Overview of Indian money market

Introduction-

The money market is a mechanism that deals with the lending and borrowing of short
term funds. The India Money Market has come of age in the past two decades. In order to
study the money market of India in detail, we at first need to understand the parameters
around which the money market in India revolves.

The performance of the Indian Money Market is heavily dependent on real interest rate
that is the interest rate that is inflation adjusted. Though the money market is free from
interest rate ceilings, structural barriers and other institutional factors can be held
responsible for creating distortions in India Money Market. Apart from the call market
rates, the other interest rates in the Indian Money Market usually do not change in the
short run.

It is due to this disparity between the opposite forces that is prevalent in the money
market in India that a well defined income path cannot be traced.

Owing to the deregulation of the interest rate in the early nineties following the economic
reforms laid down by the then finance minister Dr. Manmohan Singh, studies concerning
the behavior of interest rate were restricted. However the liquidity of the market makes
its good subject for empirical research.

The Indian Money Market involves a wide range of instruments. Here, maturities range
from one day to a year, issued by banks and corporate of various sizes. 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
domestic and foreign interest rates.

It is a centre in which financial institutions join together for the purpose of dealing in
financial or monetary assets, which may be of short term maturity or long term maturity.
The short term means, generally a period up to one year and the term near substitutes to
money, denotes any financial asset which can be quickly converted into money with
minimum transaction cost.

Money Market elements-

- Money Market Refers to the market for short-term requirement and deployment of
funds.
-

- Call Money Money lent for one day

- Notice Money Money lent for a period exceeding one day

- Term Money Money lend for 15 days or more in Inter-bank market

- Held till maturity Securities which are not meant for sale and shall be kept till
maturity

- Held for trading Securities acquired by the banks with the intention to trade by
taking advantage of the short-term price/ interest rate movements will be classified under
held for trading.

- Available for sale The securities which do not fall within the above two
categories i.e. HTM or HFT will be classified under available for sale.

- Yield to maturity Expected rate of return on an existing security purchased from

the market

- Coupon Rate Specified interest rate on a fixed maturity security fixed at the time
of issue.

- Treasury operations Trading in government securities in the market. An investor

Bank can purchase these securities in the primary market. Trading takes place in the
secondary market.

- Gilt Edged security Government security that is a claim on the government and is
a secure financial instrument which guarantees certainty of both capital and interest.
These securities are free of default risk or credit risk, which leads to low market risk and
high liquidity.

Indian money market current position-

India market news is the topic of discussion for every investor nationwide. The global
economic downturn since the last quarter of 2008 has been gaining grounds until the
Satyam scam. The fourth-biggest software firm – Satyam Computers, ever since its
drastic crash and financial wrongdoing revelations, has been in India news and global
news headlines affecting the India money market. India has many foreign investors and
the economy not being very highly affected despite the global recession; more foreign
investors are looking towards India as a safe and secured investment destination. But as
India market news make plain, the Satyam scandal may prove to be a huge loss to India,
prompting foreign investors to leave India.

Strengthening of the Indian rupee and loss of dollar over the last week of December 08
and first week of January brought in a ray of hope amongst investors, thus raising the
importance of India money market. Data released by the India news recorded buying of
local shares by overseas funds. India market news further brought to light that with the
Satyam scam, stock market indices witnessed a 7.1 percent slump. Despite the two
weeks’ rise of the rupee, it again slumped down due to the Satyam effect.
India money market is flooded with news like ‘NSE removing Satyam from Nifty,
replacing the position with Rel Capital’, ‘Satyam losing Rs 10, 000 crore in market cap’,
etc. The India market news on 7th evening shook domestic as well as global investor
confidence affecting many other top companies. Overall, the situation is expected to
improve and India money market is again going to witness a rise. Thanks to the
corrective measures taken by the RBI as well as the government. With the lending rate
cut by 350 basis points by the the RBI as well as the 200 billion rupee ($4 billion)
stimulus package announced by the government will help materialize the 7% growth
target. Duties cut on manufactured products further add to the boost. What the India news
reveals currently is not expected to be the same.

Short Term Money Market instruments India-

The money market is a market for short-term financial assets that are close substitutes of
money. The most important feature of a money market instrument is that it is liquid and
can be turned over quickly at low cost and provides an opportunity for balancing the
short-term surplus funds of lenders and the requirements of borrowers. By convention,
the term “Money Market” refers to the market for short-term requirement and
deployment of funds. Money market instruments are those instruments, which have a
maturity period of less than one year. The most active part of the money market is the
market for overnight call and term money between banks and institutions and repo
transactions. Call Money / Repo are very short-term Money Market products. There is a
wide range of participants (banks, primary dealers, financial institutions, mutual
funds,trusts,provident funds etc.) dealing in money market instruments. Money Market
Instruments and the participants of money market are regulated by RBI and SEBI.As a
primary dealer SBI DFHI is an active player in this market and widely deals in Short
Term Money Market Insrtruments.The below mentioned instruments are normally termed
as money market instruments:

– Call/ Notice/ Term Money

– Repo/ Reverse Repo
– Inter Corporate Deposits
– Commercial Paper
– Certificate of Deposit

– T-Bill

Expectations from Indian money market-

Those looking to increase their returns on the moneys in their savings bank account can
invest in this fund.

