following main functions:
1. Provision of public services such as law and order, justice national defense and so on.
2. Central banking and monetary regulation
3. Regulating economic activity in the private sector
4. Creation and maintenance of physical infrastructure
The government generates revenue in the form of taxes and income from ownership of assets. Besides these, it borrows extensively from banks, financial institutions and the public to finance its expenditure in excess of its revenues.
One of the important sources of borrowing funds is the government securities market (GSM). The government raises short term and long term funds by issuing securities. These securities do not carry risk and are as good as gold as the government guarantees the payment of interest and the repayment of principal. They are, therefore, referred to as gilt-edged securities. The government securities market is the largest market in any economic system and therefore, is the benchmark for other markets.
Importance of the Government Securities:
GSM constitutes the principal segment of the debt market. It not only provides resources to the government for meeting its short term and long term needs but also acts as a benchmark for pricing corporate papers of varying maturities. The government securities issues are helpful in implements the fiscal policy of the government. It is critical in bringing about an effective and reliable transmission channels for the use of indirect instruments of monetary control. The working of the two of the major techniques of monetary control – Open Market Operations (OMOs) and Statutory Liquidity Ratio are closely connected with the dynamics of this market.
Government securities provide the highest type of collateral for borrowing against their pledge. They have the highest degree of security of capital and the return on each security depends on the coupon rate and period of maturity. They are traded for both long and short term periods depending on the investment and liquidity preference of the investors. Switches between the short dated and long dated securities take place on the basis of difference in redemption yields.
Issuers, Investors, and Types of Government Securities:
Government securities are issued by the central government, state governments and semi-governments authorities which also include local government authorities such as city corporations and municipalities.
The major investors in this market, besides the Reserve bank, are the nationalized banks as they have to subscribe these securities to meet their requirements. The other investors are insurance companies, state government, provident funds, individuals, corporates, non-banking finance companies, primary dealers, financial institutions and to a limited extent, foreign institutional investors and non-resident Indian (NRIs).
These investors can be classified into three segments:
1. Wholesale market segment namely institutional players such as banks, financial institutions, insurance companies, primary dealers and mutual funds.
2. Middle segment comprising corporates, provident funds, trusts, non-banking finance companies and small cooperative Banks with an average liquidity ranging from Rs 7 crore to Rs 25 crore.
3. Retail segment consisting of less active investors such as individuals and non-institutional investors.
The government securities market is mostly an institutional investors market as standard lots of trade are around Rs 1 crore and 99 per cent of all trades are done through the Subsidiary General ledger (SGL) account, which is a kind of depository account held by the Reserve bank. Individuals cannot open SGL accounts. They have to open SGL-II accounts with a bank or a primary dealer provided they have a huge balance and agree to trade on an ongoing basis.
Government securities are of two types: treasury bills and government dated securities. The latter carry varying coupon rates and are of different maturities. Sometimes, the Reserve Bank converts maturing treasury bills into bonds thereby rolling over the government’s debt.