Page 64 - DCOM304_INDIAN_FINANCIAL_SYSTEM

Unit 4: Indian Capital Market

4. A system of market intermediaries in the form of PDs was made functional in 1996 with Notes
the objectives of supporting the market borrowing programme of the government,
strengthening the securities market infrastructure and improving the secondary market
liquidity in government securities. The PD system was revamped to ensure a more dynamic
and active participation of PDs in view of the Fiscal Responsibility and Budget Management
(FRBM) Act, 2003 whereby the Reserve Bank was prohibited from participating in the
primary market effective from April, 2006. The Reserve Bank permitted banks to undertake
PD business.
5. The system of automatic monetization through ad hoc Treasury Bills was abolished in
March 1997 by a historical agreement between the RBI and the Government.
6. In order to promote retail holding in government securities and broaden the investor
base, the Reserve Bank decided to provide since April 1996, liquidity facility to mutual
funds which invest exclusively in government securities. Liquidity support to eligible gilt
funds is provided by way of repo at the Bank Rate up to a limit of 20 percent of the
outstanding value in government securities for a maximum period of 14 days.
7. In order to encourage foreign participation, FIIs were allowed in January 1997 to set up
100 percent debt funds to invest in Central and state government securities, both in the
primary and secondary markets, within the overall debt ceilings announced from time to
time. Equity funds set up by FIIs are permitted to invest in debt up to a maximum of 30
percent of their total investments.

8. In order to cater to parse market preferences, and hedging needs of investors, the Reserve
Bank decided since 1994 to issue a range of new instruments with innovative features
including Zero coupon bonds, capital indexed bonds, floating rate bonds and bonds with
call and put options.
Zero Coupon Bonds (ZCBs), introduced on January 17, 1994, do not have regular interest
(coupon) payments like traditional bonds.
A Capital Indexed Bond (CIB), issued on December 29, 1997 with a maturity of 5 years,
provided for inflation hedging for the principal while the coupons of the bond were not
protected against inflation.
Floating Rate Bonds (FRBs), introduced initially in September, 1995 and discontinued
after the first issuance and reintroduced in November, 2001, had to be discontinued due to
lack of market response.

Government securities with embedded call and put options were introduced in July, 2002
for a 10-year maturity using uniform price based auction method.
9. In its quest to facilitate efficient distribution of auctioned stock by stretching the actual
distribution period for each issue and allowing the market more time to absorb large
issues without disruption and also facilitate an efficient price discovery process both for
the issuer and the investor, the RBI issued policy guidelines for trading in-When Issued
(WI) market in May, 2006. A limit of 5 percent (only buy side) of notified amount was
prescribed for banks and 10 percent (both buy and sell) for PDs.
10. In order to increase the transparency in the auction process, issuance procedures for
government securities were detailed in general notification issued by the government
from time to time. In addition, features of each issue are also notified to the public three to
seven days prior to the auction of government securities. In order to provide clear and
timely information about the borrowing programme, the RBI introduced an issuance
calendar for auctions in Central Government Securities from the financial year beginning
April, 2002.

LOVELY PROFESSIONAL UNIVERSITY 59