Investors should consider the following factors before buying units in the fund: The fund
is suitable for investors with a diversified portfolio of fixed-income investments.
Such investments include long-term government bonds, medium-term corporate bonds
and fixed-deposits. Investing in TIMMA enhances diversification because the fund takes
exposures in money market instruments. The NAV for a fund having exposure to such
instruments is not based on the market price; the NAV is simply the interest accrued on
these instruments on a daily basis. This means that the NAV will not fall below the initial
investment value, unlike in the case of bond funds that are marked-to-market.

Now, the call money market is about 4.75 per cent, and other money market instruments
such as commercial papers and T-bills are marginally higher. This means that retail
investors can earn at least 3 percentage points more than the interest on the savings bank
account. Besides, the risk is not significantly different from the savings account. TIMMA
and the savings bank account are exposed to reinvestment risk. If interest rates were to
decline further, TIMMA’s portfolio manager will have to reinvest the money at lower
rates. Similarly, monies in the savings bank account will earn lower interest rate when
rates decline.

Conclusion-

Investors need to be, however, wary of the expense ratio. The fund’s expense ratio of one
per cent is somewhat high. This essentially means that if the fund earns 5 per cent on its
portfolio, the unit-holders will receive only 4 per cent, because the fund will deduct one
per cent for managing the portfolio. Of course, given that the interest rate on savings
bank account is very low, the fund provides good returns even after adjusting for the
expense ratio.

The return differential will narrow only if the RBI cuts the repo rate and continues to
administer the savings bank rate at the current level; a cut in repo rate will lead to lower
rates on call money and other money market instruments. On balance, retail investors
who want to enhance returns on their savings bank account can buy units in this fund.

Scope of India Money Market -

The India money market is a monetary system that involves the lending and borrowing of
short-term funds. India money market has seen exponential growth just after the
globalization initiative in 1992. It has been observed that financial institutions do employ
money market instruments for financing short-term monetary requirements of various
sectors such as agriculture, finance and manufacturing. The performance of the India
money market has been outstanding in the past 20 years.

Central bank of the country - the Reserve Bank of India (RBI) has always been playing
the major role in regulating and controlling the India money market. The intervention of
RBI is varied - curbing crisis situations by reducing the cash reserve ratio (CRR) or
infusing more money in the economy.
Types of Money Market instruments in India -

Money market instruments take care of the borrowers' short-term needs and render the
required liquidity to the lenders. The varied types of India money market instruments are
treasury bills, repurchase agreements, commercial papers, certificate of deposit, and
banker's acceptance.

• Treasury Bills (T-Bills) - Treasury bills were first issued by the Indian
government in 1917. Treasury bills are short-term financial instruments that are
issued by the Central Bank of the country. It is one of the safest money market
instruments as it is void of market risks, though the return on investments is not
that huge. Treasury bills are circulated by the primary as well as the secondary
markets. The maturity periods for treasury bills are respectively 3-month, 6-month
and 1-year. The price with which treasury bills are issued comes separate from
that of the face value, and the face value is achieved upon maturity. On maturity,
one gets the interest on the buy value as well. To be specific, the buy value is
determined by a bidding process, that too in auctions.
• Repurchase Agreements - Repurchase agreements are also called repos. Repos
are short-term loans that buyers and sellers agree upon for selling and
repurchasing. Repo transactions are allowed only among RBI-approved securities
like state and central government securities, T-bills, PSU bonds, FI bonds and
corporate bonds. Repurchase agreements, on the other hand, are sold off by
sellers, held back with a promise to purchase them back at a certain price and that
too would happen on a specific date. The same is the procedure with that of the
buyer, who purchases the securities and other instruments and promises to sell
them back to the seller at the same time.
• Commercial Papers - Commercial papers are usually known as promissory notes
which are unsecured and are generally issued by companies and financial
institutions, at a discounted rate from their face value. The fixed maturity for
commercial papers is 1 to 270 days. The purposes with which they are issued are -
for financing of inventories, accounts receivables, and settling short-term
liabilities or loans. The return on commercial papers is always higher than that of
T-bills. Companies which have a strong credit rating, usually issue CPs as they
are not backed by collateral securities. Corporations issue CPs for raising working
capital and they participate in active trade in the secondary market. It was in 1990
that Commercial papers were first issued in the Indian money market.
• Certificate of Deposit - A certificate of deposit is a borrowing note for the short-
term just similar to that of a promissory note. The bearer of a certificate of deposit
receives interest. The maturity date, fixed rate of interest and a fixed value - are
the three components of a certificate of deposit. The term is generally between 3
months to 5 years. The funds cannot be withdrawn instantaneously on demand,
but has the facility of being liquidated, if a certain amount of penalty is paid. The
risk associated with certificate of deposit is higher and so is the return (compared
to T-bills). It was in 1989 that the certificate of deposit was first brought into the
Indian money market.
 • Banker's Acceptance - A banker's acceptance is also a short-term investment
plan that comes from a company or a firm backed by a guarantee from the bank.
This guarantee states that the buyer will pay the seller at a future date. One who
draws the bill should have a sound credit rating. 90 days is the usual term for
these instruments. The term for these instruments can also vary between 30 and
180 days. It is used as time draft to finance imports, exports.

It depends on the economic trends and market situation that RBI takes a step forward to
ease out the disparities in the market. Whenever there is a liquidity crunch, the RBI opts
either to reduce the Cash Reserve Ratio (CRR) or infuse more money in the economic
system. In a recent initiative, for overcoming the liquidity crunch in the Indian money
market, the RBI infused more than Rs 75,000 crore along with reductions in the CRR.