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Date : May 02, 2011
V. Financial Markets

Monetary transmission strengthened during Q4 of 2010-11 with interest rates firming up gradually across the spectrum as liquidity remained in deficit mode. The policy transmission to deposit and lending rates is visible in the current base rate regime. Asset prices, including property prices, generally remained range bound. Equity markets experienced orderly correction in Q4 of 2010-11. The rupee exhibited two-way movements against the US dollar without any intervention or active capital account management. Going forward, the financial markets need to brace up to the geopolitical risks in MENA, default risks in the Euro zone and movements in cross-border capital flows.

Global portfolio rebalancing to impact domestic financial markets

V.1 The year 2010-11 was marked by periods of volatility and tranquility in the Indian financial markets. With global uncertainties rising, volatility may aggravate further, partly from building up of speculative positions in global commodity markets. Portfolio choices are also governed by the geopolitical developments in the MENA region and availability of easy liquidity in certain advanced economies. An additional source of uncertainty for the global financial markets is the sovereign and banking sector default risks in parts of Europe (Chart V.1a) There could, however, be a rebalancing of investors’ portfolio if economic recovery in major advanced economies gains traction and causes a quicker-than-anticipated withdrawal of monetary accommodation. With rise in global equity markets (Chart V.1b) there may be a shift in investors’ preference away from the EME markets to those of the advanced economies, particularly the US.

V.2 While credit spreads shrank markedly during Q4 of 2010-11, bond yields in advanced economies firmed up reflecting the post-crisis rise in debt to GDP ratio as well as incipient signs of inflationary concerns. Apart from food prices, the rising expectations of increased crude oil prices following the geo-political risks in MENA raised inflationary expectations especially in EMEs. The initial reaction to the downside risks associated with the natural calamity hit Japanese economy has subsequently given rise to the expectations of boost in demand for its reconstruction.

Global uncertainties and anti-inflationary monetary policy stance impacting Indian markets, but orderly conditions prevail

V.3 Global uncertainties as well as domestic developments impacted Indian financial markets. The Indian markets, however, remained largely orderly, despite the challenges posed by persistent inflation and high current account deficit.

1

V.4 Call rate firmed up in step with the policy rates and remained above the upper bound of the LAF corridor for a major part of Q4 of 2010- 11, due to frictions caused by skewed SLR holdings (Chart V.2a). While issuances and rates on certificates of deposits (CDs) continued to increase during the quarter reflecting banks’ efforts to mobilise more funds, issuance of commercial paper (CP) moderated on account of the strong credit growth, even as the rates continued to be high reflecting general liquidity stress (Chart V.2b). The yield curve for government securities (G-sec) further flattened during Q4 in response to policy rate hike expectations and liquidity tightness.

V.5 The Indian rupee appreciated moderately against the US dollar. Stock markets remained volatile for the greater part of Q4, weighed by domestic and global concerns, but appreciated towards the close of the quarter on the back of strong foreign portfolio inflows. Returns in the Indian equity markets were relatively lower than most other EMEs (Table V.1). Prices in the housing market continued the rising trend during the third quarter of 2010-11.

Table V.1 : Stock Price Movements and PE Ratios in EMEs

(Per cent)

Stock Price Variations

P/E Ratios

Item

End-March 2010@

End-March 2011@

End-March 2011*

Item

End-March 2010

End-Dec. 2010

End-March 2011

1

2

3

4

5

6

7

8

Indonesia (Jakarta Composite)

93.7

32.5

-0.7

Indonesia (Jakarta Composite)

13.6

20.9

18.5

Brazil (Bovespa)

72.0

-2.5

-1.0

Brazil (Bovespa)

16.4

13.9

11.6

Thailand (SET Composite)

82.6

32.9

1.4

Thailand (SET Composite)

12.4

15.2

14.0

India (BSE Sensex)

80.5

10.9

-5.2

India (BSE Sensex)

17.7

18.7

17.3

South Korea (KOSPI)

40.3

24.4

2.7

South Korea (KOSPI)

12.2

16.0

12.9

China (Shanghai Composite)

31.0

-5.8

4.3

China (Shanghai Composite)

23.1

16.1

16.6

Taiwan (Taiwan Index)

52.0

9.6

-3.2

Taiwan (Taiwan Index)

19.1

15.4

14.7

Russia (RTS)

128.0

30.0

15.5

Russia (RTS)

9.8

8.6

9.6

Malaysia (KLCI)

51.4

17.0

1.7

Malaysia (KLCI)

18.9

17.4

17.0

Singapore (Straits Times)

69.9

7.6

-2.6

Singapore (Straits Times)

13.4

11.3

10.9

@ : Year-on-year variation.  
* : End-March 2011 over End-December 2010.
Source : Bloomberg.

