Page 66 - DCOM304_INDIAN_FINANCIAL_SYSTEM

Unit 4: Indian Capital Market

government securities among eligible participants, viz., Scheduled Commercial banks Notes
and PDs in February, 2006. The introduction of short selling paved their way for 'when
issued' trading in August, 2006.
3. Recognizing that transparency and information dissemination with the minimum time
lag are imperative for development of the secondary market, the RBI has been making
efforts to disseminate trade information on a real time basis to a wider market. The price
information on the trades is made accessible through the RBI's website.

Cardinal Principles for Efficient Government Securities Market

It has been strongly felt in the recent past across the globe that for the g-securities market to
function efficiently, it is necessary to develop deep and liquid government securities market.
The size is a key determinant of trading liquidity of the market. Amplitude of liquidity in a
market can be judged in terms of width (width of the bid-ask spread), depth (the ability to carry
and large trading promptly without significant changes in price levels), immediacy (the ability
to carry out large trading promptly without significant changes in price levels) and resilience
(the ability of prices to quickly return to normal).

While designing and developing efficient and liquid g-securities market, five fundamental
principles, as identified by the Bank for International Settlements, should be factored in. These
principles are: principle of competitiveness, principle of substitutability, principle of low
transaction costs, principle of sound infrastructure and principle of heterogeneity.

Principle of Competitiveness

So as to facilitate efficient price discovery, it is ineluctable to develop and maintain competitive
market structure in the g-securities market where the dominant market players can be challenged
by new entrants. A government security, like any financial instrument, can be traded through a
wide variety of mechanism like Over-the-Counter (OTC) markets, organized exchanges and
other platforms. A fundamental strategy is to infuse competition among the dealers which
would narrow bid-ask spreads and enhance liquidity of the market. In case of exchanges, dynamic
competition between the leading exchange and other exchanges and between the OTC market
and organized exchanges can contribute to market liquidity.
Principle of Substitutability

High degree of substitutability improves market liquidity of financial instruments including g-
securities through enhancing trading supply of securities. This calls for the market to have a low
level of fragmentation offering instruments which can be substituted for other instruments.
However, there is also a need to have some degree of heterogeneity in instruments for catering
to specific needs of investors. A tradeoff between homogeneous product of large volume and
some heterogeneity has, therefore, to be struck by having a system of issuing government
bonds at several 'key maturities' from the short end to the long end of the yield curve.

Principle of Low Transaction Costs

Adherence to the principle of low transaction costs including taxes cost of sustaining necessary
infrastructure and compensation for liquidity provision services can improve liquidity of the g-
securities market. Higher transaction cost leads to low market liquidity because it widens the
gap between the effective price received by sellers of the instrument and that paid by the buyers,
making it difficult to match sell and buy orders. It is, therefore, necessary to minimize transaction
costs as long as this does not reduce the security of the market in question.

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