Page 65 - DCOM304_INDIAN_FINANCIAL_SYSTEM

Indian Financial System

Notes Secondary Government Securities Market

A secondary market facilitates the original investor in new government debt securities to sell
his securities before maturity, and to do so with ease and without undue cost. In an active and
efficient secondary market, it is possible for investors to buy and sell existing issues on demand,
at mutually acceptable prices, and to upshot exchanges rapidly and with low transaction costs.
Such a market requires a clear structure and clearly established rules so that the parties to each
transaction know their responsibilities. The efficient operation of a secondary market also
needs a system by which buyers and sellers can become conscious of each other, and through
which the prices of securities can be advertised. Finally, a secondary market needs a way of
ensuring that the transfer of securities against money takes place efficiently, at the correct time
and between the correct participants, which is the function of a settlement organism.

Benefits of a Secondary Market

An active and efficient secondary market for government securities adds to a great extent to the
attractiveness of government bonds to investors, at no cost to the government. Investors will be
more ready to buy government securities if they know that they can reduce (or increase) their
personal holdings quickly, inexpensively and at a time of their choosing by trading in the
secondary market. Thus the liquidity and efficiency of the market contributes towards the
successful trade of primary securities and hence towards achieving financing of government by
ensuring the government's continued access to the financial market in the long run. Extensive
and well-functioning secondary markets are particularly important where the government's
borrowing needs are substantial.
Secondary markets in addition contribute towards achieving objectives other than funding the
government's borrowing needs. These include obtaining the best possible issue terms in each
operation, and therefore minimising the cost of the outstanding amount of government debt in
absolute terms. Investors will be willing to pay a higher price for government debt where the
secondary market is liquid than otherwise. Supplementary objectives, including minimising
the market impact of government debt operations and coordination between the authorities'
monetary policy and debt management, are also facilitated if the government debt supervisor is
able to operate in an efficient secondary market in government securities. Lastly, a liquid
government debt market contributes to financial market development in broad-spectrum,
through familiarising the financial community, and ultimately the broader community, with
the use of longer-term debt instruments as a means of financing and investment.

In short, the autonomous debt manager will not leave the development of the secondary market
in government bonds to the private sector only since, fundamentally, such a loom would be
likely to conflict with the normal goal of minimising above the long-term the cost of government
funding.

Measures Relating to Secondary Market

1. The Reserve Bank has, since the late 1990s, pursued a strategy of passive consolidation of
debt by raising progressively higher share of market borrowings through re-issuances.
However, due to lack of liquidity, a large proportion of the banks' holding of Central
Government domestic debt remained thinly traded. Accordingly, a debt buy back scheme
was introduced on July 19, 2003 on a purely voluntary basis for banks in need of liquidity.
In February, 2007, the RBI introduced a debt buy back scheme for Specified Development
Loans (SDLs) of two state Governments, viz., Orissa and Rajasthan.
2. In order to keep the markets liquid and active and to provide the participants a tool to
better manage their interest rate risk, the RBI permitted intra-day short selling in

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