Money market rates reflect liquidity conditions

V.6 The money market was generally orderly although liquidity conditions remained in deficit mode during the fourth quarter of 2010-11. Reflecting the high credit demand, high currency growth, and unspent surplus balance in the government account as also the hikes in policy rates by the Reserve Bank, the call rates mostly remained above the repo rate during Q4 (Chart V.2a, Table V.2). The rates in the collateralised segments also rose in line with the trend in the call money market.

V.7 Transaction volumes in the collateralised borrowing and lending obligation (CBLO) and market repo segments were higher during Q4 than Q3 of 2010-11 (Table V.3). The collateralised segment of the money market remained predominant, accounting for more than 80 per cent of the total volume of transactions during 2010-11.

V.8 With strong credit growth not matched by commensurate deposit growth, banks increasingly financed their advances by raising CDs at higher rates. During surplus liquidity situations, when the CP rates are lower than the Base Rates, corporates take greater recourse to the CPs. They, however, prefer bank financing, once the CP rates rise above the Base Rate. Leasing-finance and manufacturing companies continue to be the major issuers of CPs (Table V.4).

Table V.2 : Rates in Domestic Financial Markets

 

Money Market

Bond Market

Forex Market

Stock Market Indices

Call Rate* (Per cent)

Market Repo Rate (Non-LAF) (Per cent)

CBLO Rate (Per cent)

Comm- ercial Paper WADR (Per cent)

Certifi- cates of Deposit WAEIR (Per cent)

G-Sec 10-year yield (Per cent)

Corporate Bonds Yield - AAA 5-Yr bond (Per cent)

Exchange Rate (`/US$)

CNX Nifty **

BSE Sensex **

1

2

3

4

5

6

7

8

9

10

11

Mar-10

3.51

3.32

3.15

6.29

6.07

7.94

8.61

45.50

5178

17303

Apr-10

3.49

3.04

2.95

5.37

5.56

8.01

8.37

44.50

5295

19679

May-10

3.83

3.79

3.67

6.85

5.17

7.56

8.15

45.81

5053

16845

Jun-10

5.16

5.29

5.21

6.82

6.37

7.59

8.21

46.57

5188

17300

Jul-10

5.54

5.37

5.25

6.93

6.69

7.69

8.27

46.84

5360

17848

Aug-10

5.17

5.12

5.01

7.32

7.17

7.93

8.52

46.57

5457

18177

Sep-10

5.50

5.35

5.24

7.82

7.34

7.96

8.52

46.06

5811

19353

Oct-10

6.39

5.96

5.88

12.15

7.67

7.68

8.58

44.41

6069

20250

Nov-10

6.81

6.42

6.14

12.22

8.16

8.03

8.64

45.02

6055

20126

Dec-10

6.67

6.27

6.20

10.10

9.15

8.03

8.89

45.16

5971

19228

Jan-11

6.54

6.21

6.20

8.81

9.42

8.15

9.05

45.39

5783

19289

Feb-11

6.69

6.45

6.43

9.05

10.04

8.12

9.25

45.44

5401

18037

Mar-11

7.15

6.56

6.46

10.40

9.96

8.00

9.23

44.99

5538

18457

*: Average of daily weighted call money rates.  **: Average of daily closing indices.
WADR: Weighted Average Discount Rate. WAEIR: Weighted Average Effective Interest Rate.

V.9 The primary yields on Treasury Bills (TBs) firmed up during Q4 of 2010-11 in line with the spike in short-term interest rates (Table V.5).

V.10 Annualised volatility of one year interest rate swaps increased during Q4 of 2010-11 (Chart V.3). This may reflect market uncertainties on future short-term money market rates.

2

The yield curve responds to monetary actions and lower budgeted borrowings

V.11 Responding to the persistently high inflation and tightening liquidity conditions, G-sec yields, both in the primary and secondary markets, firmed up during January 2011, but moderated thereafter. A lower-than-expected fiscal deficit and market borrowing programme for the first half of 2011-12 improved market sentiments. Yields eased in March 2011 in response to announcement of auctioning of unutilised investment limits for FIIs for GSec and corporate debt. The flattening of yield curve despite inflationary pressures may have been aided by policy rate hikes and temporarily lower issuances (Chart V.4a).

