1. 1 Development of Financial Markets in India Rakesh Mohan Deputy Governor Reserve Bank of India Lecture at the First Indian-French Financial Forum at Mumbai, May 16, 2007

2. 2 Scheme of the Presentation  Role of Financial Markets  Money Market  Government Securities Market  Foreign Exchange Market  Financial Market Integration

3. 3 Role of Financial Markets  Intermediate between savers and investors  Generate resources for investment and growth  Allocate resources efficiently  Improve the efficacy of the transmission mechanism of monetary policy

4. 4 Financial Markets in Pre-reform Period – Major Problems  Administered Interest rates  Limited Instruments  Restrictions on Participation  Segmentation of Markets

5. 5 Money Market  Role of the Money Market Key role in the transmission of monetary policy impulses  Major Reforms Introduced Development of the Liquidity Adjustment Facility Development of collateralised instruments – CBLO and Market Repo Modification in issuance norms and maturity profile of CD and CP Setting up of central counter party – Clearing Corporation of India Ltd. (CCIL)

6. 6 Money Market Impact – Increase in Activity (Rupees crore) Average Daily Turnover Outstanding Amount YearCall Money Market Market Repo (Outside the LAF) Collateralised Borrowing and Lending Obligation (CBLO) Term Money Market Money Market - Total (2 to5) Comme rcial Paper Certificates of Deposit 12345 678 1997-9822709--- 150014296 1998-9926500--- 47703717 1999-00231616895--3005670141908 2000-013215710500--4265767511199 2001-023514430161-195655007927949 2002-032942146960303417675282681224 2003-0417191104355155192866078353212 2004-051417017135669752638528117236052 2005-06179792118320039833600341728527298 2006-072172533676323901012888032147864954

7. 7 Money Market Impact – Decline in Volatility

8. 8

9. 9 Money Market Impact – Improvement in Efficiency

10. 10 Government Securities Market  Significance of the G-Sec. Market Enables smooth raising of government borrowings Risk free rupee yield curve provides a benchmark for pricing other debt instruments Plays a key role in the monetary policy transmission mechanism

11. 11 Government Securities Market  Major Reforms in the G-Sec Market Auction system for issuance of government securities Primary Dealer (PD) system New instruments Widening of investor base Debt consolidation – re-issuance of securities Introduction of short-selling When issued market allowed Strengthening of trading and settlement infrastructure

12. 12 Government Securities Market - Impact

13. 13 Government Securities Market Reasons for the Recent Decline in Activity

14. 14 Government Securities Market Emergence of Yield Curve

15. 15 Foreign Exchange Market  Major Reforms Market-determined exchange rate in 1993 Current account convertibility in 1994 Substantial liberalisation of capital account transactions Greater flexibility to market participants to undertake foreign exchange operations Improvement in market infrastructure

16. 16 Foreign Exchange Market Increase in Activity Turnover in the Foreign Exchange Market (Turnover in US $ billion) YearMerchantInter-bankTotal 1234 1997-9821010961305 1998-9924610571303 1999-002448981142 2000-0126911181387 2001-0225711651422 2002-0332512361560 2003-0449116282118 2004-0570521882892 2005-06122031924413 2006-07 (P)178747276514

17. 17 Foreign Exchange Market Increase in Size: Relative Terms Size of the Foreign Exchange Market YearForeign ExchangeBoP sizeCol. 2 Market-Annual Turnover($ billion)over Col. 3 ($ billion) 123 4 2000-01 1387 258 5.4 2001-02 1421 237 6.0 2002-03 1560 267 5.8 2003-04 2118 362 5.9 2004-05 2892 481 6.0 2005-06 4413 664 6.6 2006-07 (Apr- Dec) 4646 642 7.2

18. 18 Foreign Exchange Market Improvement in Efficiency

19. 19 Foreign Exchange Market Decline in Volatility

20. 20 Financial Market Integration  Significance For monetary policy transmission framework  Evidence of stronger integration during the recent period (2000-2006) than the earlier period (1993-2000) Correlation between the call rate and the reverse repo improved from 0.35 to 0.86 Correlation between the call rate and the 364-day Treasury Bills yield improved from 0.40 to 0.92 Correlation between the call rate and the 10-year yield improved from 0.46 to 0.88 Correlation between the call rate and the 6-months forward premia improved marginally from 0.61 to 0.62 Correlation between interest rates (the call rate) and the stock market improved from -0.10 to -0.23.

21. 21 Financial Market Integration Interest Rates and Exchange Rate in India

22. 22 Financial Market Integration Interest Rate Spread over the Reverse Repo Rate (Per cent) Apr-1993 to Sep-2006 Apr 1993 to Mar 2000 Apr 2000 to Sep-2006 1234 Call money Rate1.752.980.43 Certificate of Deposits Rate3.335.431.07 Commercial Paper Rate4.016.091.78 91 Treasury Bill Rate1.712.900.42 364 day Treasury Bill Rate2.134.180.75 10 year Yield on GSEC3.506.211.84

23. 23 Growth of Financial Markets in India – A Comparative Picture Table 6: Depth of Financial Markets in India – Average Daily Turnover (Rs.crore) YearMoney Market (Total) Government Securities Market Foreign Exchange Market Equity Market (cash segment) Equity Derivatives at NSE 123456 2000-01 42,657 2,80221,1989,30811 2001-02 65,500 6,25223,1733,310410 2002-03 76,752 7,06724,2073,7111,752 2003-04 28,660 8,44530,7146,3098,388 2004-05 38,528 4,82639,9526,55610,107 2005-06 60,034 3,64356,3919,50419,220 2006-07 88,803 4,86383,98411,76029,803

24. 24 The Way Ahead - Measures Announced in the Annual Policy Statement G-Sec. Market  A ‘Non-Competitive Bidding Scheme’ in the auctions of State Development Loans (SDLs) to be introduced.  A system of reissuances of State Government securities to be introduced.  Use of average cut-off yield on 182-day Treasury Bills, instead of the yield on 364-day Treasury Bills as a benchmark rate for the FRBs to be issued in future.  A Working Group being set up to suggest measures for developing the interest rate futures market.

25. 25 The Way Ahead - Measures Announced in the Annual Policy Statement Foreign Exchange Market  Further liberalisation of foreign exchange facilities in view of CFCAC Overseas investment limit to be enhanced Portfolio investment abroad limit to be enhanced Increase in the existing limit for prepayment of ECBs The limit for remittance scheme for individuals to be enhanced  Expanded the range of hedging tools available to the market participants as also facilitate dynamic hedging by the residents  A Working Group on Currency Futures to be set up

26. 26 Thank You