Table V.3 : Average Daily Volumes in Domestic Financial Markets

(` crore)

 

Money Market

Bond Market

Forex Market

Stock Market #

LAF

Call Money

Market Repo

CBLO

Comm- ercial Paper *

Certifi- cates of Deposit*

G-Sec @

Corpor- rate Bond

Inter-bank (US$ mn)

1

2

3

4

5

6

7

8

9

10

11

Mar-10

37,640

8,812

19,150

60,006

75,506

3,41,054

6,221

1598

16,378

9,191

Apr-10

57,150

8,187

20,319

50,891

98,769

3,36,807

10,682

1671

18,411

9,262

May-10

32,798

8,393

17,610

42,274

1,09,039

3,40,343

18,774

1653

20,122

8,836

Jun-10

-47,347

7,129

9,481

31,113

99,792

3,21,589

14,523

1236

18,476

8,605

Jul-10

-46,653

9,477

12,011

29,102

1,12,704

3,24,810

10,105

1450

17,126

8,443

Aug-10

-1,048

7,958

15,553

45,181

1,26,549

3,41,616

12,488

1146

18,476

9,656

Sep-10

-24,155

8,606

15,927

53,223

1,12,003

3,37,322

11,582

1254

18,787

10,446

Oct-10

-61,658

8,920

14,401

43,831

1,49,620

3,43,353

10,355

1151

25,053

11,404

Nov-10

-99,311

8,865

9,967

32,961

1,17,793

3,32,982

7,645

922

22,092

11,190

Dec-10

-1,20,495

9,436

12,989

43,784

82,542

3,61,408

6,939

830

17,737

8,574

Jan-11

-92,933

7,758

11,546

44,815

1,01,752

3,77,640

7,025

912

20,054 P

8,430

Feb-11

-78,639

10,356

13,150

42,292

1,01,291

4,18,524

6,994

863

19,673 P

8,011

Mar-11

-80,963

11,278

15,134

43,201

80,305

4,24,740

8,144

1314

22.211 P

7,458

*: Outstanding position     P: Provisional.      #: Comprises volumes in BSE and NSE.
@: Average daily outright trading volume in Central Government dated securities.
Note: In col. 2 (-) ve indicates injection of liquidity while (+) ve indicates absorption of liquidity.

V.12 In the primary market, investors’ sentiment remained positive, as reflected in the sustained bid-cover ratio, which stood in the range of 1.39-3.87 during the year and 1.69-3.25 during the fourth quarter. More long dated securities were issued to take advantage of the yield curve movements (Table V.6). The spreads on five-year corporate bonds over the corresponding government bond yield widened during the fourth quarter of 2010-11 on the back of tight liquidity conditions (Chart V.4b).

Table V.4 : Major Issuers of Commercial Paper

(` crore)

End of Period

Leasing and Finance

Manufacturing

Financial Institutions

Total Outstanding

Amount

Share (%)

Amount

Share(%)

Amount

Share(%)

1

2

3

4

5

6

7

8

Mar-09

27,183

62

12,738

29

4,250

9

44,171

Jun-09

34,437

50

23,454

34

10,830

16

68,721

Sep-09

31,648

40

31,509

40

16,071

20

79,228

Dec-09

36,027

40

42,443

47

11,835

13

90,305

Mar-10

39,477

52

22,344

30

13,685

18

75,506

Jun-10

42,572

43

43330

43

13,890

14

99,792

Aug-10

57,161

45

55,933

44

13,455

11

1,26,549

Sep-10

58,098

52

40,485

36

13,420

12

1,12,003

Oct-10

80,306

54

54,894

37

14,420

9

1,49,620

Nov-10

58,871

50

45,457

39

13,465

11

1,17,793

Dec-10

49,282

60

24,960

30

8,300

10

82,542

Jan-11

55,591

55

35,601

35

10,560

10

1,01,752

Feb-11

51,339

51

40,262

39

9,690

10

1,01,291

Mar-11

46,350

58

22,695

28

11,260

14

80,305


Table V.5 : Treasury Bills in the Primary Market

Year/ Month

Notified Amount
(` crore)

Average Implicit Yield at Minimum Cut-off Price (Per cent)

91-day

182-day

364-day

1

2

3

4

5

2009-10

3,80,000

3.57

3.97

4.38

2010-11

3,03,000

6.04

6.47

6.66

Apr-10

36,000

4.14

4.64

5.07

May-10

36,000

4.39

4.76

4.92

Jun-10

12,000

5.29

5.31

5.41

Jul-10

16,000

5.51

5.86

5.88

Aug-10

33,000

6.15

6.41

6.48

Sep-10

13,000

6.11

6.41

6.59

Oct-10

26,500

6.57

6.82

6.97

Nov-10

24,000

6.82

7.15

7.14

Dec-10

19,000

7.14

7.29

7.37

Jan-11

21,000

7.17

7.37

7.55

Feb-11

29,500

7.15

7.51

7.68

Mar-11

37,000

7.23

7.49

7.61

V.13 Interest Rate Futures (IRF) on 91-day TBs were permitted by the Reserve Bank in March 2011. These futures will be cash settled with the final settlement price based on the weighted average price/yield obtained in the weekly auctions on the date of expiry of the contract. This is likely to enhance liquidity and also to provide more options for the financial markets to hedge interest rate risks through exchanges.

Deposit and lending rates transmit the anti-inflationary policy stance

V.14 Stronger transmission is evident as banks continued to increase both the lending rates and deposit rates across maturity spectrums. Deposit rates have risen rapidly to accommodate fast rise in credit and to offset the tight liquidity environment during 2010-11. Scheduled commercial banks (SCBs) raised their deposit rates in the range of 25-500 basis points between end-March 2010 and end-March 2011 across maturities. The deposit rates for 1-3 years maturity increased by 50-125 basis points during the fourth quarter (Table V.7). Several banks reviewed and increased their base rates by 75-125 basis points between July 2010 and March 2011. Base rates of 64 major banks with a credit share of around 98 per cent ruled in the range of 8.0-9.5 per cent in March 2011, reflecting greater convergence since base rates became operational effective July 1, 2010.

3

4

Exchange rate remains orderly and flexible

V.15 The rupee remained stable during the fourth quarter of 2010-11, without any intervention or active capital account management. It exhibited two-way movement against major international currencies except Euro. There was a modest appreciation against the US dollar since mid-February 2011 (Chart V.5a). While the turnover in inter-bank segment of the foreign exchange market remained volatile, the turnover in the merchant segment increased in Q4 of 2010-11.

Table V.6 : Issuances of Central and State Government Dated Securities

Item

2009-10

2010-11

1

2

3

Central Government

 

 

Gross amount raised (` crore)

4,51,000*

4,37,000

Devolvement on Primary Dealers (` crore)

7,219

5,772

Bid-cover ratio (Range)

1.4-4.3

1.4-3.9

Weighted average maturity (years)

11.2

11.6

Weighted average yield (per cent)

7.2

7.9

State Governments

 

 

Gross amount raised (` crore)

1,31,122

1,04,039

Cut-off yield (Per cent)

7.0-8.6

8.1-8.6

Weighted average yield (per cent)

8.1

8.4

* : Inclusive of MSS desequestering of ` 33,000 crore.

V.16 Volumes in the exchange traded currency derivatives increased during Q4 of 2010-11 (Chart V.5b). The growth in volumes particularly for currency futures and options has been supported by retail participation and companies. In fact, the monthly trend of turnover in OTC forwards and swap involving rupee remained sluggish during this period. While turnover in the merchant segment decreased from USD 93 billion in October 2010 to USD 64 billion in March 2011 (up to March 25), the turnover in the interbank segment declined from USD 418 billion to USD 367 billion for the corresponding period.

Equity markets underperform, remain volatile

V.17 Reflecting several macroeconomic uncertainties, Indian equity markets underachieved and remained volatile during Q4 of 2010-11. Markets lost much of the valuation gains made during the last four months of 2010, when they outperformed most of the international markets. During Q4 of 2010-11, the BSE Sensex has been the worst performer amongst the major equity indices. Slowdown of net equity investment by the FIIs in India largely contributed to the decline (Chart V.6a). In terms of the coefficient of variation, the volatility of Sensex between end-December 2010 and end-March 2011 at 3.95 per cent is much higher than the 2.0 per cent of the MSCI emerging market index and 1.9 per cent of the MSCI world index. The equity derivatives segment had gone up substantially over the year and currently constitutes almost 90 per cent of the overall investments. FII investments accounted for 19.8 per cent of the total investments in derivatives (Chart V.6b)

Table V.7 : Deposit and Lending Rates of Banks

(Per cent)

 

Sep-10

Dec-10

Mar-11

1

2

3

4

1.

Domestic Deposit Rate (1-3 years tenor)

 

 

 

 

a. Public Sector Banks

6.75-7.75

7.00-8.50

8.00-9.75

 

b. Private Sector Banks

6.50-8.25

7.25-9.00

7.75-10.10

 

c. Foreign Banks

3.00-8.00

3.50-8.50

3.50-9.10

2.

Base Rate

 

 

 

 

a. Public Sector Banks

7.50-8.25

7.60-9.00

8.25-9.50

 

b. Private Sector Banks

7.00-8.75

7.00-9.00

8.25-10.00

 

c. Foreign Banks

5.50-9.00

5.50-9.00

6.25-9.50

3.

Median Lending Rate*

 

 

 

 

a. Public Sector Banks

7.75-13.50

8.75-13.50

-

 

b. Private Sector Banks

8.00-15.00

8.25-14.50

-

 

c. Foreign Banks

7.25-13.00

8.00-14.50

-

* : Median range of interest rates at which at least 60 per cent of business has been contracted.


5

V.18 The activity in the primary segment of the domestic capital market remained buoyant during the first three quarters of 2010-11, but moderated during Q4. However, resources raised through public issuances were higher during 2010-11 than the previous year (Table V.9). During the year, resource mobilisation by mutual funds turned negative, owing to high volatility in the market, surfacing of risks in the real sector, lower retail investments possibly on account of higher returns on competing instruments (bank deposits in particular) and also due to lower corporate support to the MFs.

6

Asset price concerns remain as housing prices remain firm

V.19 Property prices continued to rise in most cities during Q3 of 2010-11, as reflected in the Reserve Bank’s Quarterly House Price Index (HPI) based on data in respect of seven cities collected from the Department of Registration and Stamps (DRS) of the respective State Governments. However, the indices for Delhi and Chennai witnessed a decline during this period (Chart V.7).

Macro-factors may determine financial market movements ahead

V.20 Going forward, macroeconomic factors may dominate financial markets movements in 2011-12. Macro-risks are large and uncertainty abounds on how they might play out. Global commodity markets are witnessing firming up of prices. Even though several hedge funds have booked profits in the global commodity markets in mid-March 2011 following the Japan earthquake, a fresh wave of speculation has arisen immediately after profit-booking as a result of MENA region event risk.

Table V.8 : Key Stock Market Indicators

Indicator

BSE Sensex

NSE Nifty

2009-10

2010-11

2009-10

2010-11

 1

2

3

4

5

1.

BSE Sensex/S&PCNX Nifty

 

 

 

 

 

(i) End-period

17527.77

19445.22

5249.1

5833.75

 

(ii) Average

15585.2

18605.18

4657.76

5583.54

2.

Coefficient of Variation

11.88

6.32

11.33

6.4

3.

Price-Earning Ratio @

21.32

21.15

22.33

22.14

4.

Price-Book Value Ratio

3.9

3.7

3.7

3.7

5.

Market Capitalisation to GDP Ratio (per cent)@

98.9

86.8

96.4

85.1

@: As at end-period.
Source :
Bombay Stock Exchange Ltd. (BSE) and National Stock Exchange of India Ltd. (NSE).


7

V.21 Domestic debt markets are likely to be conditioned by evolving fiscal and monetary policy considerations as well as possible hardening of global yields. However, the path of fiscal consolidation embarked upon by the Government could help to ease the pressure on long-term bond yields in the G-Sec market, if inflationary expectations are reined in. Sustained growth momentum could, however, continue to exert pressure on interest rates through high demand for credit. The risk of volatile portfolio flows impacting asset prices and exchange rate remains in the face of growing uncertainties in the global markets. The expected change in operating procedures could help improve the transmission of monetary policy on an enduring basis, enabling interest rate channel to work better.

Table V.9 : Resource Mobilisation from Capital Market

(` crore)

Category

2008-09

2009-10

2010-11

1

2

3

4

A. Prospectus and Rights Issues*

14,671

32,607

37,620

1. Private Sector (a+b)

14,671

25,479

24,373

a) Financial

466

326

3,877

b) Non-financial

14,205

25,153

20,496

2. Public Sector

0

7,128

13,247

B. Euro Issues

4,788

15,967

9,441

C. Mutual Fund Mobilisation(net)@

-28,296

83,080

-49,406

1. Private Sector

-34,017

54,928

-19,215

2. Public Sector #

5,721

28,152

-30,191

* Excluding offer for sale. @: Net of redemptions. #: Including UTI Mutual fund.
Source:
Mutual Fund data are sourced from SEBI and exclude funds mobilised under Fund of Funds Schemes.


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